On a number of latest TV interviews, Technique (previously MicroStrategy) founder Michael Saylor has boasted about the advantages of tax-deferred dividends that it pays to most popular shareholders. Sadly, there’s by no means a free lunch on Wall Road. These Return Of Capital (ROC) dividends are ballooning a tax debt onto most popular traders at an accelerating progress fee.
Tax deferred doesn’t imply tax free. Though Technique’s peculiar type of ROC dividends don’t impose quick taxes, their mounting obligations enhance at an ever-faster fee as future deadlines close to.
Technique advertises beneficiant, “tax equivalent” yields as excessive as 21.6% for its most popular dividends underneath the belief that the corporate will keep ROC standing. Removed from a minor footnote, the corporate has prominently featured ROC assurances on its most up-to-date quarterly earnings report, dedicating a complete slide and several other minutes of its presentation to ROC steerage.
It forecasts greater than 10 years of ROC dividend standing – a formidable feat in and of itself. Requiring cautious avoidance of optimistic taxable earnings or income to legally return capital reasonably than pay certified disbursements to shareholders, Technique should adhere to a prolonged listing of prohibited company actions.
The corporate has disclosed the dangers and significance of sustaining ROC standing in SEC filings. For instance, on July 21, it admitted, “To the extent that the amount of a distribution with respect to the Preferred Stock exceeds our current and accumulated earnings and profits, the distribution will be treated first as a tax-free return of capital to the extent of the holder’s adjusted tax basis in the Preferred Stock.”
In different phrases, the corporate should hold its earnings and income low sufficient to pay out ROC dividends.
ROC dividends delay, not cut back, tax
Even assuming Technique can keep ROC standing for dividends, tax authorities just like the IRS will nonetheless accumulate on these Return Of Capital dividends ultimately.
Because the saying goes, it’s inconceivable to make sure of something however demise and taxes.
Particularly, ROC dividends cut back traders’ tax foundation. Moderately than receiving money as a professional dividend disbursement, ROC dividends merely cut back the premise at which a taxpayer calculates their price foundation when reporting their revenue and loss on the time of sale.
For instance, Technique intends to pay $10 price of ROC dividends yearly to each STRD and STRF shareholder, i.e. a ten% annual dividend fee on their $100 Said Quantities. (Technique’s two different most popular shares, STRK and STRC, pay 8% and a variable 10.5% fee, respectively.)
Nevertheless, shareholders don’t truly obtain $10 as money of their brokerage account per share of STRD or STRF. As an alternative, Technique points a non-taxable, Return Of Capital to shareholders of file as of dividend snapshot dates.
This reduces the tax foundation, translating – by the corporate’s personal admission – “into increased taxation for the holder once the holder’s tax basis is entirely depleted or the holder sells the shares.”
Technique preferreds can’t delay taxes ceaselessly
A $10 ROC dividend on a $100 said quantity is a ten% tax foundation discount within the first yr, lowering the fee foundation to $90, but the second yr’s $10 dividend on a $90 foundation turns into an 11% tax foundation discount because it reduces the fee foundation to $80, and so forth.
Every successive yr turns into extra tax-deferred, rising the tax burden for the ultimate yr at an ever-higher fee.
Ultimately, the tax foundation of an funding may turn out to be depleted fully – akin to after ten years of $10 price of annual foundation discount on STRD or STRF, making all subsequent dividends totally taxable regardless of Technique’s ROC standing.
This whole foundation depletion additionally makes the complete Said Quantity price of dividends (i.e. $100 for many preferreds) instantly taxable each time the shareholder sells.
The tax will ultimately come due.
