President Bush’s proposal to eliminate the federal tax on corporate dividends would have a more widespread impact on privately held companies in Wisconsin than on publicly traded firms here.
While most of the debate on the corporate dividend tax has been focused on publicly held companies, the tax change would affect any entity incorporated as a Chapter C corporation – including privately held companies.
According to the Wisconsin Department of Revenue, 57,796 C-corps filed state tax returns here in the 2001 tax season. But according to the ReferenceUSA business directory, only 81 publicly held companies are headquartered in the state. That means a corporate dividend tax cut would have a far-reaching effect on Wisconsin’s privately held business community, far oustripping the impact on publicly traded companies.
While the Senate in late March moved to trim Bush’s $726 billion tax cut package, investment experts here feel the president’s proposed elimination of tax on corporate dividends would have mixed results locally.
Ken Evason, president and CEO of Jacobus Wealth Management in Wauwatosa, said the tax cut on corporate dividends would do little to stimulate the economy. But its elimination would have marked effects on the owners of C-corps and on Wisconsin municipalities.
According to Evason, the elimination of dividend taxes would change the rules for private business owners interested in taking money out of their businesses.
"When it comes to receiving income, people in my business always ask: ‘How do we do it most tax-effectively?’" Evason said.
According to a tax expert with Wipfli Ullrich Bertelson, the biggest change that could result from the removal of federal tax from corporate dividends would relate to how owners are compensated.
"The first thing that comes to mind for example is what would people who have C-corporations do with their compensation," said Mark Krueger, a tax and corporate accountant with Wipfli’s Milwaukee office in Wauwatosa. "Someone’s wage is taxed; but if there is no tax on the dividend, you may have people who are reducing their compensation to what the IRS would consider to be unreasonably low amounts and taking more compensation in dividends."
But while taking income out of a business as a dividend may become more efficient, compensating owner-managers in such a fashion might be tricky, particularly when a number of owners have different levels of equity.
"If dividends are distributed to all the owners of the company, it might appear fairer if compensation is paid out on a fair and proportionate way based on ownership," Evason said.
Evason said it is unlikely an elimination of taxes on dividends would induce many companies to reorganize as C-corps.
"I can’t see that they would do that," he said. "While the tax code would not favor S-corps anymore, S-corps are not disadvantaged."
But both Evason and Krueger agree that when it comes to initial incorporations, C-corps could become more popular.
"When people are starting corporations, one of the big drawbacks to the C-corp is the double taxation of dividends as well as these penalties for having a holding company or having an unreasonable accumulation of earnings," Krueger said. "But with the elimination of the tax, a C-corp could become a tax shelter."
According to the experts, tax-free dividends would help the owners of private companies with issues including succession planning and business investment.
"In succession planning, we used to go through great lengths so that redemption would be classified as a complete termination of interest so you could get capital-gain treatment," Krueger said. "But if dividends are not taxed, you could have the redemption taxed as a dividend. Now, all of the work we go through to achieve capital gain treatment in a redemption – we may not do that anymore."
Without a tax on corporate dividends, business owners might also be more inclined to invest in their businesses knowing they could quickly get money back out, according to Evason.
"The change would make it easier to take capital out of a business," Evason said. "In a perverse way, that could induce people to put money into the business. They might say, ‘Let’s buy a new truck’ or ‘Let’s put a new computer in.’ The idea is they could pull the resulting additional profits back out."
Evason stressed, however, that the big losers from the removal of taxes on corporate dividends would be municipalities. Wisconsin’s economically stressed local governments would have a harder time raising money on the bond market.
"The big benefit to buying municipal bonds is that tax-free status," Evason said. "If people can get a higher return and still not pay taxes on the dividend, municipalities will have a hard time raising funds for infrastructure."
April 4, 2003 Small Business Times, Milwaukee