DIVIDENDS ARE IN THE NEWS AND NOT JUST BECAUSE OF A REDUCTION IN TAX RATES
HAROLD S. SMALL, J.D., CPA, and AEP
The headlines in the daily newspapers on May 24, 2003 were about dividends and Annika Sorenstam. This column will not provide commentary on Annika’s play at the Colonial or repeat the articles that discussed the new tax law approved by Congress and signed by the President. However, I will address issues relating to dividends (with a brief reference to the change in the tax law).
Although the final law was not available to me at the time of writing this column, it appeared that it would include a reduction in tax rates on capital gains and dividends to 15% for most taxpayers for five years, and then the higher existing income tax rates will be reinstated in 2008. Some members of Congress have indicated that they hope to extend the tax cut before it expires. This is a significant change and can provide very significant planning opportunities. However, another significant change occurred with the announcement of the decision of Farmer Bros. Co. V. Franchise Tax Board (2003), by the Second District, California Court of Appeals 4th District only a few days before.
The Court in Farmer Bros. stated that it is a “case
of first impression” and went on to state “...we hold that [California] Revenue
and Taxation Code section 24402 (section 24402), known as the ‘dividends
received deduction,’ violates the commerce clause of the United States
Constitution (commerce clause) by discriminating against corporations engaged
in interstate commerce. [footnote omitted] Section
24402 affords to a corporate taxpayer an income tax deduction for a portion of
the dividends it receives from another corporation when the dividends are
declared from income which was included in the payer corporation’s measure of
In this case, the California Franchise Tax Board (“FTB”) appealed from a judgment awarding the taxpayer, Farmer Bros. (“Taxpayer”), state tax refunds totaling $811,000 for the tax years 1992 through 1998, plus interest and costs, as a remedy for overpaying taxes under the provisions of section 24402. The trial court determined the statute to be unconstitutional under the commerce clause and this appellate court agreed and affirmed the judgment.
Taxpayer is a
Section 24402 states “Taxpayers are permitted a deduction under Section 24402, for dividends received which were declared from income included in the measure of tax of the declaring corporation under this part.” A formula was created, which provided for a percentage of the dividends received to be deductible.
The Farmers Bros. Court quoted from the
decision of Hunt-Wesson, Inc. v.
Franchise Tax Bd. (2000) 528 U.S. 458, 460--461 [120 S.Ct. 1022,
1024--1025] and stated “California, like many other States, uses what is called
a ‘unitary business’ income-calculation system for determining its taxable
share of a multistate corporation’s business income. . . . [¶] The income of
Some of the dividends received by Taxpayer from some corporations in certain years were not deductible pursuant to the FTB formula. The facts in Farmers Bros. indicate that the Taxpayer timely filed amended tax returns and claimed a dividends received deduction for all dividends received for the years at issue and requested refunds of taxes totaling over $800,000. Taxpayer’s claim was based upon §24402 violating the commerce clause of the U.S. Constitution. FTB denied the refund claim and appealed to the State Board of Equalization (“Board”). The Board sustained the FTB’s action and stated that it “does not have the authority to deny the application of Revenue and Taxation Code section 24402 on constitutional grounds.” The Taxpayer filed a claim for refund of corporate franchise/income tax. In its amended complaint, “Taxpayer asserted that section 24402 is unconstitutional under the commerce clause of the United States Constitution because it discriminates on its face against interstate commerce by improperly taxing income that is not attributable to business transacted in California and the deduction cannot be justified as a lawful compensatory tax.”
The Court later
stated, “We conclude that section 24402 is discriminatory on its face because
it affords to taxpayers a deduction for dividends received from corporations
subject to tax in
Although §24402 was amended, it appears that issues relating to dividends between entities may result in a different income/-franchise tax treatment than previously understood. Entity taxpayers that receive dividends need to review how the decision in Farmers Bros. may affect their planning and their tax compliance, and should consult with attorneys and accountants familiar with this area.
FOREGOING CONCEPTS AND IDEAS ARE GENERAL STATEMENTS AND ARE INTENDED TO PROVIDE
CONCEPTS FOR CONSIDERATION IN BUSINESS AND TAX PLANNING. CAREFUL CONSIDERATION NEEDS TO BE GIVEN BY
THE USER REGARDING THE USE AND APPLICATION OF THE CONCEPTS. YOUR LEGAL AND TAX
COUNSEL SHOULD BE CONSULTED BEFORE THE IMPLEMENTATION OF ANY OF THE IDEAS
INDICATED HEREIN. SHOULD YOU HAVE
QUESTIONS REGARDING THIS MATTER, HAROLD S. SMALL, ESQ., CAN BE REACHED AT
© by Harold S. Small 2003