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CHAPTER 23

INCOME FROM DIVIDENDS

The law expressly states that the gross income of a taxpayer shall include gains, profits and income derived from dividends. 1

Definition. The term “dividend, as used in the Revenue Act of 1918 (with one exception where it is used in connection with dividends paid by insurance companies on policy and annuity contracts) is defined therein to mean (1) any distribution made by a corporation, other than a personal-service corporation, to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, or (2) any such distribution made by a personal-service corporation out of its earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918.2 Amounts distributed in the liquidation of a corporation are expressly required to be treated as payments in exchange for stock or shares, and any gain or profits realized thereby will be taxed to the distributee

1 Revenue Act of 1918, $8 213 (a) and 234 (a) 10. The Revenue Act of 1916 provided that subject only to such exemptions and deductions as were thereinafter allowed, the net income of a taxpayer should include gains, profits and income derived from dividends (Revenue Act of 1916, $ 2 (a).).

2 Revenue Act of 1918, § 201 (a). It will be noted that the new definition, aside from its provision for personal-service corporation distributions, omits the words “or ordered to be made"; substitutes the word "accumulatedfor “accrued”; and also expressly includes distributions made “in other property." See Revenue Act of 1916, 8 31 (a), Reg. 33 Rev., Art. 106.

as other gains or profits. It is to be noted that under this definition any distribution other than a distribution in liquidation which is made by a corporation of earnings or profits accumulated snce February 28, 1913, is a dividend; it need not necessarily be called a dividend. On the other hand, if the distribution is not out of earnings or profits accumulated since February 28, 1913 (and prior to January 1, 1918, in the case of personal-service corporations), it does not become a dividend within the meaning of the law by reason of the fact that it is called a dividend by the corporation making the distribution. The term "corporation," as used in this chapter, includes associations, joint-stock companies, and insurance companies.4 The term “taxpayer,” unless otherwise indicated, includes any person, trust, or estate subject to the tax, and the term “person" includes individuals, partnerships and corporations. The term “taxable year” means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income of the taxpayer is computed ; 6 and the term “personal-service corporation” means a corporation whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves regularly engaged in the active conduct of the affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor, but does not include any foreign corporation nor any corporation fifty per centum or more of whose gross income consists either (1) of gains, profits or income derived from trading as a principal, or (2) gains, profits, commissions or other income derived from a government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.? The term “foreign corporation” means a

3 Revenue Act of 1918, § 201 (c). 4 Revenue Act of 1918, g 1. 5 Revenue Act of 1918, § 1. 6 Revenue Act of 1918, $ 200. 7 Revenue Act of 1918, $ 200.

corporation created or organized outside the United States.8 The term "non-resident foreign corporation" means a foreign corporation which is not engaged in trade or business within the United States and has no office or place of business in this country, and a “resident foreign corporation” is a corporation which is engaged in trade or business in this country, or has an office or place of business in the United States. 9

DIVIDENDS ON LIFE INSURANCE POLICIES. It is a custom of insurance companies to return each year a portion of the premium paid by the insured. The amount so returned is usually designated as a "dividend” and is either received in cash by the insured or applied by him to the reduction of the next annual premium. The law expressly provides that amounts received as a return of premiums paid by the taxpayer is not income.10 Where, , however, dividends are received on a paid-up policy the amount must be included and should be considered the same as dividends from corporations, 11 unless, of course, the dividend was not paid by the insurance company out of earnings or profits accrued since the incidence of the tax.

DIVIDENDS FROM ASSOCIATIONS. Since associations, jointstock companies and insurance companies (whether incorporated or not) are treated as corporations and limited partnerships may be so treated, 12 the net earnings of such organizations should be considered as divi

Thus under the 1916 Law and former laws private banks, which had the form of corporate organization, were required to make returns as corporations, and the owners of the bank were authorized to treat as dividends the earnings which they received therefrom.14 The recipi

8 Revenue Act of 1918, § 1.
9 See Chapter 14 on Foreign Corporations.
10 Revenue Act of 1918, $ 213 (a) 2.
11 T. D. 2137.

12 See the discussion of limited partnerships in Chapter 10 on Partnerships.

18 T. D. 2152. 14 T. D. 2137.

dends. 13

ent of profits of associations or limited partnerships should, therefore, ascertain whether the association or partnership is paying the tax as a corporation and in such event should treat the net profits of the association as dividends.

DIVIDENDS FROM CO-OPERATIVE MERCHANDISING ORGANIZATIONS. Dividends paid by co-operative merchandising organizations in the nature of a periodical refund to members or prospective members or patrons generally in proportion to the purchases made by the recipient were held under the 1916 Law to be wholly different from ordinary dividends based on stock-holdings, and were not required to be listed as income by the recipient.15

Extent to Which Dividends Are Taxable. The extent to which a dividend is taxable depends upon the status of the corporation paying the same and upon the status of the recipient of the dividend. 16 As a general rule, income from dividends is only subject to the surtaxes, and, except in the case of certain stock dividends, is taxable at the rates in force in the year received.

DIVIDENDS PAID BY DOMESTIC CORPORATIONS. In the case of dividends declared and paid by a domestic corporation which is liable to income tax upon its net income or by a personal-service corporation out of earnings and profits upon which income tax has been imposed, the dividend is not subject to the normal tax if received by an individual, the amount of the same being expressly allowed as a credit for the purpose of the normal tax.17 If the individual is a non-resident alien the credit of such dividends for purposes of the normal tax will be allowed only in case he files a true and accurate return of his total income received from all sources, corporate or otherwise in the United States, in the manner prescribed by law.18 If such a dividend is received by a corporation, domestic

15 T. D. 2737. See Chapter 15 on Exempt Organizations. 16 Revenue Act of 1918, § 201 (d). 17 Revenue Act of 1918, $ 216 (a). 18 Revenue Act of 1918, $ 217.

or foreign, the amount thereof is allowed as a deduction from the taxable income of the corporation receiving the same.

19 DIVIDENDS PAID BY PERSONAL-SERVICE CORPORATIONS. In the case of dividends declared and paid by personal-service corporations out of earnings or profits upon which income tax has been imposed,—that is, earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918,—the above mentioned rules apply.20

DIVIDENDS PAID BY NON-RESIDENT FOREIGN CORPORATIONS. Dividends paid by a non-resident foreign corporation deriving no income from this country if paid out of its earn.ings or profits accumulated since February 28, 1913, are taxable when received by a citizen or resident of this country and must be reported for the purpose of both the normal and the surtaxes. When received by a domestic corporation such dividends are subject to income and excess-profits taxes. When received by non-resident aliens or foreign corporations they are subject to no tax, although they may be paid by the paying agent for the paying corporation at a place within the United States.

DIVIDENDS PAID BY RESIDENT FOREIGN CORPORATIONS. When a foreign corporation derives its entire income from business done wholly within the United States, and pays the income tax upon its entire net income, dividends declared by it should be treated in the same manner as dividends from domestic corporations.21 If a foreign corporation pays the income tax on a part of its net income, the dividends it pays should be treated, to that extent, as

19 Revenue Act of 1918, 8 234 (a) 6 and (b). Under the 1913 Law corporations were not permitted to deduct the amount received as dividends from other corporations subject to the income tax. This was likewise true of the 2% tax imposed by the 1916 Law, but for the purpose of the 4% tax imposed by the 1917 Law the amount of such dividends was permitted as a credit. (Revenue Act of 1917, $ 3; Reg. 33 Rev., Art. 105.)

20 See Revenue Act of 1918, 88 216 (a), 234 (a) 6, and 217.

21 Revenue Act of 1918, 88 216 (a) and 234 (a) 6. See T. D.

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