Corporations that receive dividends from other corporations get a special break: the dividends‑received deduction under § 243. For corporations that own 20% or more of the distributing corporation’s stock, the deduction is 65% of the dividend (historically higher, now 50% for less‑than‑20% owners and 65% for 20%+ owners). That means only a small portion of the dividend is actually taxed.
But sometimes the IRS argues that a payment that looks like a dividend is really part of the sale price of stock. Litton Indus., Inc. v. Commissioner, 89 T.C. 1086 (1987), shows how this plays out.
Litton owned all the stock of Stouffer. Stouffer declared a 30 million. The IRS argued the “dividend” was really part of the sale price.
The Tax Court sided with Litton. Why? Timing. The dividend was declared six months before the sale, and at that time, there was no specific buyer, no binding agreement, and Litton hadn’t even decided on the form of sale. The court distinguished Waterman Steamship Corp. v. Commissioner, 50 T.C. 650 (1968), rev’d, 430 F.2d 1185 (5th Cir. 1970), where the dividend and sale happened almost simultaneously.
The lesson: If a parent corporation wants to extract cash from a subsidiary before selling it, timing is critical. Declare the dividend well before the sale, and don’t have a prearranged buyer. Otherwise, the IRS may challenge the dividend and deny the dividends‑received deduction.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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