TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, July 22, 2004

Tax Consequences of Microsoft's $32 Billion Dividend

Thursday, July 22, 2004

Interesting NY Times article today on the tax considerations underlying Microsoft's announcement of a $32 billion dividend. Among the tax angles noted in the story are:

• The role of Bush's reduction of the dividend tax to 15%, and Kerry's threat to restore the 35% rate. Says one economist: "There has never been an easier way to hand yourself 85% money, and that opportunity may have about a six-month half-life."

• Bill Gates saves over $600 million as a result of the lower dividend tax rate.

• By contributing the dividend to charity, Gates can use the charitable deduction to offset ordinary income taxed at 35%, compared to the 15% tax on the dividend.

• Foreign investors have an incentive to sell their Microsoft stock before the payment of the dividend because it is subject to a 30% withholding tax (unless their country has a tax treaty with the U.S. providing a 15% tax rate).

• Microsoft's stock price needs to rise by $2 per share (to $30.81) to avoid having the dividend treated as an extraordinary dividend. If it does, individual investors will be able to buy the stock to capture the dividend taxed at 15% and then sell to recognize a short term capital loss to offset short term capital gains otherwise taxed at 35%.

(Thanks to Ellen Aprill and Steven Sholk for the tip.)

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The tax angles are all quite useless, actually.

1) Long term capital gains are taxed at 15% anyway. If dividend taxation was raised, MSFT could simply not pay the dividend, Gates could sell roughly 10% of his stock holdings, and his tax 'savings' would be the same.
2) Gates could similarly donate the long term capital gains on a stock sale and get the same charitable deduction. Even better, he could donate the stock and get a deduction for the appreciated value without ever selling it.
3) As pointed out by the Times article, but not mentioned here, playing the dividend/short term capital loss gambit would require an individual taxpayer to hold the stock 61 days, or the dividends become unqualified for 15% treatment.

Moving the dividend rate to the same rate as long-term capital gains was a good law change. It put stock price appreciation and dividends on equal footing. It fundamentally doesn't change the taxation rate that would have most likely occurred anyway, but encourages companies like MSFT to actually generate tax impacts by paying dividends versus store them for longer periods of time in undistributed earnings.

What proves the point is that a guy like Warren Buffett who criticized lowering dividend taxation as an unfair sop to the rich, still hasn't paid a dividend out of Berkshire Hathaway. It's because he knows that 0% tax due on not paying dividends is still better than 15% on dividends.

Posted by: Kory | Jul 22, 2004 7:30:01 PM