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Tax break for DRIPs.

Many corporations raise capital by adopting dividend reinvestment plans (DRIPs), which permit shareholders to reinvest dividends at a discount. In conjunction With DRIPs corporations often adopt optional investment plans (OIPs), which permit investment of additional finds in corporate stock on a discounted basis. To participate in OIPs it often is necessary to participate in DRIPs.

In revenue ruling 78-375 (sections 305(c) and (b)(2)) the Internal Revenue Service said a shareholder realizes taxable dividend income with respect to the DRIP based on the fair market value of the stock on the date of distribution. A purchaser of stock in the OIP also sustains dividend income measured by the difference between the value of the stock purchased and the amount of the optional payment.

However, in letter ruling 9509039 the IRS said the bargain element in an OIP would not be a taxable constructive dividend when

1. There was no link between the DRIP and OIP. A shareholder could participate in the OIP regardless of participation in the DRIP.

2. A shareholder not participating in the OIP would not be entitled to a compensatory payment from the corporation.

3. The shareholder obtaining the ruling did not reinvest dividends under the DRIP.

Observation: This ruling creates an incentive for capital-hungry corporations to remove the link between their DRIPs and their OIPs by providing shareholders participating in OIPs a rare opportunity to convert dividends into capital gains.

- Robert Willens, CPA, managing director at Lehman Brothers, New York City.
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Title Annotation:dividend reinvestment plans
Author:Willens, Robert
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Jun 1, 1995
Previous Article:Small business tax solutions.
Next Article:A link to the IRS.

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