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18 IRET Congressional Advisory 1 (1993)

handle is hein.taxfoundation/iretcgadv0017 and id is 1 raw text is: IRET_ June 3, 1993 No. 18 HOUSE TAX BILL: STRIPPING STRIPPED STOCK OF CAPITAL GAINS TREATMENT Strips are the principal component of bonds stripped of their interest coupons (which are sold separately) and resold at an original would either give a deduction for amounts saved and tax the gross returns (akin to a deductible IRA) or give no deduction and tax none of the returns on saving (akin to tax exempt bond treatment). All saving would be given one or another of these treatments. With no deduction for saving, the correct treatment for either the interest on bonds or the dividends on stock is not to tax them. In the case of the stripped principal sold at a discount, the price appreciation should not be taxable to the holder. Under current law, dividends are paid from after-tax corporate income. The dividend payments are not deductible by the corporation. Furthermore, dividends on stock (common or issue discount to appreciation. The accruing price appreciation is treated as taxable interest for tax purposes. The practice has spread to preferred stock. The stock is stripped of its dividend rights (which are sold separately) and the stock is resold at a discount from a fixed redemption price payable at a future date. Current law treats the rise in the stock price as a yield interest via price preferred shares, The House proposal would move the tax code in the wrong direction, i.e., closer to universal double taxation of saving, raise the cost of cap ital and reduce saving in the United States, and slow the growth of investment, productivity, employment. capital gain. The House tax bill converts the treatment to ordinary income. In doing so, it accentuates the income tax bias against saving. Current law subjects the returns on saving to double taxation. Income is taxed when earned. If used for consumption, there is little additional federal tax. If used for saving or investment, it is taxed again on the returns. A neutral tax code wages, and whether stripped or not) are taxed as ordinary income to the shareholder, who purchased the stock with after-tax income. Thus, the dividend is subject to repeated taxation, reducing the value of the stock and raising the cost of capital to the company. If stripped preferred stock can be reissued at a discount and subject to capital gains treatment, it enhances the initial value of the original issue stock, and lowers the cost of capital, making up in some small part for the multiple taxation of the regular dividend. The correct solution to the stripped preferred stock problem is to stop taxing the regular dividend, or, as a second best answer, to allow the corporation a deduction for the dividends it pays out. Absent such fundamental reform, the Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www. ret.org

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