Revenue Ruling 82-16: Tax Treatment of Shareholder Fees

Revenue Ruling 73-54 is guidance from the Internal Revenue Service that clarifies the tax implications when a corporation pays professional fees on behalf of a shareholder. This situation often occurs during a significant corporate restructuring event. The ruling establishes a framework for determining how these payments should be treated for tax purposes by both the company and the individual shareholder. It creates a clear line between expenses that are for the benefit of the corporation and those that are for the personal benefit of the shareholder.

Applicability of the Ruling

The principles in Revenue Ruling 73-54 apply to a corporate reorganization structured as a “split-off.” In a split-off, a parent corporation transfers the assets of a business to a subsidiary. A shareholder of the parent corporation then exchanges some or all of their parent company stock for stock in this newly separated subsidiary.

This transaction differs from a “spin-off,” where a parent company distributes subsidiary stock to its shareholders without them having to surrender any parent stock. The split-off involves a direct exchange by a specific shareholder, making the nature of associated costs more complex. The ruling becomes relevant when the parent corporation pays for professional fees generated as part of this exchange.

Applying this ruling requires separating corporate-level expenses from shareholder-level expenses. Corporate expenses are those that relate directly to the reorganization plan for the corporation’s benefit. Examples include legal fees for drafting the reorganization plan, costs for a corporate-level tax opinion, and general legal advice on the structural change. These costs are considered to serve a corporate business purpose.

When the corporation pays these corporate expenses, the payment is not a taxable event for the shareholder. The corporation can capitalize these costs as part of the reorganization or, in some cases, deduct them. These payments do not create a direct economic benefit for an individual shareholder.

The ruling’s focus is on shareholder-level expenses, which are costs an individual shareholder incurs to evaluate their personal financial position. Examples include hiring a law firm for advice on the stock exchange as a personal investment or fees for financial planners to assess the impact on the shareholder’s portfolio. These services help them make an informed decision or manage their private financial affairs.

When the corporation pays these personal bills, it provides a direct economic benefit to that shareholder. This action—the corporate payment of a shareholder’s personal advisory or financial planning fees related to a split-off—activates the tax treatment detailed in the ruling.

Tax Consequences for the Shareholder and Corporation

When a corporation pays for a shareholder’s personal expenses, the IRS recharacterizes the payment as a “constructive dividend.” A constructive dividend occurs when a corporation provides an economic benefit to a shareholder without formally declaring a dividend. Even though the payment is made to a third party, like a law firm, the value is treated as if it were distributed directly to the shareholder as income. This concept prevents companies from disguising shareholder distributions as deductible corporate expenses.

Under Revenue Ruling 73-54, the payment of a shareholder’s personal investment or financial planning fees is treated as a constructive dividend to that shareholder. The amount of this dividend is equal to the exact dollar amount of the personal fees paid by the corporation.

For the shareholder, the constructive dividend is considered taxable income that must be reported on their personal tax return. If the dividend meets certain criteria, it can be classified as a “qualified dividend,” which is taxed at more favorable long-term capital gains rates. To be a qualified dividend, the dividend must be from a U.S. or a qualifying foreign corporation, and the shareholder must meet a holding period requirement for the underlying stock.

If the criteria for a qualified dividend are not met, the constructive dividend is treated as an ordinary dividend. Ordinary dividends are taxed at the shareholder’s regular marginal income tax rates.

From the corporation’s perspective, the tax consequences are also significant. Because the payment is classified as a dividend distribution rather than an operational expense, it is not a deductible business expense. The corporation cannot use the payment to reduce its taxable income. This means the company pays for the shareholder’s personal fees with after-tax dollars, which can impact its profitability.

Reporting and Documentation Requirements

A corporation must maintain clear documentation to support the transaction, distinguishing between corporate-level and shareholder-level expenses. Invoices from professional firms should be requested to clearly delineate services for the corporation’s plan versus those for the shareholder’s personal advice. Corporate minutes and board resolutions should also document the authorization for the payment, providing a clear audit trail for the transaction.

The corporation reports the payment on IRS Form 1099-DIV, “Dividends and Distributions.” The corporation must prepare this form for the shareholder, including the following information:

• The corporation’s name, address, and Taxpayer Identification Number (TIN)
• The shareholder’s name, address, and TIN
• The total amount of the constructive dividend in Box 1a, “Total ordinary dividends”
• The qualified dividend amount, if applicable, in Box 1b

The corporation must send a copy of Form 1099-DIV to the shareholder by January 31 of the year following the payment. A copy must also be sent to the IRS, with a deadline of the end of February for mail filing or the end of March for electronic filing.

Upon receiving Form 1099-DIV, the shareholder must report the dividend income on their personal federal income tax return, Form 1040. The amount from Box 1a is reported on Schedule B, “Interest and Ordinary Dividends.” If an amount is shown in Box 1b as a qualified dividend, the shareholder can benefit from the lower capital gains tax rates on that portion of the income, which is calculated separately on the tax return.