What Is Form 1059 for Extraordinary Dividends?

Corporate shareholders receiving a large dividend relative to their investment may encounter Form 1059. This form is required when a corporation receives what the Internal Revenue Code defines as an “extraordinary dividend.” The purpose of the form is to ensure the corporate shareholder correctly adjusts its tax basis in the stock for which the dividend was paid. This adjustment prevents a corporation from receiving a dividend with preferential tax treatment and then selling the stock at an artificial loss. The form is filed as an attachment to the corporation’s main income tax return, such as Form 1120, for the year the dividend was received.

Identifying an Extraordinary Dividend

An extraordinary dividend is identified through specific tests outlined in the Internal Revenue Code. The main test compares the dividend amount to a threshold, which is the corporation’s adjusted basis in the stock. However, a corporate shareholder may elect to use the stock’s fair market value on the day before the ex-dividend date as the benchmark instead. For preferred stock, a dividend is extraordinary if it equals or exceeds 5% of this benchmark. For common stock, the threshold is 10%. For instance, if a corporation holds common stock with a tax basis of $20,000, a dividend of $2,000 or more would trigger the rules.

The holding period of the stock is a factor in this determination. These rules apply only if the corporation has held the stock for two years or less before the dividend announcement date. If the stock has been held for more than two years, a dividend is not classified as extraordinary, though exceptions apply. These exceptions include dividends paid as part of a partial liquidation or a stock redemption that is not pro-rata.

The rules also account for situations where a company might issue several smaller dividends. Multiple dividends received within certain timeframes are aggregated and treated as a single dividend for testing purposes. All dividends with ex-dividend dates within an 85-consecutive-day period are combined. A broader rule applies to dividends with ex-dividend dates within a 365-consecutive-day period, treating them as extraordinary if their aggregate amount exceeds 20% of the shareholder’s adjusted basis.

Tax Consequences of Receiving an Extraordinary Dividend

The main consequence of receiving an extraordinary dividend is the reduction of the shareholder’s tax basis in the stock. The reduction is for the “nontaxed portion,” which is the amount of the dividend offset by the dividends-received deduction (DRD). The DRD is a special deduction available to corporations to reduce the tax on dividends received from other corporations. For example, if a corporation has a $10,000 basis in its stock and receives a $1,500 extraordinary dividend fully covered by the DRD, the basis is reduced by $1,500 to a new basis of $8,500.

A tax event occurs if the nontaxed portion of the extraordinary dividend is larger than the shareholder’s stock basis. In this case, the basis is reduced to zero, and the excess amount is recognized as a capital gain in the year the dividend is received. This gain must be reported on the corporation’s tax return. For example, if the stock basis was $1,000 and the nontaxed portion of the dividend was $1,500, the basis would be reduced to zero, and the corporation would report a $500 capital gain for that tax year.

Information Required to Complete Form 1059

To complete Form 1059, a corporate shareholder must gather specific information, including:

• The shareholder’s name and Employer Identification Number (EIN)
• The name and EIN of the corporation that paid the dividend
• The date the dividend was received and the total amount of the distribution
• The shareholder’s adjusted basis in the stock immediately before the dividend
• The fair market value of the stock at that time
• The nontaxed portion of the dividend, determined by the dividends-received deduction
• The shareholder’s holding period for the stock

This information is used to complete the three parts of Form 1059. Part I is for reporting general information about the shareholder and the dividend-paying corporation. Part II guides the calculation of the basis reduction and any resulting capital gain, and Part III documents the new, adjusted basis in the stock. The most current version of Form 1059 can be found on the IRS website.

Filing Instructions for Form 1059

The completed Form 1059 must be filed with the corporate income tax return for the tax year in which the extraordinary dividend was received. For most corporations, this means attaching Form 1059 to their Form 1120, U.S. Corporation Income Tax Return.

There is no separate deadline or mailing address for Form 1059, as it is part of the complete tax return package. It must be included when the corporation files its return by the original due date or an extended due date. Failure to include Form 1059 when required can lead to an incomplete return, potentially resulting in penalties and interest charges.