Written by: Suzanne Cody, CPA, CGA, Senior Partner
Preferred shares are a hybrid investment having both the characteristics of owner’s equity and fixed income. These shares represent an ownership interest, do not have a maturity date, do not generally have voting rights, and have a par value (the value as declared in writing by the corporation) which is arbitrarily assigned by the issuing corporation. They usually pay out at a fixed rate set at the date of issue. They are senior to common stock but rank behind debt or liquidation proceeds which means that your investment will be paid back before any common stock investments but after creditors’ debts are settled.
Preferred shares have a face value like a bond and dividends are paid at a percentage of the face value. Hence, the par value of preferred stock has some economic significance. For example, if a corporation issues 5% preferred stock with a par value of $100, the preferred stockholder will receive a dividend of $5 (5% times $100) per share per year. If the corporation issues 10% preferred stock having a par value of $25, the stock will pay a dividend of $2.50 (10% times $25) per year. In each of these examples the par value is meaningful because it is a factor in determining the dividend amounts.
In years gone by, a popular method of legal income splitting was to have a business owner issue shares directly or indirectly to their minor children. The corporation would declare dividends on the shares owned by the minors, and because they had little or no income, a significant amount could be paid out or be made payable to the children tax-free. This came to an end in 2000 when the Income Tax Act was amended to prevent this income splitting by assessing a “kiddie tax”. Under this rule, when a child under age eighteen receives dividends from a private corporation, the dividends are now taxed at the highest federal tax rate and except for the dividend tax credit, the minor is not able to make use of any other credits normally available.
There are also “attribution rules” which would make you pay personally pay income tax on some of your child’s earnings. In order to purchase the preferred shares, the child requires money. If you ‘gift’ this to him or her, then as soon as the ‘gift’ starts to earn income, that income becomes attributable to you for tax purposes.
So remember, if someone tells you it might be a good idea to share the wealth with your underage children, you should talk to your accountant!