Barron's, Shirley A. Lazo, 16 January 2006
ON JAN 4, SHAREHOLDERS of Ameritrade Holding okayed its acquisition of TD Waterhouse Group's U.S. retail securities business from Toronto-Dominion Bank for $2.9 billion in stock.
That will give Toronto-Dominion 32.6% of the shares of Ameritrade, making the Canadian banking concern the biggest stockholder in what will be called TD Ameritrade. The new company expects to lead the online brokerage industry in trades, with some 239,000 daily.
In connection with the deal, Ameritrade on Dec. 5 declared a distribution of $6 a share, payable Jan. 24. No ex-date has been set, but it's likely to coincide with the payment date. Toronto-Dominion won't get the distribution, however, because the Jan. 17 record date for the transaction precedes the date on which any Ameritrade stock will be issued to the bank.
For those who are entitled to the cash, there are a couple of key questions.
THE FIRST IS WHETHER the special distribution is a dividend.
In a recent report, Robert Willens, Lehman Brothers managing director, writes that the distribution is a dividend only to the extent that it "comes out of earnings and profits (E&P), either accumulated or of the taxable year in which the distribution is made."
Since the Ameritrade distribution is being made early in the year, Willens says the portion that will be a dividend won't be conclusively determined until early in 2007, when Ameritrade's 2006 operating results, including the activities of TD Waterhouse, will be known.
Another element that must be considered is an IRS ruling that, for tax purposes, whoever holds the stock on the record date is entitled to a declared dividend. (In the case of large dividends, the ex-date usually follows the record date.)
Accordingly, Willens maintains, "if the stock is sold after the record date but before the ex-dividend date, the amount paid by the buyer of the stock represents, in reality, payment for two separate items: the stock and the right to receive from the seller" a sum equal to the distribution.
In the Ameritrade transaction, the buyer's basis in the dividend right will be equal to $6, and there will be no gain or loss on collection of the money. On the other hand, Willens observes, "a portion of the amount received by the seller will be treated as dividend income." Thus, the seller, not the buyer, will treat that amount as qualified dividend income, eligible for a relatively low tax rate.
Such income is taxed at a maximum 15% if the stock on which the payout is made is held more than 60 days in the 121-day period beginning 60 days before the ex-dividend date. If the holding period requirement isn't satisfied, the tax rate jumps to the holder's top bracket (up to a maximum of 35%).
Another question raised by the Ameritrade deal is whether the dividend can be "stripped."
Stripping is the process of converting short-term capital gains, which can be taxed at hefty rates, into dividend income, which is taxed at 15% or less.
"A dividend strip is most effective if a loss from the sale of the stock on which the dividend was paid can be classified as a short-term capital loss," Willens comments. If so, the loss can offset the investor's unrelated short-term capital gains, which, in turn, are "replaced by dividend income, eligible to be taxed at preferential rates."
While Congress has tried to discourage stripping, it hasn't eliminated it. Therefore, writes Willens, if a dividend is considered extraordinary, any loss from the sale of the stock on which it was paid will be a long-term capital loss, to the extent that the loss doesn't exceed the dividend. Long-term capital losses can offset an investor's long-term capital gains (which otherwise are taxed at 15%).
"Of course," Willens adds, "replacing long-term capital gains with dividend income [which is taxed at the same rate] does not provide the investor with a tax advantage."
FOR STRIPPING, Willens observes, a dividend is considered extraordinary if it equals or exceeds a "threshold percentage" of the cost basis of the stock on which it's paid. For common shares, that's 10%.
Alternatively, the stock's fair-market value on the day before it goes ex-dividend can be used to determine whether the dividend is extraordinary.
If the dividend element of the distribution is less than $2.50 a share, Willens says stripping possibilities will clearly exist. The big problem is that no one will know whether the Ameritrade dividend is extraordinary, and thus a good stripping candidate, until it's too late -- early 2007 when the results of Ameritrade's 2006 operations are disclosed.
The bottom line: "Except in cases where the taxpayer has only short-term capital gains (against which the long-term capital losses...can be offset), the Ameritrade special distribution, in light of the uncertainty, is probably not an attractive candidate for dividend stripping."
;
ON JAN 4, SHAREHOLDERS of Ameritrade Holding okayed its acquisition of TD Waterhouse Group's U.S. retail securities business from Toronto-Dominion Bank for $2.9 billion in stock.
That will give Toronto-Dominion 32.6% of the shares of Ameritrade, making the Canadian banking concern the biggest stockholder in what will be called TD Ameritrade. The new company expects to lead the online brokerage industry in trades, with some 239,000 daily.
In connection with the deal, Ameritrade on Dec. 5 declared a distribution of $6 a share, payable Jan. 24. No ex-date has been set, but it's likely to coincide with the payment date. Toronto-Dominion won't get the distribution, however, because the Jan. 17 record date for the transaction precedes the date on which any Ameritrade stock will be issued to the bank.
For those who are entitled to the cash, there are a couple of key questions.
THE FIRST IS WHETHER the special distribution is a dividend.
In a recent report, Robert Willens, Lehman Brothers managing director, writes that the distribution is a dividend only to the extent that it "comes out of earnings and profits (E&P), either accumulated or of the taxable year in which the distribution is made."
Since the Ameritrade distribution is being made early in the year, Willens says the portion that will be a dividend won't be conclusively determined until early in 2007, when Ameritrade's 2006 operating results, including the activities of TD Waterhouse, will be known.
Another element that must be considered is an IRS ruling that, for tax purposes, whoever holds the stock on the record date is entitled to a declared dividend. (In the case of large dividends, the ex-date usually follows the record date.)
Accordingly, Willens maintains, "if the stock is sold after the record date but before the ex-dividend date, the amount paid by the buyer of the stock represents, in reality, payment for two separate items: the stock and the right to receive from the seller" a sum equal to the distribution.
In the Ameritrade transaction, the buyer's basis in the dividend right will be equal to $6, and there will be no gain or loss on collection of the money. On the other hand, Willens observes, "a portion of the amount received by the seller will be treated as dividend income." Thus, the seller, not the buyer, will treat that amount as qualified dividend income, eligible for a relatively low tax rate.
Such income is taxed at a maximum 15% if the stock on which the payout is made is held more than 60 days in the 121-day period beginning 60 days before the ex-dividend date. If the holding period requirement isn't satisfied, the tax rate jumps to the holder's top bracket (up to a maximum of 35%).
Another question raised by the Ameritrade deal is whether the dividend can be "stripped."
Stripping is the process of converting short-term capital gains, which can be taxed at hefty rates, into dividend income, which is taxed at 15% or less.
"A dividend strip is most effective if a loss from the sale of the stock on which the dividend was paid can be classified as a short-term capital loss," Willens comments. If so, the loss can offset the investor's unrelated short-term capital gains, which, in turn, are "replaced by dividend income, eligible to be taxed at preferential rates."
While Congress has tried to discourage stripping, it hasn't eliminated it. Therefore, writes Willens, if a dividend is considered extraordinary, any loss from the sale of the stock on which it was paid will be a long-term capital loss, to the extent that the loss doesn't exceed the dividend. Long-term capital losses can offset an investor's long-term capital gains (which otherwise are taxed at 15%).
"Of course," Willens adds, "replacing long-term capital gains with dividend income [which is taxed at the same rate] does not provide the investor with a tax advantage."
FOR STRIPPING, Willens observes, a dividend is considered extraordinary if it equals or exceeds a "threshold percentage" of the cost basis of the stock on which it's paid. For common shares, that's 10%.
Alternatively, the stock's fair-market value on the day before it goes ex-dividend can be used to determine whether the dividend is extraordinary.
If the dividend element of the distribution is less than $2.50 a share, Willens says stripping possibilities will clearly exist. The big problem is that no one will know whether the Ameritrade dividend is extraordinary, and thus a good stripping candidate, until it's too late -- early 2007 when the results of Ameritrade's 2006 operations are disclosed.
The bottom line: "Except in cases where the taxpayer has only short-term capital gains (against which the long-term capital losses...can be offset), the Ameritrade special distribution, in light of the uncertainty, is probably not an attractive candidate for dividend stripping."
