Strategy (formerly MicroStrategy) founder Michael Saylor has touted the benefits of tax-deferred dividends paid to preferred shareholders in several recent TV interviews. Sadly, there is no such thing as a free lunch on Wall Street. These return on capital (ROC) dividends are inflating the tax liability to preferred investors at an accelerating rate of growth.
Deferring taxes does not mean you don’t have to pay taxes. Although Strategy’s special form of ROC dividends are not immediately taxable, the obligation increases at an increasingly accelerated rate as future deadlines approach.
The strategy touts a generous “tax equivalent” yield of as much as 21.6% as a preferred dividend, assuming the company maintains its ROC status. More than a minor footnote, the company made the ROC guarantee a big part of its latest quarterly earnings report, devoting an entire slide and several minutes of its presentation to ROC guidance.
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predict ROC dividend status over 10 years – a formidable feat in itself. Strategy must comply with a long list of prohibited corporate practices, as it must carefully avoid positively taxable income and profits in order to legally return capital rather than pay eligible expenses to shareholders.
The company discloses the risks and importance of maintaining ROC status in its SEC filings. For example, on July 21, the company acknowledged that “to the extent that the amount of distributions with respect to the preferred stock exceeds the Company’s current and accumulated earnings and profits, the distributions will initially be treated as a tax-free return of capital to the extent of the adjusted tax basis of the holder of the preferred stock.”
In other words, the company must keep its revenues and profits low enough to pay the ROC dividend.
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Even assuming the strategy is able to maintain ROC status with respect to dividends, tax authorities such as the IRS will ultimately collect return on capital dividends.
As the saying goes, it’s impossible to be sure of anything but death and taxes.
Specifically, ROC dividends reduce the investor’s tax base. Rather than receiving cash as a qualified dividend payment, ROC dividends simply lower the basis on which the taxpayer calculates the cost basis when reporting gains and losses on the sale.
For example, Strategy plans to pay ROC dividends worth $10 annually to all STRD and STRF shareholders. This means an annual dividend rate of 10% on a stated amount of $100. (Strategy’s other two preferred shares, STRK and STRC, pay 8% and a floating rate of 10.5%, respectively.)
However, shareholders do not actually receive $10 in cash in their brokerage account for each share of STRD or STRF. Instead, Strategy issues a tax-free return on capital to shareholders of record as of the dividend snapshot date.
This reduces the tax base, which means – even the company itself admits –”Increased taxation on holders The holder’s tax base is completely depleted or the holder sells the shares. ”
Taxes cannot be delayed forever with a priority strategy
An ROC dividend of $10 on a stated amount of $100 would result in a 10% tax basis reduction in the first year, reducing the cost basis to $90, while a $10 dividend in the second year on a $90 basis would result in a 11% tax basis reduction, as the cost basis would be reduced to $80.
The amount of tax deferral increases each year.the tax burden in the final year will increase more than ever.
Eventually, such as after 10 years of $10 worth of annual reductions in STRD or STRF, the investment’s tax base may be completely depleted and all subsequent distributions may become fully taxable, regardless of the strategy’s ROC status.
This reduction in total basis will result in the payment of the full stated amount of the dividend (i.e. $100 for first priority). taxable immediately Every time a shareholder sells.
Taxes will be due someday.
