[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.562-2]

[Page 301]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.562-2  Preferential dividends.

    (a) Section 562(c) imposes a limitation upon the general rule that a 
corporation is entitled to a deduction for dividends paid with respect 
to all dividends which it actually pays during the taxable year. Before 
a corporation may be entitled to any such deduction with respect to a 
distribution regardless of the medium in which the distribution is made, 
every shareholder of the class of stock with respect to which the 
distribution is made must betreated the same as every other shareholder 
of that class, and no class of stock may be treated otherwise than in 
accordance with its dividend rights as a class. The limitation imposed 
by section 562(c) is unqualified, except in the case of an actual 
distribution made in connection with a consent distribution (see section 
565), if the entire distribution composed of such actual distribution 
and consent distribution is not preferential. The existence of a 
preference is sufficient to prohibit the deduction regardless of the 
fact (1) that such preference is authorized by all the shareholders of 
the corporation or (2) that the part of the distribution received by the 
shareholder benefited by the preference is taxable to him as a dividend. 
A corporation will not be entitled to a deduction for dividends paid 
with respect to any distribution upon a class of stock if there is 
distributed to any shareholder of such class (in proportion to the 
number of shares held by him) more or less than his pro rata part of the 
distribution as compared with the distribution made to any other 
shareholder of the same class. Nor will a corporation be entitled to a 
deduction for dividends paid in the case of any distribution upon a 
class of stock if there is distributed upon such class of stock more or 
less than the amount to which it is entitled as compared with any other 
class of stock. A preference exists if any rights to preference inherent 
in any class of stock are violated. The disallowance, where any 
preference in fact exists, extends to the entire amount of the 
distribution and not merely to a part of such distribution. As used in 
this section, the term distribution includes a dividend as defined in 
subchapter C, chapter 1 of the Code, and a distribution in liquidation 
referred to in section 562(b).
    (b) The application of the provisions of section 562(c) may be 
illustrated by the following examples:

    Example 1. A, B, C, and D are the owners of all the shares of class 
A common stock in the M Corporation, which makes its income tax returns 
on a calendar year basis. With the consent of all the shareholders, the 
M Corporation on July 15, 1954, declared a dividend of $5 a share 
payable in cash on August 1, 1954, to A. On September 15, 1954, it 
declared a dividend of $5 a share payable in cash on October 1, 1954, to 
B, C, and D. No allowance for dividends paid for the taxable year 1954 
is permitted to the M Corporation with respect to any part of the 
dividends paid on August 1, 1954, and October 1, 1954.
    Example 2. The N Corporation, which makes its income tax returns on 
the calendar year basis, has a capital of $100,000 (consisting of 1,000 
shares of common stock of a par value of $100) and earnings or profits 
accumulated after February 28, 1913, in the amount of $50,000. In the 
year 1954, the N Corporation distributes $7,500 in cancellation of 50 
shares of the stock owned by three of the four shareholders of the 
corporation. No deduction for dividends paid is permissible under 
section 562(c) and paragraph (a) of this section with respect to such 
distribution.
    Example 3. The P Corporation has two classes of stock outstanding, 
10 shares of cumulative preferred, owned by E, entitled to $5 per share 
and on which no dividends have been paid for two years, and 10 shares of 
common, owned by F. On December 31, 1954, the corporation distributes a 
dividend of $125, $50 to E, and $75 to F. The corporation is entitled to 
no deduction for any part of such dividend paid, since there has been a 
preference to F. If, however, the corporation had distributed $100 to E 
and $25 to F, it would have been entitled to include $125 as a dividend 
paid deduction.

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