Why is preferred stock not tax-deductible?
Preferred shares are a hybrid form of capital issued by firms that are equity-based but pay out a stable dividend as if they were debt. Because the dividends paid out use after-tax dollars, preferred shares do not offer the firm an immediate tax deduction, as interest paid on debt would.
Preferred Stock: No Tax Advantage
Like common stock dividends, preferred share dividends are distributions of profits, not interest payments. The IRS does not consider distributions of profits tax-deductible. Corporations issue preferred stock for valid reasons, but a tax advantage isn't one of them.
Preferred stock dividends are not tax deductible to the company who issues them. Preferred stock dividends are paid out of after-tax cash flows so there is no tax adjustment for the issuing company.
Most preferred stock dividends are treated as qualified dividends, meaning they are taxed at the more favorable rate of long-term capital gains.
Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.
[13] For accounting purposes, the preferred stockholders here are required to treat the preferred stock as debt since it is a collateralized mortgage obligation (CMO). See FASB Technical Bulletin 85-2, effective for CMOs issued after March 31, 1985, and FASB Issue Summary Number 89-4, Supplement Number 6.
Issuing preferred shares allows companies to diversify their capital structure, access additional funding sources and cater to investors with specific preferences for steady income and reduced risk. That tends to be a different group of investors than those who gravitate toward common shares.
Dividends on preferred shares are taxable income, but the tax rate you pay depends on whether the IRS considers the dividends to be "qualified." Qualified dividends are taxed at lower rates than ordinary income. For 2023 and 2024, the tax rate ranges from 0 % to 20% depending on your tax bracket.
Reduced Interest Rate Risk: Many preferreds can reduce the interest rate risk in a diversified portfolio given their potential to be called by the issuer and or become floating rate securities. With potential relatively high starting yields, preferreds may be used as a substitute for equities or high yield bonds.
Common stock is usually sold at the fair market value, with a higher potential for capital gains. Preferred stock is usually sold at a higher amount based on the valuation and due to the liquidation preference it receives.
How is preferred stock treated?
Preferred stocks are like bonds, and both make consistent payments. Also like bonds, preferred stocks can pay a fixed dividend, but may also pay a floating rate that depends on some benchmark interest rate. Unlike debt, payments on preferred stock are not tax-deductible.
Similar to a bond, a preferred stock regularly pays income. The difference is that preferred stocks pay income in the form of a dividend, whereas bonds pay interest and the return of principal at maturity. Preferred stock is sensitive to fluctuations in interest rates.
Preferred stock must have a holding period of at least 90 days during the 180-day period that begins 90 days before the stock's ex-dividend date. Holding also applies when receiving new stock in a company spun off from the original company in which the investor purchased stock.
Preferred stocks are particularly attractive investments after major dislocations such as the great financial crisis or the Pandemic. This occurs because the asset class usually becomes oversold with most securities trading well below par value.
- High-yield savings accounts.
- Money market funds.
- Short-term certificates of deposit.
- Series I savings bonds.
- Treasury bills, notes, bonds and TIPS.
- Corporate bonds.
- Dividend-paying stocks.
- Preferred stocks.
Government bonds (aka "Treasurys") are generally considered the safest investments because they're backed by the full faith and credit of the U.S. government. Other types of bonds include corporate bonds and municipal bonds (earnings on the latter are exempt from federal taxes).
In most cases, preferred stock is considered perpetual. This means that the initial capital invested will not be returned. An investor must sell their shares at their choosing to redeem the shares.
Investors like preferred stock because this type of stock often pays a higher yield than the company's bonds. So if preferred stocks pay a higher dividend yield, why wouldn't investors always buy them instead of bonds? The short answer is that preferred stock is riskier than bonds.
Since preferred stock comes with a fixed dividend yield, they are highly sensitive to interest rates. If market-wide interest rates rise above the yield of a preferred stock, it will become harder to sell that stock on the market, and investors would have to accept a steep discount if they wish to sell.
Some founders are now getting roughly 10%, 15%, or 20% of their normal common allocation in founder preferred stock. This is a special class of stock that converts to preferred stock when the founders sell it to investors during a future round of financing.
Does Coca-Cola have preferred stock?
CocaCola total common and preferred stock dividends paid for the twelve months ending December 31, 2023 were $-14.220B, a 17.53% decline year-over-year. CocaCola annual total common and preferred stock dividends paid for 2023 were $-7.952B, a 4.41% increase from 2022.
| Preferred Stock ETF | Dividend Yield* | Expense Ratio |
|---|---|---|
| Invesco Preferred ETF (PGF) | 5.5% | 0.56% |
| SPDR ICE Preferred Securities ETF (PSK) | 5.6% | 0.45% |
| Invesco Financial Preferred ETF (PGX) | 5.8% | 0.50% |
| VanEck Preferred Securities ex Financials ETF (PFXF) | 6.9% | 0.41% |
APPLE INC.
The Company is authorized to issue Common Stock and Preferred Stock.
The dividends for preferred stocks are by definition determined in advance and paid out before any dividend for the company's common stock is determined. The dividend may be a set percentage or may be tied to a particular benchmark interest rate. The dividend is generally paid on a quarterly or annual basis.
If you want income now and don't want to take on additional risk, then preferred stocks are probably your best option. If you want long-term returns for the future, then common stocks are probably your best option. Common stocks will give you more growth potential, but you won't get a fixed dividend payment.
