A corporation raises capital by the issuance of shares entitling holders to an ownership interest. The stock holders will be issued stock certificates. When a company’s profits increase, the value of the company shares also increases.
Stocks can be transferred from one person to another. Stocks can be legally gifted. This can act as a strategy to shift income for tax benefits. Capital gain taxes are paid based on the applicable tax rate of the receiver. Therefore, when an original buyer of stocks is in a higher tax bracket, a lesser amount of tax will be paid on gifting stocks.
When a person gifts stocks of a corporation to another with a bona fide intention, if the beneficial ownership of the stock is also transferred along with dividend rights, the dividend income from the stock will be shifted to the donee. Even if the original owner transfers only a partial interest to a donee, the partial dividend income will shift to the donee. If a donee of a life interest in stock also has dividend rights, the donee can be taxed for the dividends during his/her life[i].
The general rule is that a stockholder cannot gift the right to dividends alone while keeping apart the ownership of the stock. According to the assignment of income rules, a shareholder will be taxed for the dividend received. This rule is applicable even if the corporation pays the dividend directly to the donee. The corporation’s dividend payment to the donee is the shareholder’s gift or assignment of stock to the donee[ii].
Under certain conditions, a shareholder can make a gift of stock to another even by retaining the rights to dividends. In such conditions, the original shareholder receives the dividends and is liable to pay taxes for the dividends. This can continue even if the company pays the dividend to the donee as s/he is the record owner of the stock[iii].
[i] Mahaffey v. Helvering, 140 F.2d 879 (8th Cir. 1944)
[ii] Ward v. Commissioner, 58 F.2d 757 (9th Cir. 1932)
[iii] Smith v. Commissioner, 70 T.C. 651 (T.C. 1978)