October 5, 2021
What are constructive dividends?
Constructive dividends are how the IRS classifies a common practice of a company officer, using company assets for personal gains for tax purposes. A typical scenario – in small businesses – may be the use of a company credit card to purchase groceries. In larger corporations, it could be using company vehicles as personal transportation.
In reviewing such transactions, the IRS will typically consider these transactions as “constructive dividends” and simply tax the person. “Dividends” here refer to dispersals to the individual as shareholder compensation. But there are times when the practice goes too far.
When do constructive dividends become criminal matters?
This can be an extremely subjective point. Mostly, constructive dividends are one of the benefits of being a company’s shareholder. However, a company is not a blank check to its owners and officers, and the benefits of being a corporate officer must not be seen as abusive. Certain “red flag” dividends can appear as:
- Excessive levels of personal expenditures
- Frequent, low-interest loans
- Use of company property for private reasons
- Generous payments to family
- Debt management
By themselves, any of these activities may not raise a red flag. The IRS would look at frequency, amounts, benefits to you, and many other factors before taking any action.
What are the penalties for constructive dividend abuse?
At the very least, a person would be liable to pay income taxes on the constructive dividends once they have been classified as such. At worst, the IRS could see the activity as a form of embezzlement and take action.
The personal benefits that come with being a company officer are quite good. However, there are strict limits to what is and is not acceptable. Crossing those boundaries may indeed land you into some trouble.