Question

The Barryman Drilling Company was initially planning on repurchasing $1,000,000 worth of the company's 500,000shares of stock, which is currently trading at a price of $10.00 per share. Stan Barryman is the founder of the company and still holds 10,000shares of company stock that he originally purchased for $8.00 per share. After consideration, the company is reconsidering its plan to repurchase its common stock and instead plans to pay the $1,000,000 as a cash dividend, which amounts to $2.00 per share of common stock. If dividends are taxed at 15 percent, what tax liability does this create for Stan Barryman? What will be Stan's after-tax proceeds from the dividend distribution?

Answer 1

Stan holds 10,000 shares of common stock in the company.

Dividend to be distributed will be $2.00 per share of common stock.

Dividend distributed to Stan = 10,000 shares x $2 per share = $20,000

Tax on Dividend = 15%

Tax Liability for Stan = Dividend tax on dividend proceeds = 15% on $20,000 = $3,000

(Please note that Stan is not selling his shares, so there is no capital gains tax applicable here. He is just receiving the dividends distributed by the company)

Stan's after tax proceeds from the dividend distribution = Dividends distributed to Stan - Tax liability of Stan on Dividend receipts = $20,000 - $3,000 = $17,000

Thus, dividend distribution creates a tax liability of $3,000 for Stan. Stan's after-tax proceeds from the dividend distribution is $17,000.