Monday, July 12, 2010

Tax Loophole of the Day - Weyerhaeuser Edition

"Forest products maker and homebuilder Weyerhaeuser Co (WY.N) said it would pay a $5.6 billion special dividend as part of its conversion to a real estate investment trust, sending its shares up 6.4 percent in morning trading.

For each share held, stockholders will receive $26.47, based on a calculation using Friday's closing stock price of $35.84, the company said on Monday.

About 90 percent of the dividend will be in stock, adding 538 million shares and more than tripling the company's share count, using the same metric of Friday's close, it said."

Now, WY is doing this because they want to convert to a REIT, (Real Estate Investment Trust) which requires them, according to the company, to payout the  "company's previously undistributed earnings since its inception."  This is where the $5.6 billion dollar number comes from.

What I find absurd is that they are allowed to "pay" these undistributed earnings out in cash or stock.  Look - when they "pay" 90% of a dividend in stock, they're not "paying" out anything  - it's just like a stock split.   When a stock splits 2 for 1, for example, that's a 100% stock dividend.  You receive 100% of the "value" of your current holdings in new stock - if you had 100 shares, you now have 200 shares.  Of course, this dilutes the shares outstanding, and the price adjusts accordingly (down 50%, in the case of a 2-1 split), and no value is created -nothing is "paid" out to shareholders.

The company, on the call this morning, noted:

"The distribution can be made with the combination of stock and cash and the entire distribution is taxable to shareholders as an ordinary dividend."

The entire distribution is taxable! Not just the cash portion!  The Reuters article was astute in noting:

"Shareholders who receive the special cash dividend will, in effect, assume most of the company's tax burden"

But wait - it gets better:  the company said it had discussed the possibility of a reverse stock split with its board, but will wait until after the distribution to further explore that possibility!

So, first they do what boils down to a stock split (with some cash thrown in too), restructuring their tax liabilities, and then will consider a reverse stock split!  Talk about a tax loophole.  Magic.

Note:  I have no position in WY - and there may well be future value for shareholders in this transaction based on the fact that as a REIT, WY will be able to distribute future earnings to shareholders with favorable tax treatment (from the company: Another benefit for shareholders is that most of the dividends received from a timber REIT is capital gain in nature.  Capital gain dividends are traditionally tax at rates more favorable than ordinary dividends and they can be used to their full extent to offset capital losses.)  - but it's shocking to me that they are allowed to meet the REIT requirements of "paying" out prior accumulated earnings by giving their shareholders more stock.   

EDIT: please note: nothing in this post, or any other post, for that matter, should ever be construed as tax or investment advice. 



Nemo said...

but it's shocking to me that they are allowed to meet the REIT requirements of "paying" out prior accumulated earnings by giving their shareholders more stock.

Why is that so "shocking"? As you noted, the stock distribution is taxable. So the government gets its cut (no pun intended).

Kid Dynamite said...

Nemo, I hear you, it's the phrasing of "paying out" that is bugging me. as stated, they aren't paying out anything.

mistere said...

Actually the 90% dodge goes back to regular reits and the gift that the IRS gave them by allowing dividends paid in kind to count for purposes of requiring that 90% of income is paid out each year. I believe in 2009 they issued a ruling that allowed this change due to the cash/ lending crunch.

mistere said...

dodge is wrong choice of words.. adjustment is perhaps better

Kid Dynamite said...

ahhh. now that you mention it, i vaguely recall what you're talking about...

it's just pretty insane to me that shareholders are paying taxes on 100% of the distribution, while only actually receiving 10%.

David Merkel said...

But even though the taxes will be higher than the cash distribution, so many investors have tax-loss carryforwards that they won't be affected.

I mean, I am looking at this on pullbacks. Looks like a neat idea.

But What do I Know? said...

It seems to me that they are sticking the shareholders with a tax bill--let's say I get $200 from the "distribution" -- $20 in cash and $180 in stock. I then have $200 in income for which I have only received $20 in cash, and as for the stock, I'm with you, KD, it sounds like a split to me. So for the privilege of paying taxes on phantom income, people rush out to purchase this bad boy yesterday.

What am I missing?

Kid Dynamite said...

yes BWDIK - exactly.

now, post REIT conversion, the company pays out 90% of its earnings to shareholders, avoiding double taxation, and shareholders also get favorable tax treatment on those distributions - cap gains vs ord income, but still - it seems somehow perverse to me to pay tax today on money that you're NOT getting, with the tradeoff of getting tax benefits on much smaller distributions for many years to come.

it would all be much more reasonable if the current shareholders were actually GETTING a payout - but they're not. (well, they're getting 10% of if)

Kid Dynamite said...

here's a surprisingly astute article on the dividend:

it only misses one major factor - the fact that shareholders don't actually GET the entire distribution - they get 10% of it in cash, and the rest in stock, which is not a distribution of any value at all, as was my point.

Chris of Stumptown said...

The stock dividend part of the REIT conversion had been floated several years ago.

I don't think recent tax changes had anything to do with it.

I may look at this for my IRA as obviously I have no tax consequences there.

Anonymous said...

The ONLY reason this method for converting to a REIT works is that the IRS waived the requirement that RIC's pay in cash the dividends.

The ruling allows up to 90% of the payment to be in stock.

That ruling ends this year.

The IRS ruling was to keep RIC's solvent through the credit crisis.

WY use of this is opportunistic.


R. Dobb

Anonymous said...

Between getting the distribution in cash and getting it in stock (a choice Weyerhaeuser seems to be offering) I see zero benefit to getting it in stock. If it's going to be taxed it a may a well be liquid. Or am I missing something?

Kid Dynamite said...

the total cash given out is limited though (to roughly 10% of the total)... so if everyone chooses cash, you get prorated.