Corporate shareholders may prefer that the distribution be treated as a dividend, allowing the corporation to take advantage of the special dividends-received deduction under Code § 243 (which allows the dividends to only be taxed once at the corporate level).
On the other hand, individual shareholders often prefer that the distribution be treated as a redemption, for three reasons: A distribution qualifies as a stock redemption only if it significantly reduces the interest of the shareholder in the corporation.
A corporation will not recognize any gain or loss on a distribution of cash to its shareholders. But if the corporation distributes appreciated property, the corporation must recognize gain as if the property were sold to the shareholder at fair market value. Important Note: These two rules operate as a loss disallowance system.
If the corporation distributes appreciated property, the corporation is taxed on the gain under Code § 311(b).
Most frequently, companies pay cash dividends, which are direct cash payments in accordance to how many shares a shareholder owns.
But that section only covers gain on distributions of appreciated property.
If the corporation distributes property that has depreciated (i.e., property with a built-in loss), Code § 311(b) does not apply.
A dividend is classified as a stock dividend when a company issues stock to shareholders as a form of compensation.
For accounting purposes, when a company issues less than 25% of its outstanding shares, the transaction is considered to be a stock dividend.