Windstream Spinoff Hits Dividend Even More Than You Think

by Michelle Corbet  on Monday, Aug. 18, 2014 12:00 am  

Jeff Gardner

On July 29, Windstream Holdings Inc. sent shock waves through Wall Street when it announced it would spin off most of its physical assets — mostly copper wires and fiber-optic cables — into a separate, publicly traded real estate investment trust.

The news energized Windstream stock, the price of which rose 26 percent in intraday trading before closing up a sweet 12 percent.

Other telecom stocks saw similar gains that day, after Windstream included in its announcement that it got a personal nod from the Internal Revenue Service that it could reclassify its infrastructure as real estate, cutting Windstream’s debt by $3.2 billion.

But a day later, the stock had settled back to just 7.5 percent above the pre-announcement close and has stayed in that neighborhood. Perhaps investors had time to consider some of the practical effects.

REITs, entities that we traditionally think of as owners of offices, apartments or shopping malls rather than telephone wires, have a tax advantage that other corporate entities do not: REITs don’t have to pay corporate income tax as long as they distribute at least 90 percent of taxable earnings in the form of dividends.

So by forming a REIT, Windstream is cutting its annual tax bill. Some analysts predict the move will cut the company’s tax responsibilities in half. But there’s no such thing as a free lunch.

Dividends paid by REITS are taxed as regular income — up to 43.3 percent. They don’t get the same favorable tax treatment as dividends from other corporations — a 15 or 20 percent tax rate, plus a 3.8 percent Obamacare surcharge for those of a higher tax bracket. So while Windstream’s tax rate goes down, the shareholder’s tax rate goes up.

That’s true of any REIT, and increased profitability could theoretically offset a higher tax rate. But that won’t be happening at Windstream, at least not immediately.

As was widely noted when the REIT spinoff was announced, Windstream is using the spinoff as an opportunity to reduce its $1-per-share dividend — the one that investors have loved and analysts have questioned as unsustainable. After the spinoff, Windstream anticipates paying 10 cents a share annually and the REIT 60 cents — for a total of 70 cents rather than the treasured $1.

But, in most cases, the hit to the shareholders’ bottom line will be considerably more than the obvious 30 percent.

That’s because in 2013, only 49 cents of that $1 dividend paid by Windstream was taxable income. The IRS classified the other 51 cents as a return of investor capital — essentially Windstream was giving stockholders’ money back to them, a true testament to the unsustainability of the dollar dividend. And even the IRS agrees that getting your own money back is not a taxable event. (In 2012, an even larger share of Windstream’s dividend was nontaxable.)

So let’s do the math using the highest possible federal tax bracket: For every $1 dividend received from Windstream in 2013, a high-income shareholder paid 23.8 percent on 49 cents of it. That’s a bit under 12 cents out of every dollar going to Uncle Sam.



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