Weyerhaeuser’s Special Dividend: 

  WY has become a most tax efficient vehicle, 
  but there was a cost to get there

WY will transform from being a regular C corporation into a Real Estate Investment Trust (REIT). Owners of WY will go from paying two levels of taxation on lumber profits to paying just one level of tax. Because of some unique tax attributes of timber, that single layer of tax will be at long-term gains rates. But there was a cost to changing from being a 110-year-old corporation into a REIT and whoever owned the shares on July 22^nd paid it.

WY is not the first company to take this route, it is the fifth.  Plum Creek Timber Company was the first in 1999; Rayonier was next in 2004, followed by Longview Fibre and Potlatch. WY is the second largest holder of U.S. timberland behind Plum Creek. A REIT is a flow through vehicle as long as at least 90% of its income is distributed to shareholders, similar rules to those controlling mutual funds. If the income is not distributed the REIT would be taxed as a regular corporation. Any long-term capital gains earned by the REIT will retain their character as they are distributed into the hands of its shareholders.

In order to wind-up the C corporation, the company had to distribute all of its Earnings and Profits that hadn’t been paid out to shareholders over its long history. This amounted to $5.6 Billion; $26.47 a share. WY was trading at about $36 at the time of the announcement. The ex-dividend date was just 1 week from the company’s announcement although it will not be paid until September. Taxable shareholders will feel the pain next April when they realize they need to pay a tax on what turned out to be mostly phantom income.

You see WY is paying 90% of its special $5.6 Billion dividend in stock. Although the bulk of the dividend will be paid in stock, the entire $26.47 dividend will be taxable. The number of shares outstanding willl go up substantially from 211.6 million  to approximately 526.6 million; equating to a 2.5 for 1 stock split. A stock split creates dilution across the shareholder base and is thought to have no economic value. Unlike a “normal” stock split this one will be taxable.

The chart below illustrates why taxpayers owning WY with a cost basis of $13.53 (a projected ex-dividend price if the stock closed at $40 the night before) or more should have avoided WY’s dividend record date. Anyone holding the shares with a higher cost basis would have been well served by selling at $40 the day before WY went ex-dividend and buying in again the next morning at $13.53.

TAXABLE INCOME

 Back to the good news, on an ongoing basis WY’s holders will have increased the after tax income from their timber holdings by atleast 50%. The chart below shows the math. As a corporation the government’s 2 levels of tax would take 48 out of every 100 of timber profit; as an timber REIT cutting down or selling trees, WY holders will keep 80 out of every 100. This comparison assumes that dividends would continue to be taxed at long-term gains rates. The double tax on corporate profits ran to (and might again reach) 61%. Compare that to a stream of long-term gains that could be taxed at just 15 or 20% and you can see why WY and these other companies converted to REIT status.

$100 gross income                                   $100  gross income
-$35 corporate  tax                                  $    0  No Corporate Tax
$65 paid to holders                      Income Taxed as Long term Gains

$55.25 after 15% tax                                $85   after 15% tax
$52      after 20% tax                                $80   after 20% tax

There is the possibility that dividends will revert to being taxed as ordinary income. In that case shareholders would keep only $39 after a 35% tax at the corporate level and a 39.6% Federal tax.  Timber REIT holders would double their after tax income versus what they’d keep if they stayed in C corporate form

Converting a timber company to a REIT seems a true stroke of tax efficient genius; I just hope that taxable holders were smart enough to not stay around and windup voluntarily paying the toll for the conversion.

For those thinking that a very large dividend might create some interesting out-sized tax arbitrage possibilities, think twice the government has thought of that too. There are “extraordinary dividend” rules for both corporations and individuals treating both long and short positions. Investors with capital gains might see a utility in buying WY before the ex-dividend date and selling soon after. These investors should be aware that not only do the shares have to held for a minimum of 61 days unhedged for the dividend to be qualified but any losses will be long-term not short-term. There is a possibility here that those with ONLY short-term gains could exploit (see articles on our website on “extraordinary dividends”).   Investors with capital losses might think shorting WY before the ex-dividend date and covering right after will turn their capital losses into an interest deduction. They too will be disappointed, the “extraordinary dividend” rules force a minimum 1 year holding period in order for the short dividend expense to be a deduction rather than an adjustment in basis.