Don’t Forget – Trust Preferred Shares Still Exist
By: Tim McPartland,
As we were doing work on the site trying to get our quotes fixed on the debt pages we noticed ‘Trust Preferreds’. This is a segment that we continually forget about, but it is certainly an area where the income investor may have some interest.
Remember that Trust Preferreds are preferred stocks of trusts that are formed by the issuer to purchase their debentures. It is kind of a tax dodge of sort that was allowed years ago. It works like this. 1) the Issuer forms a Trust 2) the Trust sells preferred stock 3) the Trust uses the proceeds to purchase debentures of the parent (issuer). The benefit to the issuer is that the interest they pay to the trust is now tax deductible. If they issued preferred stock directly to you and I and paid us dividends it would not be tax deductible.
Of course this wrangling means that the dividends that you receive as a holder of the Trust Preferreds are not dividends for tax purposes–they are treated as interest and as such are not taxed at the lower qualified tax rate. On the other hand a purchase here is somewhat safer than a preferred stock, because it is essentially debt (disguised as a preferred) and in a liquidation these shares would be higher on the food chain than regular preferred shares. Additionally, because it is debt there is a maturity date (most of the time) which in a rising rate environment would mean a little less volatility than the regular preferred shares.
One should be cautioned that most of these issues are now redeemable and as such one should consider only those issues at or just above par (by 2%) or there is a risk of capital loss if called for redemption.