Taxable Preferred Securities
What are Taxable Preferred Securities?
How Do Taxable Preferred Securities Work?
Like shares of common stock, shares of preferred stock represent an ownership stake in a company. However, as the term "preferred" suggests, preferred stock carries certain advantages. For example, if a company declares bankruptcy, preferred shareholders are second in line to get paid -- after bondholders but before common stockholders.
Dividends on preferred stocks must also be paid before dividends on common stocks. Dividends paid on common stock are not guaranteed and can fluctuate from quarter to quarter, but preferred shareholders are usually guaranteed a fixed dividend paid on a regular basis. As a result, preferred stocks often act similar to bonds.
If the dividends paid on preferred stocks are not tax-exempt, then they are taxable preferred securities.
Why Do Taxable Preferred Securities Matter?
Like taxable bonds, taxable preferred securities have higher pre-tax yields than tax-exempt preferred securities. When comparing taxable and tax-exempt securities, it is always important to adjust the yields so you are comparing them on an apples-to-apples basis (known as "taxable equivalent yield").