What is Cumulative Preferred Stock?

Cumulative preferred stock is a form of preferred stock that allows the issuer of the stock to withhold or omit the payment of dividends under certain conditions. While the payment date for the dividends may pass, this does not mean the investor loses the dividend altogether. Instead, the dividend payments will accumulate until such time as the issuer determines circumstances have changed and the dividends may be distributed to the shareholders.

One of the more common reasons for delaying a dividend payment on cumulative preferred stock is poor performance of the corporation that issued the stock. When the earnings generated during the period are not up to projections, the company may shortly experience a period where available cash is low. Depending on the terms and conditions connected with the issuance of the stock, the company may inform shareholders that the dividend payments scheduled for the upcoming quarter will be omitted.

Shareholders who own shares of cumulative preferred stock have a couple of advantages over investors who hold shares of common stock. When the company begins to issue dividend payments again, every investor holding shares of the stock will receive past and present dividend payments before any dividend payments are issued to shareholders with common stock.

A second benefit is that the holder of cumulative preferred stock is protected when the board of directors suspends the payment of dividends. While this will impact investors holding common stock, these holders may still claim any and all dividends earned up to the date of the board action.

The temporary suspension of making dividend payments is not unusual. Generally, the suspension will not last for more than a couple of payment periods before dividend payments resume. In the interim, investors with cumulative preferred stock are still accumulating dividends in their accounts, even though payments are not currently taking place. Once the issuing corporation begins to issue payments again, the investor can look forward to the omitted payments being caught up over the next few payment cycles.

It is important to remember that even though dividends are being credited to the investor account, there is no tax liability until the dividend payments are actually received. For this reason, corporations who do issue cumulative preferred stock usually have a practice of dating the payments so they fall into the tax year where the payments are actually issued, rather than back dating the payments. This means the investor does not have to file amended returns to account for stock dividends earned in previous periods and possibly incur a penalty.