A preferred stock is a class of ownership in a corporation that provides a higher claim on its assets and earnings as compared to common stock. There is no direct tax advantage to the issuing of preferred shares when compared to other forms of financing such as common shares or debt.
Why There Is No Direct Tax Advantage
The reason for this is that preferred shares, which are a form of equity, are paid fixed dividends with after-tax dollars. This is the same case for common shares. If dividends are paid out, it is in after-tax dollars.
Preferred shares are considered to be like debt in that they pay a fixed rate like a bond (a debt investment). It is because interest expenses on bonds are tax deductible — while preferred shares pay with after-tax dollars — that preferred shares are considered a more expensive means of financing. Issuing preferred shares does have its benefits over bonds in that a company can stop making payments on preferred shares where they are unable to stop making payments on bonds without going into default.
Why Issuing Preferred Shares Benefits Companies
There are a few reasons why issuing preferred shares are a benefit for companies.
One benefit of issuing preferred shares is that for financing purposes they do not reflect added debt on the company's financial books. This actually can save money for the company in the long run. When the company looks for debt financing in the future, it will receive a lower rate since it will appear the company's debt load is lower — causing the company to in turn pay less on future debt.
Preferred shares also tend not to have voting rights, so it creates another benefit in that issuing preferred shares does not dilute the voting rights of the company's common shares.
(For more information on preferred shares, see Introduction to Convertible Preferred Shares.)