What Is an Income Participating Security?

An income participating security (IPS) is a type of investment that combines common stock shares and income-yielding bonds. It is designed to provide regular income payments in the form of dividends paid on the stock and interest paid on the bonds.

An income participating security may also be called an income deposit security (IDS) or an enhanced income security (EIS).

A Closer Look at the IPS

A company that issues an IPS has a stable cash flow, limited capital expenditures demands, and low growth prospects. The company needs a way to encourage investment because its stock is unlikely to move dramatically.

For this reason, the bond portion of an IPS will offer a higher yield than most bonds.

The dividends paid on an IPS come out of the company's free cash flow. Usually, the company commits to distributing a specific percentage of free cash flow to IPS holders. Therefore, the amount paid may vary from month to month or from quarter to quarter, as with any stock dividend.

An income participating security generally trades on an exchange, and its two components can be separated and traded individually. Usually, the buyer must own the IPS for a specific length of time before it is sold.

The Tax Implications

Note that an IPS is sometimes called an income deposit security, and the reason relates to the tax implications of this type of investment.

Some portion of the IPS distribution may be considered a return of capital rather than an ordinary taxable dividend. A return of capital is taxed at 15%, which is the tax rate on capital gains.

The bond interest portion of an IPS, however, is taxable as ordinary income.