Dividends in arrears are unpaid dividends on cumulative preferred stock that have piled up because the board of directors chose to skip one or more scheduled payments. They do not go away. The company must pay the full backlog to preferred shareholders before common shareholders can receive a single dollar in dividends.
When a Dividend Goes Into Arrears
A preferred dividend enters arrears when the board votes to skip a scheduled payment, a step known as “passing” the dividend. Boards typically do this when cash reserves are low, earnings have declined, or management wants to redirect funds toward operations or expansion.
A skipped preferred dividend is not the same as a missed bond payment. Interest on a bond is a binding debt; a preferred dividend is discretionary until the board formally declares it. Passing the dividend is not a default, and creditors cannot force the company into bankruptcy over it. The unpaid amount sits in a holding pattern until the board decides to resume distributions, and there is no fixed deadline for catching up.
Only Cumulative Preferred Stock Accumulates Arrears
Whether skipped dividends accumulate depends entirely on the terms of the shares. Cumulative preferred stock requires the company to track every missed payment and eventually pay the full backlog before anything goes to common shareholders. Those rights are set out in the company’s certificate of incorporation or an authorized board resolution.
Non-cumulative preferred stock works differently. If the board passes a dividend on non-cumulative shares, that payment is gone for good. The shareholder has no right to collect it later, and no arrears accumulate. Because of this risk, investors generally pay a premium for cumulative shares, and most publicly traded preferred stock carries the cumulative feature. Before buying preferred shares, check the prospectus or charter for the specific dividend terms; that language controls your rights.
How the Balance Is Calculated
The math is straightforward. Multiply the stated dividend per share by the number of periods missed, then by the number of shares outstanding.
- Preferred stock terms: $2.00 annual dividend per share, paid quarterly ($0.50 per quarter)
- Shares outstanding: 100,000
- Quarters missed: 6
- Total arrears: $0.50 × 6 × 100,000 = $300,000
In this example, the company would need to pay the full $300,000 backlog plus the current quarter’s $50,000 preferred dividend before it could distribute anything to common shareholders. When a company has struggled for several years, the arrears balance can grow large enough to make resuming common dividends impractical even after the business recovers.
Payment Priority Over Common Shareholders
The defining feature of cumulative preferred stock is strict payment priority. When the board is ready to resume dividends, the company must first clear the entire arrears balance across all cumulative preferred shares, then pay the current period’s preferred dividend, and only then distribute anything to common shareholders.
This priority is set by the company’s charter and reinforced by state corporate law. Many state statutes restrict a corporation’s ability to pay dividends in ways that would impair the preferences owed to senior classes of stock. Directors who ignore the priority and pay common dividends while preferred arrears remain outstanding can face personal liability.
Where to Find the Amount Owed
Dividends in arrears do not appear as a liability on the balance sheet. A dividend becomes a legal obligation, and therefore a recorded liability, only after the board formally declares it. Until then, the unpaid amount is an unrecognized commitment.
Companies disclose the existence and total amount of cumulative preferred dividends in arrears in the footnotes to their financial statements. Generally accepted accounting principles require this footnote disclosure so investors know about the obligation even though it is not on the main financial tables.1PwC. 23.3 Commitments Look in the Stockholders’ Equity section or the Notes to Financial Statements in the company’s 10-K or 10-Q filings with the SEC.
Effect on Earnings Per Share
Arrears also affect reported earnings per share. When a company calculates basic EPS, it must subtract cumulative preferred dividends from net income in the numerator, even if those dividends were never declared or paid during the period. The reasoning is that earnings belonging to preferred shareholders should not inflate the per-share figure available to common shareholders.
A company can therefore report positive net income but show a lower or even negative EPS for common stock once the preferred obligation is accounted for. When comparing companies, check whether the EPS figure already reflects this deduction, especially for firms with large outstanding preferred balances.
Voting Rights After Missed Payments
Preferred shareholders usually have no voting rights. Most cumulative preferred stock agreements, though, include a protective provision that grants voting rights after dividends have gone unpaid for a set number of periods, commonly six quarterly payments. Once the trigger is hit, preferred shareholders voting as a class can typically elect two additional directors to the board and keep that right until the arrears balance is paid in full.2SEC.gov. Prospectus for 9.00% Series A Cumulative Redeemable Preferred Stock The threat of losing board seats creates a strong incentive for management to resolve arrears when the company can afford to.
Tax Treatment When Arrears Are Paid
If you hold cumulative preferred shares with dividends in arrears, you owe no tax on the unpaid amounts while they remain unpaid. Dividends are taxed in the year you actually receive the payment, not in the year they were originally due.3Internal Revenue Service. Publication 550 (2024), Investment Income and Expenses When the company finally catches up and sends a lump sum covering several years of back dividends, the entire amount is reportable as income in the year of receipt.
The portion of the payment treated as a dividend, meaning it comes out of the corporation’s current or accumulated earnings and profits, is included in your gross income.4Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property If the dividends qualify as “qualified dividends,” they are taxed at the preferential long-term capital gains rates of 0%, 15%, or 20% depending on your overall income. To qualify, you must have held the preferred stock for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date. For preferred dividends attributable to a period exceeding 366 days, the required holding period extends to at least 91 days during a 181-day period.5Internal Revenue Service. IRS Gives Investors the Benefit of Pending Technical Corrections on Qualified Dividends
A large lump-sum catch-up payment could push you into a higher tax bracket in the year you receive it. If you expect one, consider talking to a tax professional about whether estimated tax payments are needed to avoid underpayment penalties.
What Happens in Bankruptcy or Liquidation
If a company with dividends in arrears enters bankruptcy, the outlook for preferred shareholders is generally poor. Preferred stock, including any accumulated arrears, is an equity claim, not a debt claim. Bondholders, trade creditors, and secured lenders all stand ahead of preferred shareholders in the payout line. Preferred rank above common, but in many bankruptcies little is left after creditors are paid.
In a Chapter 11 reorganization, the absolute priority rule governs distribution of value. Senior creditors must be paid in full before any junior class receives anything. Preferred shareholders with large arrears may receive only a fraction of what they are owed, or nothing at all, unless the reorganized company has enough value to cover all debt claims first.
A voluntary liquidation outside bankruptcy can play out better. The charter typically provides that preferred holders receive their liquidation preference plus any accumulated arrears before common shareholders get a distribution, provided the company’s assets are sufficient to cover the amount owed.