Dividends in arrears are unpaid dividends on cumulative preferred stock that have piled up because the board chose not to declare them in one or more prior periods. They do not vanish. The company must pay the full backlog to preferred shareholders before common shareholders receive a single dollar of dividends. The obligation sits outside the balance sheet as an unrecognized commitment, but it shapes voting rights, earnings per share, tax bills, and the pecking order in a bankruptcy.
How a Dividend Ends Up in Arrears
A preferred dividend is discretionary until the board formally declares it. When directors vote to skip a scheduled payment, that is called “passing” the dividend. Skipping is not a default. Unlike missed interest on a bond, a passed preferred dividend is not a legal debt, and creditors cannot force the company into bankruptcy over it.
The unpaid amount stays in a holding pattern until the board votes to resume distributions. There is no fixed deadline for catching up. But if the shares are cumulative, the balance keeps growing with each missed period, and the company cannot pay common dividends until it clears the backlog.
Cumulative vs. Non-Cumulative Preferred Stock
Whether skipped dividends actually accumulate depends on the terms in the company’s certificate of incorporation or the board resolution that created the stock class. Cumulative preferred stock requires the company to track every missed payment and eventually pay the full backlog before touching common dividends.
Non-cumulative preferred stock works differently. A passed dividend on non-cumulative shares is gone permanently. The shareholder has no right to collect it later. Because of that 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. The language in those documents controls your rights.
How to Calculate Dividends in Arrears
The math is straightforward. Multiply the stated dividend rate per share by the number of periods missed, then multiply by shares outstanding.
Consider a preferred stock with a $2.00 annual dividend paid quarterly at $0.50 per share, and 100,000 shares outstanding. If the company passes six consecutive quarterly dividends, the arrears balance is $0.50 × 6 × 100,000, or $300,000. Before paying anything to common shareholders, the company would need to clear that $300,000, plus the current quarter’s $50,000 preferred dividend. For a company that has struggled for years, the 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 distributions, three things must happen in order: pay the entire arrears balance on all cumulative preferred shares, 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, which restricts a corporation’s ability to pay dividends in ways that would impair the preferences of a senior stock class. Directors who ignore the priority and pay common dividends while preferred arrears remain outstanding can face personal liability for breaching their fiduciary duties.
Where Dividends in Arrears Appear in Financial Statements
A detail that surprises many investors: dividends in arrears do not appear as a liability on the balance sheet. A dividend becomes a recorded liability only after the board formally declares it. Until that declaration, the unpaid amount is an unrecognized commitment.
Companies instead 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 are aware of the obligation even though it does not show up in the main financial tables.1PwC. 23.3 Commitments You can typically find the disclosure in the Stockholders’ Equity section or the Notes to Financial Statements within a company’s 10-K or 10-Q filings with the SEC.
The Effect on Earnings Per Share
Arrears also change how a company reports earnings per share. Under ASC 260, the basic EPS calculation subtracts cumulative preferred dividends from net income in the numerator, even if those dividends were never declared or paid during the period. The logic is that earnings owed to preferred shareholders should not inflate the per-share figure available to common shareholders.
A company can therefore report positive net income and still show a lower or even negative EPS for common stock once the preferred obligation is accounted for. When comparing companies with large preferred stock balances, check whether the reported EPS already reflects this deduction.
Voting Rights After Missed Payments
Preferred shareholders typically have no voting rights under normal circumstances. Most cumulative preferred stock agreements, though, include a protective provision that grants voting rights after dividends have gone unpaid for a specified number of periods, commonly six quarterly payments. Once triggered, preferred shareholders voting as a class can usually elect two additional directors, giving them a direct voice in governance until the arrears balance is cleared.
This mechanism is standard in publicly listed preferred stock. SEC filings for listed preferred issues commonly specify that after six missed quarterly dividends, preferred holders gain the right to elect two additional board members at a special or annual meeting, with that right continuing until all accrued and unpaid dividends are paid in full.2SEC.gov. Prospectus for 9.00% Series A Cumulative Redeemable Preferred Stock The prospect of losing board seats creates a strong incentive for management to resolve arrears when cash permits.
Taxes When the Company Finally Pays
You owe no tax on arrears 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 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 that payment coming out of the corporation’s current or accumulated earnings and profits is included in your gross income as a dividend.4Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property If the dividends qualify as “qualified dividends,” they are taxed at the 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 stock 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 catch-up payment in a single year can push you into a higher tax bracket. If you expect one, consider talking to a tax professional about whether you need to make estimated tax payments to avoid an underpayment penalty.
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 rather than a debt claim. Bondholders, trade creditors, and secured lenders all stand ahead of preferred shareholders in the payout line. Preferred ranks above common, but in many bankruptcies little or nothing remains after creditors are paid.
In a Chapter 11 reorganization, the absolute priority rule controls. Senior creditors must be paid in full before any junior class receives anything. Preferred shareholders with large arrears balances 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. Some plans offer junior stakeholders warrants or options in the restructured company, which are far less valuable than the original dividend rights.
Preferred shareholders fare better in a voluntary liquidation outside of bankruptcy. 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.