President Bush’s pending proposal to eliminate (or at least substantially reduce) taxes on corporate dividends could create substantial value for family businesses. It could even improve the long-term survival rates of family companies.

The proposal probably won’t survive in its initial form, but any reduction of taxes on dividends for family shareholders would significantly affect the way family companies resolve a constant headache: the conflict between filling the shareholders’ liquidity needs and the company’s growth capital needs.

Let us count the ways:

• By making dividends more appealing to shareholders, the Bush tax plan would reduce the urge to sell stock to gain liquidity.

• By eliminating the “dividend tax” on stock sold in a redemption plan (as well as the imputed “stock dividend“ tax to the non-selling shareholders), it would make periodic stock redemption plans more attractive to the inactive cousins and aunts who are unhappy with their minority stakes.

• It would make the sub-Chapter S corporation and all its restrictions obsolescent, since no double taxes would be imputed on dividends.

• Family businesses would be more inclined to use “holding company” structures to design control and capital programs, since the issue of double taxation of funds passing from one affiliate to another would be eliminated.

• It would encourage companies to design “true” dividend policies, which could declare extraordinary dividends for extraordinary events, such as sale of assets.

• It would make “preferred recapitalizations” more attractive as a succession vehicle, since dividends on preferred stocks would no longer carry a large penalty.

• Because shareholders’ after-tax liquidity would increase, the Bush plan would allow a larger amount of capital to remain in the company for re-investment if the shareholders didn't desire more immediate liquidity.

One caveat: As less money leaves the company and its shareholders to go to the government, the company will have more capital with which to create—or destroy—value. In such a situation, shareholders will need to carefully analyze the best use of the additional available funds—whether to leave them in the company or reinvest them elsewhere.