Corporate & Partner Tax Instructor: Dwight Drake

C Corp Distribution Lingo

1. Dividend – Corp distributes cash or property to shareholders as a result of operations – not part of redemption of stock or liquidation. Distribution is “with respect to stock” and qualifies as dividend under 316.

2. Return of Capital - Corp distributes cash or property with respect to its stock which is not 316 dividend, nor part of redemption or liquidation.

3. Stock dividend – Corp distributes its own stock or debt obligation to its shareholders as a result of operations – not associated with a redemption or liquidation.

4. Redemption – Corp distributes money or property to shareholder to purchase (or redeem) stock owned by the shareholder.

5. Liquidation – Corp distributes money or property to shareholder as part of plan to liquidate or partially liquidate the business of the corporation.

Corporate & Partner Tax Instructor: Dwight Drake

316 “Dividend” Definition

Distribution is treated as dividend if:

1. Out of earnings and profits accumulated since 2/28/1913

2. Out of its earnings and profits for the current year, determined at end of year and without regard to E & P amount at time of distribution.

Priority rules:

- Every distribution deemed made from E & P to the extent thereof. Corp can’t designate otherwise.

- Distributions deemed made from the most recent E & P.

Corporate & Partner Tax Instructor: Dwight Drake

The 301 Triple Tax Priority

Distribution Amount: Amount of money plus fair market value of property distributed.

Triple Priority: Distribution with respect to stock:

Priority One: If dividend under 316, included in gross income.

Priority Two: If not dividend, applied to reduce adjusted basis of stock. Tax free return of capital.

Priority Three: If exceeds basis, excess treated as gain from the sale or exchange of property.

Corporate & Partner Tax Instructor: Dwight Drake

Determining E & P

Concept: The true economic growth and improvement of the corporation. No precise definition.

Calculation: Start with taxable income, then:

Increase for other economic gains: Tax exempt interest, life insurance proceeds, tax refunds, etc. (but not nonrecognition gains under 1033, 351, etc.)

Increase for deductions that have no economic effect: Dividends received

deduction, excess percentage depletion, etc. Decrease for economic losses not reflected in taxable income: federal taxes,

losses between related parties, excess T & E expenses

Timing differences: Depreciation, 453 installment sales; FIFO inventory, etc.

Corporate & Partner Tax Instructor: Dwight Drake

Problem 518 Current Earnings and Profits Calculation:

Taxable Income 8,450

Add Items:

Tax-exempt interest 3,000 Dividend deduction 3,500 Excess Depreciation 1,800 (STL, half yr. convention) Total Increases 8,300 Subtract Items: Excess LTGL (current only) 2,500 Est. fed taxes 800 Total Decreases (3,300) Current E & P 13,450

Corporate & Partner Tax Instructor: Dwight Drake

Problem 518 Taxable Income Calculation:

Income items:

Gross profit from sales 20,000 Dividends 5,000 LTCG 2,500

Total 27,500

Deductions

Salaries 10,250 Dividend deduction (243) 3,500 Depreciation 2,800 LTCL (To extent of LTCG) 2,500

Total 19,050

Taxable Income 8,450

Corporate & Partner Tax Instructor: Dwight Drake

Problem 522 Basic Facts: A owns all common stock of P Corp, basis of 10k from prior 351

exchange.

(a) Year 1: 5k current E&P, no accumulated E&P, 17.5k distribution. What tax effect.

- 5k dividend for current E&P per 316 and 301.

- 10k return of capital

- 2.5k treated as gain on sale of stock per 301. May be LTCG.

A stock basis reduced to 0. P Corp’s E&P is 0.

(b) Year 2: 15k deficit in accumulated E&P. Current E&P 10k and 10k distributed to A.

- A has 10k dividend per 316(a)(2).

- P Corp’s accumulated deficit E&P remains at 15k.

- P Corp’s current E&P reduced to 0 per 312(a)(1).

Corporate & Partner Tax Instructor: Dwight Drake

Problem 522 Basic Facts: A owns all common stock of P Corp, basis of 10k from prior 351

exchange.

(c) Year 2: 10k accumulated E&P. 4k current E&P. April 1 – 10k to A. July 1 – A sells ½ stock to B for 15k. Oct 1 – 5k to A, 5k to B.

- Current E&P allocated pro rata to all distributions in year. Accumulated E&P allocated on first come-first serve basis. Thus…

- April 1 10k distribution to A: 2k from current E&P and 8k from accumulated. Current reduce to 2k, accumulated reduced to 2k (10k-8k).

- October 1 10k distribution to A & B: 2k for current (1k each) and 2k from accumulated (1k each). Each have return of capital of 3k (5k-2k).

P Corp E&P reduced to 0.

Corporate & Partner Tax Instructor: Dwight Drake

Problem 522 Basic Facts: A owns all common stock of P Corp, basis of 10k from prior 351

exchange.

(d) Year 2: 10k accumulated E&P. 10k current deficit E&P. April 1 – 10k to A. July 1 – A sells ½ stock to B for 15k. Oct 1 – 5k to A, 5k to B.

- Current E&P deficit allocated pro rata during year to reduce accumulated E&P. Accumulated E&P allocated on first come-first serve basis. Thus…

- April 1 10k distribution to A: 2.5 k from current deficit (1/4 year), so accumulated E&P down to 7.5k. Dividend 7.5k, return of capital 2.5k.

- October 1 10k distribution to A & B: No E&P left, so all return of capital.

- B’s basis reduced from 15k to 10k.

- A’s 10k basis reduced to 7.5k by 4/1 distribution and to 2.5k by 10/1 distribution. Sale of half stock to B creates 13,750 gain (15k less 1.25k basis).

Corporate & Partner Tax Instructor: Dwight Drake

Problem 527 Basic Facts: Z owns all common stock of S Corp, basis of 8k; 25k accumlated

E&P, no current E&P.

(a) S distributes to Z inventory – FMV 20k, basis 11k.

- S Corp has gain of 9k (20k-11k) per 311(b)(1) and current E&P goes to 9k.

- Z has 20k dividend: 9k from current E&P; 11k from accumulated E&P

- Z basis in inventory 20k.

- S Corp accumulated E&P to next year 14k (25k-11k)

(b) Same as (a) but no accumulated E&P.

- S Corp has gain of 9k (20k-11k) per 311(b)(1) and current E&P goes to 9k. - Z has 9k dividend: 9k from current E&P; 8k return of capital; 3k LTCG - Z basis in inventory 20k. - S Corp accumulated E&P to next year is 0. Property distribution reduces

E&P to extent thereof per 312(a).

Corporate & Partner Tax Instructor: Dwight Drake

Problem 527 Basic Facts: Z owns all common stock of S Corp, basis of 8k; 25k accumulated

E&P, no current E&P.

(c) S distributes to Z land – FMV 20k, basis 11k, debt 16k.

- S Corp has gain of 9k 1231 gain (20k-11k) per 311(b)(1) and current E&P goes to 9k.

- Z has 4k dividend (20k less 16k): Plenty of accumulated E&P

- Z basis in land 20k.

- S Corp accumulated E&P to next year is 30k (25k plus 9k gain, less 4k distribution)

Corporate & Partner Tax Instructor: Dwight Drake

Problem 527 Basic Facts: Z owns all common stock of S Corp, basis of 8k; 25k accumulated

E&P, no current E&P.

(d) S has 15k current E&P distributes to Z land – FMV 20k, basis 30k.

- S Corp has loss of 10k (30k-20k), but can’t recognize per 311(a)

- Z has 20k dividend : Plenty of accumulated E&P

- Z basis in land 20k.

- S Corp accumulated E&P to next year is 10k (25k + 15k current E & P, less 30k basis in land)

Note: if sold and then distributed cash, S Corp recognizes 10k loss. Z still has 20k dividend. S Corp’s E&P carryover still 10k (40k less 10k loss, less 20k distribution). Only difference is 10k recognized loss.

Corporate & Partner Tax Instructor: Dwight Drake

Problem 527 Basic Facts: Z owns all common stock of S Corp, basis of 8k; 25k accumulated

E&P, no current E&P.

(e) S distributes to Z equipment – FMV 10k, basis 0 for tax; 2k for E&P

- S Corp has gain of 10k ordinary gain (10k-0k).

- Z has 10k dividend: Plenty of accumulated E&P

- Z basis in equipment 10k.

- S Corp accumulated E&P to next year is 23k (25k + 10k gain, less 2k basis in land, less 10k distribution)