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Chapter
8
Distributions to Business
Owners
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Key Words / Outline
Slide 8-3
C Corporations
Subject to double taxation
Distributions out of earnings and profits
taxable to shareholders as dividends
Dividends now taxable at maximum rate of 15%
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Slide 8-4
Earnings and Profits
Two types:
Current Earnings and profits
Accumulated Earnings and profits
Any payment out of either account will
result in a taxable dividend to the
shareholder
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Slide 8-5
Current Earnings and Profits
 Any distribution not in excess of current
earnings and profits is a dividend
 Negative accumulated earnings and
profits ignored if current earnings and
profits positive
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Slide 8-6
Accumulated Earnings and Profits
Current earnings and profits reduced by
dividends added into accumulated earnings
and profits
If current earnings and profits is negative, it
is netted from accumulated earnings and
profits to determine if a distribution is a
dividend
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Slide 8-7
Nondividend Distributions
Any distribution in excess of earnings and
profits
Treated as a return of capital to extent of
stock basis
Stock basis must be reduced by nontaxable
portion
Any excess is capital gain
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Slide 8-8
Property Distributions
Distributions of appreciated property cause
a corporation to recognize gain
Current earnings and profits also increased
as a result of the gain recognized
Earnings and profits reduced by fair market
value of appreciated property distributed
Losses not recognized on distributions of
depreciated property
Earnings and profits decreased by adjusted
basis of depreciated property
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Slide 8-9
Stock Dividends
Distributions of additional shares of stock
Generally nontaxable to shareholder
Will be treated as a taxable distribution if
shareholders can choose between stock
and cash
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Slide 8-10
Constructive Dividends
Payments or transfers for the benefit of the
shareholders
Treated as taxable distributions
Examples:
Corporation pays personal expenses
Use of corporate property for personal
purposes
Unreasonable compensation to
shareholder/employee
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Slide 8-11
Penalty Taxes
Designed to prevent conversion of ordinary
income into capital gain by appreciation of
corporate stock
Types:
Accumulated earnings tax
Personal holding company tax
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Slide 8-12
Accumulated Earnings Tax
Tax imposed upon corporation if a
corporation accumulates funds beyond
reasonable need of the business
Tax imposed at a 15% rate
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Slide 8-13
Accumulated Earnings Tax Base
Tax imposed on after tax income reduced
by
Any dividends paid during the period
Accumulated earnings tax credit
Amount needed by corporation to meet reasonable
business needs
Never less than $250,000 except for personal service
corporations
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Slide 8-14
Personal Holding Company Tax
Imposed at the highest individual tax rate
on undistributed personal holding company
taxable income
Currently maximum rates for both corporations
and individuals is 35% so no incentive to shelter
corporate income from tax at individual rates
Corporation must be a personal holding
company
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Slide 8-15
Personal Holding Company
60% of ordinary gross income from
investment sources such as dividends,
interest, rent and royalties
Five or fewer individuals own directly or
indirectly more than 50% of stock during the
last half of the year
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Undistributed Personal
Holding Company Taxable Income
Slide 8-16
After-tax ordinary income less dividends
paid
Deficiency dividends can be paid to
eliminate the tax
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Slide 8-17
Partnership Distributions
Two types:
Current distribution – reduces partner’s capital
account
Liquidating distribution – extinguishes partner’s
interest in partnership
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Slide 8-18
Cash Distributions
Generally nontaxable
Exception: cash distribution in excess of
partner’s outside basis
Distributions reduce outside basis
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Property
Distributions-Accounting Treatment
Slide 8-19
Gain or loss recognized on distribution to
extent property exceeds or is less than fair
market value.
Gain or loss allocated to all partners
Partner’s capital account reduced by fair
market value of distribution
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Property Distributions-Tax
Consequences
Slide 8-20
Generally nontaxable to partner
No gain or loss recognized to partnership
Partner’s basis in property is same as
partnership’s basis in property
If basis of property is greater than recipient
partner’s outside basis, basis of property to
partner is outside basis of partnership. Outside
basis become zero
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Slide 8-21
S Corporation Distributions
Generally nontaxable as long as does not
exceed shareholder’s basis in stock
Cash distribution decreases shareholder’s
basis in S corporation stock
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Slide 8-22
Special Rules for S Corporations
with Earnings and Profits
Only applies to S corporations that were
formerly C corporations
Special rules do not apply if C corporation
had no earnings and profits when S election
made or all earnings and profits distributed
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Slide 8-23
S Corporations with E and P
Cash distributions nontaxable to extent do
not exceed accumulated adjustments
account (AAA)
Any amount in excess of AAA treated as a
taxable dividend to extent of earnings and
profits
Any amount in excess of earnings and
profits is a nontaxable return of capital up to
shareholder’s basis in stock
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Accumulated Adjustments
Account
Slide 8-24
Represents undistributed S corporation
earnings
Cash distributions reduce account but not
below zero
Losses reduce AAA
Any distribution during a loss year is
deemed made before account is decreased
for the loss
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Slide 8-25
C Corporation Conversions
S corporations reverting to C corporations
have a favorable transition rule on
distributions
Any distribution made within one year of
conversion is nontaxable as long as AAA not
exceeded
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Slide 8-26
Property Distributions
Generally C corporation rules apply to S
corporations making these distributions
Gains but not losses recognized
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