Slide 7-1
Assignments
For next class:
Problems: C4-33, C4-34, C4-35, C4-37, C4-38,
C4-40, C4-41, C4-42
Chapter
4
Corporate Nonliquidating
Distributions
C Corporations
Earnings and Profits
Slide 7-4
Earnings and Profits (E&P)
Current E&P Calculation:
Regular taxable income (loss)
- Federal income taxes (paid or accrued)
+/- E&P adjustments
= Current E&P
Slide 7-5
Earnings and Profits (E&P)
Accumulated E&P Calculation:
Beginning accumulated E&P
+ Current period E&P
- Distributions paid out of E&P
= Ending accumulated E&P
Slide 7-6
Earnings and Profits (E&P)
Problems C4-28 and C4-29
Slide 7-7
Earnings and Profits (E&P)
Reminder: Dividends are distributions paid out
of current and accumulated E&P
But what if one is negative and the other is positive?
Slide 7-8
Example 1: E&P Ordering Rules
Assume:
Beginning accumulated E&P is $(100,000)
Current period E&P is $120,000
Cash distributions during the year were $140,000:
$30,000 on 3/31
$30,000 on 6/30
$40,000 on 9/30
$40,000 on 12/31
Q: What portion of the distribution is paid out
of current E&P?
Slide 7-9
E&P Ordering Rules
[IRC §316(a) and Reg. §1.316-2(a)]
Distributions of property made during the year
are first deemed to be paid out of current E&P
Calculated on last day of year, without reducing by
current year distributions [Reg. §1.316-2(b)]
Allocated on pro rata basis regardless of when
distributions are actually made during the year
(distribution/total distributions) [Reg. §1.316-2(b)]
Slide 7-10
E&P Ordering Rules
[Reg. §1.316-2(b)] Distributions of property
made during the year that exceed current E&P
are next deemed to be paid out of accumulated
E&P in chronological order (earliest year first)
Slide 7-11
Example 1: E&P Ordering Rules
Assume:
Beginning accumulated E&P is $(100,000)
Current period E&P is $120,000
Cash distributions of $30,000 on 3/31 and 6/30,
$40,000 on 9/30 and 12/31, total of $140,000
Current E&P is prorated to each distribution:
$30,000 on 3/31 ($25,714 is paid out of E&P)
$30,000 on 6/30 ($25,714 is paid out of E&P)
$40,000 on 9/30 ($34,286 is paid out of E&P)
$40,000 on 12/31 ($34,286 is paid out of E&P)
Slide 7-12
Example 2: E&P Ordering Rules
Assume:
Beginning accumulated E&P is $135,000
Current period E&P is ($76,000)
Cash distribution during the year (paid on April 1st)
was $145,000
Q: What portion of the distribution is paid out
of accumulated E&P?
Slide 7-13
E&P Ordering Rules
[Reg. §1.316-2(b)] When current E&P is
negative and beginning accumulated E&P is
positive
Negative current E&P is prorated to the distribution
date (excluding the distribution date itself) and
subtracted from beginning accumulated E&P
Distribution is deemed to be paid out of E&P to the
extent that the number above is positive
Slide 7-14
Example 2: E&P Ordering Rules
Assume:
Beginning accumulated E&P is $135,000
Current period E&P is ($76,000)
Cash distribution during the year (April 1st) was
$145,000
Prorated current period E&P deficit:
Days from 1/1 to 4/1 = 90
90/365 x ($76,000) = ($18,740)
E&P on 4/1 = $135,000 + ($18,740) = $116,260
$116,260 dividend, $28,740 return of capital
C Corporations
Taxation of Property Distributions
Slide 7-16
Taxation of Shareholders
[IRC §301(c)(1)] Distributions of property that
are dividends are included in the shareholder’s
taxable income
Maximum 15% tax rate for qualifying dividends
received by individual shareholders [IRC §1(h)(11)]
Dividends received deduction allowed for dividends
received by corporate shareholders [IRC §243(a)]
Slide 7-17
Taxation of Shareholders
[IRC §301(c)(2) & (3)] Distributions of
property that are not dividends:
Are applied against and reduce the shareholder’s
adjusted basis in the stock (but not below zero)
Are treated as gains from the sale or exchange of
property if they exceed the stock’s adjusted basis
(capital gain if the stock is a capital asset)
Slide 7-18
Taxation of Shareholders
[IRC §301(d)] The shareholder’s basis in
noncash property received as a distribution from
a C corporation is the property’s FMV on the
date of the distribution (not reduced by any
liabilities assumed)
Slide 7-19
Example 3 - Distributions
A corporation distributes $100,000 to its sole
shareholder, $80,000 of the distribution is paid
out of the corporation’s current and accumulated
E&P. The shareholders basis before the
distribution is $30,000.
$80,000 is taxable dividend income
$20,000 is nontaxable but reduces the shareholder’s
basis to $10,000
Slide 7-20
Example 4 - Distributions
A corporation distributes $100,000 to its sole
shareholder, $45,000 of the distribution is paid
out of the corporation’s current and accumulated
E&P. The shareholders basis before the
distribution is $30,000.
$45,000 is taxable dividend income
$30,000 is a nontaxable return of capital that reduces
the shareholder’s basis to $0
$25,000 is a taxable capital gain
Slide 7-21
Taxation of C Corporation
[IRC §311(a)(2)] Except as otherwise provided
in subsection (b), no gain or loss is recognized to
a corporation on the distribution of property with
respect to its stock
Slide 7-22
Taxation of C Corporation
[IRC §311(b)] C Corporations must recognize
gains on distributions of appreciated property to
shareholders as if the property were sold at its
FMV (appreciated means FMV > adjusted basis)
Gain increases taxable income and FIT
Gain increases E&P (based on E&P basis)
If shareholder assumes a liability as part of the
distribution, the FMV of the property transferred is
deemed to be no less than the amount of the liability
Slide 7-23
Taxation of C Corporation
E&P is reduced (but not below zero) by
Cash distributed [IRC §312(a)(1)]
Principal amount of the corporation’s debt
obligations distributed [IRC §312(a)(1)]
The FMV of any appreciated property distributed
[IRC §312(b)(2)]
The E&P adjusted basis of any other property
distributed [IRC §312(a)(3)]
E&P reduction for distributions is net of any
liabilities that shareholder assumes in connection
with the distribution [IRC §312(c)]
Slide 7-24
Example 5 – Noncash Distributions
A corporation distributes land with a FMV of
$100,000 and an adjusted basis of $108,000 to
its sole shareholder. The shareholder assumes a
$35,000 mortgage on the land. The corporation’s
E&P before considering this distribution is
$120,000. The corporation’s tax rate is 34%.
What are the tax consequences to the
shareholder and the corporation?
Slide 7-25
Example 5 – Noncash Distributions
Shareholder:
Distribution amount equals $65,000
[$100,000 (FMV) less $35,000 (liability assumed)]
$65,000 of taxable dividend income
Basis in land is $100,000 (FMV)
Corporation:
No gain or loss on the distribution
E&P is reduced by $73,000 [$108,000 (basis) less
$35,000 (liability assumed)] to $47,000
Slide 7-26
Example 6 – Noncash Distributions
A corporation distributes land with a FMV of
$125,000 and an adjusted basis of $108,000 to
its sole shareholder. The shareholder assumes a
$35,000 mortgage on the land. The corporation’s
E&P before considering this distribution is
$120,000. The corporation’s tax rate is 34%.
What are the tax consequences to shareholder
and corporation?
Slide 7-27
Example 6 – Noncash Distributions
Shareholder:
Distribution amount equals $90,000
[$125,000 (FMV) less $35,000 (liability assumed)]
$90,000 of taxable dividend income
Basis in land is $125,000 (FMV)
Slide 7-28
Example 6 – Noncash Distributions
Corporation:
$17,000 recognized gain [$125,000 (FMV) less
$108,000 (basis)] on the distribution
E&P effects:
Increases by $17,000 gain recognized
Decreases by $5,780 FIT on gain (at 34%)
Decreases by $90,000 distribution
[$125,000 (FMV) less $35,000 (liability assumed)]
E&P balance is $41,220