Chapter 7
Corporations keep two separate E&P accounts
Current earnings and profits – economic income earned during the current year
Accumulated earnings and profits – undistributed earnings and profits accumulated in all
prior years
Non Taxable Income included in earnings and profits: tax exempt income that can be
distributed to shareholders. Included in E&P by adding these amounts to compute current E&P
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Municipal interest
Life insurance proceeds
Deductible expenses that do not reduce E&P – deductions that require no cash outlay or are
carryovers from another year no not represent current economic outflows and cant be used to
reduce current E&P. these deductions are added back to taxable income when computer
current E&P
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Dividends Received Deduction
Net capital loss carryovers
Net operating loss carryovers
Charitable contribution carryovers
Non deductible expenses that reduce current E&P: a corporation reduces current E&P for
certain expenditures that are not deductible in computing taxable income but require a cash
outflow.
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Federal income taxes paid or accrued
Expenses incurred in earning tax exempt income
Current year charitable contributions in excess of the taxable income percentage (no
percentage limited for E&P purposes)
Premiums on life insurance in excess of the policys cash surrender value
Current year net capital loss ( no limit for E&P)
Non deductible meal expenses
Non deductible entertainment expenses
Non deductible political contributions
Non deductible penalties and fines
Disallowed business interest expense
Items requiring separate accounting methods for E&P Purposes. Some types of income
deferred from the current year must be included in current E&P. Certain expenses deducted in
computing taxable income are deferred in current E&P
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Organizational expenditures must be capitalized
Depreciation must be calculated using the E&P method
o Property acquired after 1986 (ADS) Alternative Depreciation System must be
used. Requires that assets be depreciated using the asset depreciation range
o Bonus depreciation is not allowed
o Amounts expenses under section 179, (first year expensing) must be amortized
over 4 years for E&P
Ordering of E&P Distributions
Corporations must refer to both current and accumulated E&P in determining the amounts of
distributions that are deemed to be dividends
1. Distributions are dividends up to the balance of the current E&P
2. Distributions in excess of current E&P are dividends up to balance of the in accumulated
E&P
Whether a distribution is considered a dividend depends on whether the balance in these
accounts is positive or negative
1. Positive current E&P; positive accumulated E&P
a. Distributions are paid out of current E&P first. Any amount in excess of current
E&P comes from accumulated E&P.
2. Positive current E&P; negative accumulated E&P
a. Distributions paid out of current E&P are considered dividends
b. Distributions in excess of current E&P are considered a return of capital
c. If the non dividend exceeds the stock basis, its considered a capital gain
3. Negative current E&P; positive accumulated E&P
a. Tax status is determined by the balance in Accum E&P on the date of distribution
b. The available accum E&P is computed by allocating the current negative E&P up
to the distribution date and then subtracting from accumulated E&P
c. Distributions in excess of E&P are a return on capital
4. Negative current E&P; negative accumulated E&P
a. None of the distribution is treated as a dividend
b. Distributions will be a return of capital to the extend of the tax basis, any excess
will be a capital gain
E&P cannot be reduced below zero by distributions, it can only be reduced by a loss
Chapter 8
Realization gain or loss that results from an exchange of property rights in a transaction.
Amount realized the value of everything received by the seller in a transaction (cash, FMV of
other property, and relief of liabilities) less selling costs.
Adjusted tax basis an asset’s carrying value for tax purposes at a given point in time,
measured as the initial basis (for example, cost) plus capital improvements less
depreciation or amortization.
Transactions subject to tax deferral
For shareholders to receive a tax deferral in a transfer of property to a corporation, the
transferors must meet all three requirements in SS 351 as follows:
1. One or more shareholders must transfer property to a corporation
2. Shareholders who transfer property to the corporation (i.e. the transferrors) must receive
stock of the transferee corporation in exchange for the property they transfer.
3. Immediately after the transfer the transferors, together, must control the corporation to
which they transferred the property.
Boot -property given or received in an otherwise nontaxable transaction such as a likekind exchange that may trigger gain to a party to the transaction. The term boot derives
from a trading expression describing additional property a party to an exchange might
throw in “to boot” to equalize the exchange.
Type of stock can be common or preferred, voting or non voting, does not include stock
warrants, rights or options. Property transferred in exchange for debt is not eligible for
deferral under section 351
When a transferor of property (shareholder) receives boot in a section 351 transaction
1. Gain, but not loss, is recognized when property other than the corporations stock (boot)
is received in the exchange
2. Gain is recognized in an amount equal to the lesser of the gain realized or the fair
market value of the boot received.
3. The tax basis of the stock received in the exchange equals the adjusted tax basis of the
property transferred, less any liabilities assumed by the corporation on the property
contributed.
4. The shareholders stock basis is increased by any gain recognized and reduced by the
fair market value of any boot received.