Chapter 5 "Corporations: Earnings and Profits and Dividend Distributions"
Read all pages of L.O. 1 through L.O. 4
A corporation can make distributions to shareholders in a variety of ways including
nonliquidating cash or property distributions that are the subject of this chapter.
Dividends in General
Dividends are a gross income item (IRC § 61(a)(7)).
Issues for tax treatment at shareholder level:
 Corporate shareholders:

Individual shareholders:
Section 301 governs distributions to shareholders with respect to a corporation’s stock. The
distribution is characterized in the following order:
1. dividend to the extent of current or accumulated earnings and profits (IRC § 301(c)(1))
taxed as described above
2. return of shareholder investment/recovery of capital (IRC § 301(c)(2))
not taxed; AB of stock reduced
3. gain from sale or exchange of stock (IRC § 301(c)(3))
taxed as capital gain (LT or ST depending on holding period of stock)
Handout # 1
Measuring Earnings and Profits of a Corporation
E&P in general
E&P is not specifically defined in the Code, but the Code and Regulations provide a lot of
examples on the effect that corporate transactions have on E&P. The concept of E&P is aimed at
measuring economic income or the extent to which a corporation can pay a dividend without
impairing paid in capital.
HW 2
Computation of Current E&P
Current taxable income
Plus income that was excluded from taxable income
(e.g., tax-exempt interest, key person life insurance proceeds net of CSV of policy)
Plus items not deducted in measuring E&P (some of these are “artificial” tax deductions)
(e.g., organizational cost amortization, DRD, production activities deduction)
Minus expenses or losses not deductible in determining taxable income
(e.g., fines and penalties, 50% M&E, expenses related to tax-exempt income, key person
life insurance premiums net of increase in CSV of policy, related party loss)
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Plus or minus amounts subject to carryover
(e.g., NOLs, capital losses, charitable contributions)
Plus or minus accounting method adjustments
(e.g., depreciation including §179, gains and losses on depreciable assets, installment
sales – not allowed for E&P, completed contract – not allowed for E&P, LIFO vs. FIFO)
Plus federal tax refunds (or receivable) /Minus federal taxes paid (or payable)
= Current E&P
25, 27, 28 a, b, and c, HW 3, 4, rest of 28
Accumulated E&P => Sum of all prior years' E&P minus sum of all prior years' dividend
distributions (years after 2/28/1913)
To measure accumulated E&P going forward:
Accumulated E&P at beginning of year + Current E&P - Distributions treated as dividend
= Accumulated at end of year
E&P can be negative (have a deficit) due to operations.
HW 5
Allocating E&P to Distributions
1. If both current and accumulated E&P are positive, distributions are dividends to the
extent of the E&P.
If there is more than one distribution during the year and there is not sufficient E&P
to cover all the distributions, then E&P is allocated to the distributions following
these rules:
 allocate current E&P prorata based on the amount of distributions
 then allocate accumulated E&P chronologically
Handout #2
2. If current E&P is positive and accumulated E&P is negative, a distribution will be a
dividend to the extent of current E&P (i.e., ignore accumulated E&P).
If there is more than one distribution during the year and there is not sufficient current
E&P to cover all the distributions then
 allocate current E&P prorata based on the amount of the distributions
Handout #3
3. If current E&P is negative and accumulated E&P is positive, the accumulated amount and
the current amount as of the distribution date are netted. Current E&P at the date of the
distributions must be determined either based on actual information or by allocating the
year’s E&P prorata based on time.
Handout #4 and #5
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4. What is the other possibility for how the current and accumulated amounts can be
related?
Why don't we have to talk about that situation?
7, 31, 26, 32 HW 6, 24, 30, 33, 34, 35, 41
Property Distributions
General Rules
Distributing Corporation:
Taxable Income effects: Gains but not losses are recognized; character is based on the type of
asset distributed; measurement is done asset by asset
12, 13
E&P effects:
o A gain increases taxable income and also increases E&P
o The reduction in E&P for the distribution = Greater of 1. FMV or 2. AB of
property
THEN
minus any corporate liability relief (i.e., the liability relief is subtracted from
whichever number applies)
Shareholder:
 The dollar measurement of the distribution is the net FMV of property received (i.e.,
FMV minus corporate liabilities assumed by the shareholder)
 Then follow regular corporate E&P rules to determine whether the dollar amount is taxed
as dividend, return of capital, or capital gain (in the book examples, there is always
enough E&P to make it a dividend)
 The AB of the property = FMV
40, HW 14
Complication/Exception to General Rule: Corp. is relieved of a liability > FMV of the property it
distributes
The minimum FMV for measuring gain is the liability relief (i.e., use liability relief instead of
FMV if liability relief is larger); all FMVs above become “deemed” FMVs = liability relief
39 HW 42, 45
Overall 38 a to d, HW 1, 9, 18, 43, 44
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