Assignments

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Assignments

• For next class
• Problems C4-33, C4-34, C4-35, C4-37, C4-38,
  C4-40, C4-41, C4-42

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Corporate Nonliquidating Distributions
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Chapter
3
C Corporations

• Earnings and Profits

4
Earnings and Profits (EP)

• Current EP Calculation Regular taxable
  income (loss) - Federal income taxes (paid
  or accrued) /- EP adjustments Current
  EP

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Earnings and Profits (EP)

• Accumulated EP Calculation Beginning
  accumulated EP Current period EP-
  Distributions paid out of EP Ending
  accumulated EP

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Earnings and Profits (EP)

• Problems C4-28 and C4-29

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Earnings and Profits (EP)

• Reminder Dividends are distributions paid out of
  current and accumulated EP
• But what if one is negative and the other is
  positive?

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Example 1 EP Ordering Rules

• Assume
• Beginning accumulated EP is (100,000)
• Current period EP 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 EP?

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EP 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 EP
• 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)

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EP Ordering Rules

• Reg. 1.316-2(b) Distributions of property made
  during the year that exceed current EP are next
  deemed to be paid out of accumulated EP in
  chronological order (earliest year first)

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Example 1 EP Ordering Rules

• Assume
• Beginning accumulated EP is (100,000)
• Current period EP 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 EP is prorated to each distribution
• 30,000 on 3/31 (25,714 is paid out of EP)
• 30,000 on 6/30 (25,714 is paid out of EP)
• 40,000 on 9/30 (34,286 is paid out of EP)
• 40,000 on 12/31 (34,286 is paid out of EP)

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Example 2 EP Ordering Rules

• Assume
• Beginning accumulated EP is 135,000
• Current period EP 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 EP?

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EP Ordering Rules

• Reg. 1.316-2(b) When current EP is negative
  and beginning accumulated EP is positive
• Negative current EP is prorated to the
  distribution date (excluding the distribution
  date itself) and subtracted from beginning
  accumulated EP
• Distribution is deemed to be paid out of EP to
  the extent that the number above is positive

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Example 2 EP Ordering Rules

• Assume
• Beginning accumulated EP is 135,000
• Current period EP is (76,000)
• Cash distribution during the year (April 1st) was
  145,000
• Prorated current period EP deficit
• Days from 1/1 to 4/1 90
• 90/365 x (76,000) (18,740)
• EP on 4/1 135,000 (18,740) 116,260
• 116,260 dividend, 28,740 return of capital

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C Corporations

• Taxation of Property Distributions

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Taxation of Shareholders

• IRC 301(c)(1) Distributions of property that
  are dividends are included in the shareholders
  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)

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Taxation of Shareholders

• IRC 301(c)(2) (3) Distributions of property
  that are not dividends
• Are applied against and reduce the shareholders
  adjusted basis in the stock (but not below zero)
• Are treated as gains from the sale or exchange of
  property if they exceed the stocks adjusted
  basis (capital gain if the stock is a capital
  asset)

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Taxation of Shareholders

• IRC 301(d) The shareholders basis in noncash
  property received as a distribution from a C
  corporation is the propertys FMV on the date of
  the distribution (not reduced by any liabilities
  assumed)

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Example 3 - Distributions

• A corporation distributes 100,000 to its sole
  shareholder, 80,000 of the distribution is paid
  out of the corporations current and accumulated
  EP. The shareholders basis before the
  distribution is 30,000.
• 80,000 is taxable dividend income
• 20,000 is nontaxable but reduces the
  shareholders basis to 10,000

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Example 4 - Distributions

• A corporation distributes 100,000 to its sole
  shareholder, 45,000 of the distribution is paid
  out of the corporations current and accumulated
  EP. 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 shareholders basis to 0
• 25,000 is a taxable capital gain

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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

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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 gt adjusted basis)
• Gain increases taxable income and FIT
• Gain increases EP (based on EP 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

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Taxation of C Corporation

• EP is reduced (but not below zero) by
• Cash distributed IRC 312(a)(1)
• Principal amount of the corporations debt
  obligations distributed IRC 312(a)(1)
• The FMV of any appreciated property distributed
  IRC 312(b)(2)
• The EP adjusted basis of any other property
  distributed IRC 312(a)(3)
• EP reduction for distributions is net of any
  liabilities that shareholder assumes in
  connection with the distribution IRC 312(c)

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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 corporations
  EP before considering this distribution is
  120,000. The corporations tax rate is 34.
• What are the tax consequences to the shareholder
  and the corporation?

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Example 5 Noncash Distributions

• Shareholder
• Distribution amount equals 65,000100,000
  (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
• EP is reduced by 73,000 108,000 (basis) less
  35,000 (liability assumed) to 47,000

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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 corporations
  EP before considering this distribution is
  120,000. The corporations tax rate is 34.
• What are the tax consequences to shareholder and
  corporation?

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Example 6 Noncash Distributions

• Shareholder
• Distribution amount equals 90,000125,000
  (FMV) less 35,000 (liability assumed)
• 90,000 of taxable dividend income
• Basis in land is 125,000 (FMV)

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Example 6 Noncash Distributions

• Corporation
• 17,000 recognized gain 125,000 (FMV) less
  108,000 (basis) on the distribution
• EP effects
• Increases by 17,000 gain recognized
• Decreases by 5,780 FIT on gain (at 34)
• Decreases by 90,000 distribution125,000
  (FMV) less 35,000 (liability assumed)
• EP balance is 41,220