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AssignmentsAssignments

For next class:Problems: C4-33, C4-34, C4-35, C4-37, C4-38,

C4-40, C4-41, C4-42

ChapterChapter44Corporate Nonliquidating

DistributionsCorporate Nonliquidating

Distributions

C CorporationsC Corporations

Earnings and Profits

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Earnings and Profits (E&P)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

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Earnings and Profits (E&P)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

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Earnings and Profits (E&P)Earnings and Profits (E&P)

Problems C4-28 and C4-29

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Earnings and Profits (E&P)Earnings and Profits (E&P)

Reminder: Dividends are distributions paid out of current and accumulated E&PBut what if one is negative and the other is positive?

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Example 1: E&P Ordering RulesExample 1: E&P Ordering Rules

Assume:Beginning accumulated E&P is $(100,000)Current period E&P is $120,000Cash 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?

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E&P Ordering RulesE&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)]

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E&P Ordering RulesE&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)

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Example 1: E&P Ordering RulesExample 1: E&P Ordering Rules

Assume:Beginning accumulated E&P is $(100,000)Current period E&P is $120,000Cash distributions of $30,000 on 3/31 and 6/30,

$40,000 on 9/30 and 12/31, total of $140,000Current 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)

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Example 2: E&P Ordering RulesExample 2: E&P Ordering Rules

Assume:Beginning accumulated E&P is $135,000Current period E&P is ($76,000)Cash distribution during the year (paid on April 1st)

was $145,000Q: What portion of the distribution is paid out

of accumulated E&P?

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E&P Ordering RulesE&P Ordering Rules

[Reg. §1.316-2(b)] When current E&P is negative and beginning accumulated E&P is positiveNegative 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

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Example 2: E&P Ordering RulesExample 2: E&P Ordering Rules

Assume:Beginning accumulated E&P is $135,000Current period E&P is ($76,000)Cash distribution during the year (April 1st) was

$145,000Prorated current period E&P deficit:

Days from 1/1 to 4/1 = 9090/365 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 CorporationsC Corporations

Taxation of Property Distributions

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Taxation of ShareholdersTaxation of Shareholders

[IRC §301(c)(1)] Distributions of property that are dividends are included in the shareholder’s taxable incomeMaximum 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 ShareholdersTaxation 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)

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Taxation of ShareholdersTaxation 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)

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Example 3 - DistributionsExample 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

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Example 4 - DistributionsExample 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

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Taxation of C CorporationTaxation 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 CorporationTaxation 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 FITGain 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

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Taxation of C CorporationTaxation 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)]

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Example 5 – Noncash DistributionsExample 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?

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Example 5 – Noncash DistributionsExample 5 – Noncash Distributions

Shareholder:Distribution amount equals $65,000

[$100,000 (FMV) less $35,000 (liability assumed)]$65,000 of taxable dividend incomeBasis in land is $100,000 (FMV)

Corporation:No gain or loss on the distributionE&P is reduced by $73,000 [$108,000 (basis) less

$35,000 (liability assumed)] to $47,000

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Example 6 – Noncash DistributionsExample 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?

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Example 6 – Noncash DistributionsExample 6 – Noncash Distributions

Shareholder:Distribution amount equals $90,000

[$125,000 (FMV) less $35,000 (liability assumed)]$90,000 of taxable dividend incomeBasis in land is $125,000 (FMV)

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Example 6 – Noncash DistributionsExample 6 – Noncash Distributions

Corporation:$17,000 recognized gain [$125,000 (FMV) less

$108,000 (basis)] on the distributionE&P effects:

Increases by $17,000 gain recognizedDecreases 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