Ch 18 Flashcards
Ch 18 Corp Taxation: Non Liquidating Distributions
A C Corp can distribute its after-tax profits to its shareholders in the form of…
1) Dividend
2) Stock Redemption
3) Partial Liquidation
Dividend
Any distribution of property made by a corporation to its shareholders out of its earnings + profits (E+P) account.
E+P prop or $ —> S/H from Corp
Stock Redemption
a property distribution made to shareholders in return for some or all of their stock in the distributing corporation that is not in partial or complete liquidation of the corporation
Partial Liquidation
a distribution made by a corporation to shareholders that results from a contraction of the corporation’s activities
If a shareholder serves in some other capacity in the business (eg. employee, creditor, lessor), the company may be able to distribute its before-tax profits to this person in the form of …
Compensation (salary or bonus)
Interest
Rent
Are dividends deductible from taxable income to the corporation?
No
Are dividends included in a shareholder’s gross income?
Yes
Constructive Dividend
a payment made by a corporation to a shareholder that is recharacterized by the IRS or courts as a dividend even though it is not characterized as such by the corpration
Examples of Constructive Dividends
- Unreasonable Compensation
- Shareholder use of corporate assets without an arm’s length payment
- Interest payment to shareholder at excessive interest rates
- payments made by a corporation on behalf of a shareholder
When a corporation distributes property to shareholders (in their capacity as shareholders), the shareholders will characterize the distribution as either…
Dividend Income
OR
Return of Capital
Return of Capital Distribution
not considered income to share holder
but rather a reduction in the shareholder’s tax basis in the stock
If return of capital “distribution” exceeds the tax basis of the stock, how is the excess distribution (above basis) taxed?
capital gain from sale of shares
Stock Dividends
a dividend of a corporation’s own stock
Congress intended earnings and profits to be a measure of the corporation’s ________ ________ available for distribution to its shareholders.
economic earnings
Corporate E + P is divided into what 2 accounts:
Current E + P (CE+P)
Accumulated E + P (AE+P)
Distributions are designated as dividends from E + P in the following order:
Current, then Accumulated
What happens to undistributed current E + P?
It is added to the balance of accumulated E + P on the first day of the next tax year
How do distributions affect E + P?
- distributions reduce E + P, but cannot produce a deficit in E + P (although E + P can have a deficit from losses)
- a corporation can’t distribute E + P if there is a deficit in E + P
- a corporation that makes a distribution in excess of E + p must report the distribution on Form 5452 and include in the calculation of its E + P balance to support tax treatment
Earnings + Profits
economic income eligible for distribution to shareholders
the computation of current E + P begins with
taxable income or loss
corporate current E + P begins with taxable income or loss and then adjustments are made in the following categories
- certain nontaxable income is included in E + P
- certain deductions do not reduce E + P
- certain nondeductible expenses reduce E + P
- the timing of certain items of income and deduction is modified for E + P calculations because separate accounting methods are required for E + P purposes
Nontaxable income included in current E + P
- tax-exempt income is economic income and can be distributed to shareholders
- thus tax-exempt income increases E + P
- examples: tax exempt municipal interest + tax exempt life insurance proceeds
(contributions to capital do not represent income and are not included in E + P)
Deductible expenses that do not reduce current E + P
deductions that require no cash outlay by the corporation or are carryovers from another tax year don’t represent current economic outflows and can’t be used to reduce E + P
eg: dividends received deduction
domestic production activities deduction
capital loss carryovers from a different tax year
net operating loss carryovers from a different tax yr
Do deductions allowed for employee exercises of nonqualified stock options reduce E + P?
Yes, because the bargain element of the option reflects an economic cost to the corporation even though it does not require a cash outflow from the corporation
Nondeductible expenses that reduce current E + P
items that are not deductible in computing taxable income but require a cash outflow; eg,
- federal income taxes paid or accrued
- expenses incurred in earning tax-exempt income
- current year charitable contributions in excess of 10% of taxable income
- premiums on life insurance contracts in excess of the increase in the policy’s cash surrender value
- current-year net capital loss
- meals and entertainment expenses disallowed
- nondeductible lobbying expenses and political contributions
- penalties and fines
Items Requiring Separate Accounting Methods for E + P Purposes
Installment sales method
Like-kind exchange deferred gain
Organization expenditures
Depreciation
Possible scenarios for E + P balances
- Positive current E + P, positive accumulated E + P
- Positive current E + P, negative accumulated E + P
- Negative current E + P, positive accumulated E + P
- Negative current E + P, negative accumulated E + P
Order of Distributions when both CE + P and AE + P are positive, distributions exceed CE+P and shareholders ownership changes during the year
- Paid from current 1st
- If distributions exceed current E + P, amount distributed out of current E + P is allocated pro rata to all distributions made throughout year
- Any distribution out of AE+P is allocated to recipients in chronological order in which distributions were made
Distributions when CE+P is positive and AE+P is negative
- Current 1st - treated taxable as dividends
- Excess CE+P treated as nontaxable reductions in shareholders tax basis in stock
- Then excess treated as gain from sale of stock
Distributions when CE+P is negative and AE+P is positive
- Prorate CE+P to distribution date and add it to the AE+P balance at the beginning of the year to get the total E+P at distribution date.
- Excess distributions - treated as reductions in the shareholders’ tax basis in their stock
- Excess above that - treated as a capital gain
Distributions when both CE+P and AE+P are negative
- None of the distribution is treated as a dividend
- 1st reductions in shareholders’ tax basis in stock
- Then capital gain
When noncash property is received, shareholder determines the amount distributed as follows:
Money received
+FMV of other property received
-Liabilities assumed by s/h on property received
=Amount Distributed
As a general rule, a shareholder’s tax basis in noncash property received as a dividend equals…
the property’s FMV
Tax consequences to a corporation paying noncash property as a dividend
- Losses are not recognized
- Taxable gains are recognized on distribution to the extent that the FMV exceeds corporation’s tax basis
- Since gain increases taxable income, it also increases E+P
If liability is assumed by the shareholder receiving a property distribution and the liability is greater than the property’s FMV, the property’s FMV is deemed to be…
the amount of the liability assumed by the shareholder
If liability is assumed by the shareholder receiving a property distribution and the liability is less than the property’s FMV, the gain recognized is…
the excess of the property’s FMV over its tax basis
When a corporation distributes appreciated noncash property (FMV > income tax basis),
it must recognize the gain and pay income tax on the gain
Effect on CE+P when corporation gives property to shareholder and FMV > regular income tax basis:
- If E+P basis = regular income tax basis,
gain increases CE+P and
taxes paid (or payable) decreases CE+P - If E+P basis does not = regular income tax basis,
gain increases CE+P by FMV over E+P basis and
taxes paid (or payable) decreases CE+P
When a corporation distributes appreciated noncash property (FMV < income tax basis),
it is not allowed to deduct the loss for taxable income tax purposes
Effect on CE+P when corporation gives property to shareholder and FMV < regular income tax basis:
corporation cannot deduct the loss in determining CE+P
thus the distribution does not affect current E+P
