Ch 18

Question 1

A C Corp can distribute its after-tax profits to its shareholders in the form of…

Answer 1

1) Dividend
2) Stock Redemption
3) Partial Liquidation

Question 2

Dividend

Answer 2

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

Question 3

Stock Redemption

Answer 3

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

Question 4

Partial Liquidation

Answer 4

a distribution made by a corporation to shareholders that results from a contraction of the corporation’s activities

Question 5

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 …

Answer 5

Compensation (salary or bonus)
Interest
Rent

Question 6

Are dividends deductible from taxable income to the corporation?

Answer 6

No

Question 7

Are dividends included in a shareholder’s gross income?

Answer 7

Yes

Question 8

Constructive Dividend

Answer 8

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

Question 9

Examples of Constructive Dividends

Answer 9

1. Unreasonable Compensation
2. Shareholder use of corporate assets without an arm’s length payment
3. Interest payment to shareholder at excessive interest rates
4. payments made by a corporation on behalf of a shareholder

Question 10

When a corporation distributes property to shareholders (in their capacity as shareholders), the shareholders will characterize the distribution as either…

Answer 10

Dividend Income
OR
Return of Capital

Question 11

Return of Capital Distribution

Answer 11

not considered income to share holder

but rather a reduction in the shareholder’s tax basis in the stock

Question 12

If return of capital “distribution” exceeds the tax basis of the stock, how is the excess distribution (above basis) taxed?

Answer 12

capital gain from sale of shares

Question 13

Stock Dividends

Answer 13

a dividend of a corporation’s own stock

Question 14

Congress intended earnings and profits to be a measure of the corporation’s ________ ________ available for distribution to its shareholders.

Answer 14

economic earnings

Question 15

Corporate E + P is divided into what 2 accounts:

Answer 15

Current E + P (CE+P)

Accumulated E + P (AE+P)

Question 16

Distributions are designated as dividends from E + P in the following order:

Answer 16

Current, then Accumulated

Question 17

What happens to undistributed current E + P?

Answer 17

It is added to the balance of accumulated E + P on the first day of the next tax year

Question 18

How do distributions affect E + P?

Answer 18

• 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

Question 19

Earnings + Profits

Answer 19

economic income eligible for distribution to shareholders

Question 20

the computation of current E + P begins with

Answer 20

taxable income or loss

Question 21

corporate current E + P begins with taxable income or loss and then adjustments are made in the following categories

Answer 21

1. certain nontaxable income is included in E + P
2. certain deductions do not reduce E + P
3. certain nondeductible expenses reduce E + P
4. 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

Question 22

Nontaxable income included in current E + P

Answer 22

• 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)

Question 23

Deductible expenses that do not reduce current E + P

Answer 23

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

Question 24

Do deductions allowed for employee exercises of nonqualified stock options reduce E + P?

Answer 24

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

Question 25

Nondeductible expenses that reduce current E + P

Answer 25

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

Question 26

Items Requiring Separate Accounting Methods for E + P Purposes

Answer 26

Installment sales method Like-kind exchange deferred gain Organization expenditures Depreciation

Question 27

Possible scenarios for E + P balances

Answer 27

1. Positive current E + P, positive accumulated E + P 2. Positive current E + P, negative accumulated E + P 3. Negative current E + P, positive accumulated E + P 4. Negative current E + P, negative accumulated E + P

Question 28

Order of Distributions when both CE + P and AE + P are positive, distributions exceed CE+P and shareholders ownership changes during the year

Answer 28

- 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

Question 29

Distributions when CE+P is positive and AE+P is negative

Answer 29

- 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

Question 30

Distributions when CE+P is negative and AE+P is positive

Answer 30

- 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

Question 31

Distributions when both CE+P and AE+P are negative

Answer 31

- None of the distribution is treated as a dividend - 1st reductions in shareholders' tax basis in stock - Then capital gain

Question 32

When noncash property is received, shareholder determines the amount distributed as follows:

Answer 32

Money received +FMV of other property received -Liabilities assumed by s/h on property received =Amount Distributed

Question 33

As a general rule, a shareholder's tax basis in noncash property received as a dividend equals...

Answer 33

the property's FMV

Question 34

Tax consequences to a corporation paying noncash property as a dividend

Answer 34

- 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

Question 35

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...

Answer 35

the amount of the liability assumed by the shareholder

Question 36

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...

Answer 36

the excess of the property's FMV over its tax basis

Question 37

When a corporation distributes appreciated noncash property (FMV > income tax basis),

Answer 37

it must recognize the gain and pay income tax on the gain

Question 38

Effect on CE+P when corporation gives property to shareholder and FMV > regular income tax basis:

Answer 38

1. If E+P basis = regular income tax basis, gain increases CE+P and taxes paid (or payable) decreases CE+P 2. 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

Question 39

When a corporation distributes appreciated noncash property (FMV < income tax basis),

Answer 39

it is not allowed to deduct the loss for taxable income tax purposes

Question 40

Effect on CE+P when corporation gives property to shareholder and FMV < regular income tax basis:

Answer 40

corporation cannot deduct the loss in determining CE+P | thus the distribution does not affect current E+P