Chapter 15 Corporate Nonliquidating Distributions ©2008 CCH. All Rights Reserved W. Peterson Ave. Chicago, IL

Dividend Distsributions Dividend to the extent of the corporation’s current and accumulated E&P. Dividends in excess of E&P are returns of capital – reduce shareholder basis. Once basis=0, then gain on sale. CCH Federal Taxation Comprehensive Topics 2 of 59

Earnings and Profits E&P is computed annually Not defined by IRC, but adjustments to and from taxable income. (pg 15-4 through 15-5) Distributions from current E&P first, then from accumulated E&P CCH Federal Taxation Comprehensive Topics 3 of 59

E&P (cont’d) Distributions<current E&P, then dividends, even if accum E&P<0 Distributions>current E&P, but not greater then sum ofcurrent and accum, then:  Current E&P/Total dist = % dist If distribution is greater than E&P available, then return of capital based on %. CCH Federal Taxation Comprehensive Topics 4 of 59

Property Distributions – S/H FMV at date of distribution If liability attached, then FMV-liability. Dividend income to extent of E&P. S/H basis in the property is FMV, and holding period is as of date of distribution. CCH Federal Taxation Comprehensive Topics 5 of 59

Property Distributions – Corp Corporation recognizes gain equal to FMV-AB Losses are not recognized. No gain or loss if distributes its own stocks. If property encumbered by a liability, then for gain calculations, FMV = greater of FMV or liability. CCH Federal Taxation Comprehensive Topics 6 of 59

Property Distributions – Corp (cont’d) E&P is reduced by AB. If appreciated property is distributed, then E&P is increased by appreciation, then decreased by FMV. Decrease in E&P by the property’s AB or FMV, is reduced by liability on property. CCH Federal Taxation Comprehensive Topics 7 of 59

Constructive dividends Unreasonable compensation Corporate payment of shareholder responsibilities Shareholder loans Corporate loans Free personal use of corporate property Bargain sales/rentals to shareholders Premium sales/rentals to the corporation CCH Federal Taxation Comprehensive Topics 8 of 59

Stock Dividends – Non Taxable Proportionate stock sales are not taxable. Shares in NT dividend take on holding period of original shares. E&P is not reduced. CCH Federal Taxation Comprehensive Topics 9 of 59

Stock Dividends –Taxable Taxable if there is an option of stock or property Disproportionate distributions Some receive common/some preferred Distributions on preferred stock Distribution of convertible preferred stock CCH Federal Taxation Comprehensive Topics 10 of 59

Stock Dividends –Taxable S/H dividends (to extent of E&P) is stock’s FMV. Basis of stock is FMV on distribution date. Holding period as of distribution date. E&P is reduced by FMV of stock. CCH Federal Taxation Comprehensive Topics 11 of 59

Stock Redemptions Sale or exchange treatment if Section 302/303 requirements met (page 15-22). Sale or exchange is preferential b/c return of capital and potential capital gain, not a dividend. Constructive ownership – attribution (family members, partners, corporations with >=50% ownership CCH Federal Taxation Comprehensive Topics 12 of 59

Stock redemptions 302(b)(1) – exchange treatment id redemption is not essentially a dividend. Vague test – BUT interpreted to mean there must be a meaningful reduction in s/h interest. (i.e., a loss of controlling interest). CCH Federal Taxation Comprehensive Topics 13 of 59

Stock redemptions 302(b)(2) – 3 mechanical tests if met, assure exchange treatment.  After redemption, s/h owns less than 50%  S/H proportionate interest must be 80% less than before redemption CCH Federal Taxation Comprehensive Topics 14 of 59

Stock redemptions 302(b)(3) – Complete termination of s/h interest Family attribution can be waived if s/h signs agreement to sever all ties for 10 years. S/H can be a creditor and can be an owner again if stock is inherited. CCH Federal Taxation Comprehensive Topics 15 of 59

Stock redemptions 302(b)(4) – determined at corporate level, not s/h. If distribution is considered a partial liquidation, then it will be exchange treatment. Corporation must cease to conduct its trade or business, or have contracted the business. Conduct a new trade or business. Must have been active 5 years before the distribution CCH Federal Taxation Comprehensive Topics 16 of 59

Stock redemptions 303 – Redemptions of stock to pay a s/h’s federal and state death taxes, funeral and administrative expenses receive gain treatment. Some criteria must be met. CCH Federal Taxation Comprehensive Topics 17 of 59

Tax Consequences - Corporation Costs incurred by a corp in redeeming its stock must be capitalized and not amortized. CCH Federal Taxation Comprehensive Topics 18 of 59