1. Principles of Taxation: Advanced Strategies
Slide 7-1
Chapter 7
Distributions to Business Owners
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2. C Corporations Subject to double taxation
Slide 7-2
Subject to double taxation
Distributions out of earnings and profits taxable to shareholders as dividends
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3. Earnings and Profits Two types: Current Earnings and profits
Slide 7-3
Two types:
Current Earnings and profits
Accumulated Earnings and profits
Any payment out of either account will result in a taxable dividend to the shareholder
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4. Current Earnings and Profits
Slide 7-4
Any distribution not in excess of current earnings and profits is a dividend
Negative accumulated earnings and profits ignored if current earnings and profits positive
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5. Accumulated Earnings and Profits
Slide 7-5
Current earnings and profits reduced by dividends added into accumulated earnings and profits
If current earnings and profits is negative, it is netted from accumulated earnings and profits to determine if a distribution is a dividend
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6. Nondividend Distributions
Slide 7-6
Any distribution in excess of earnings and profits
Treated as a return of capital to extent of stock basis
Stock basis must be reduced by nontaxable portion
Any excess is capital gain
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7. Property Distributions
Slide 7-7
Distributions of appreciated property cause a corporation to recognize gain
Current earnings and profits also increased as a result of the gain recognized
Earnings and profits reduced by fair market value of appreciated property distributed
Losses not recognized on distributions of depreciated property
Earnings and profits decreased by adjusted basis of depreciated property
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8. Stock Dividends Distributions of additional shares of stock
Slide 7-8
Distributions of additional shares of stock
Generally nontaxable to shareholder
Will be treated as a taxable distribution if shareholders can choose between stock and cash
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9. Constructive Dividends
Slide 7-9
Constructive Dividends
Payments or transfers for the benefit of the shareholders
Treated as taxable dividends
Examples:
Corporation pays personal expenses
Use of corporate property for personal purposes
Unreasonable compensation to shareholder/employee
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10. Penalty Taxes
Slide 7-10
Designed to prevent conversion of ordinary income into capital gain by appreciation of corporate stock
Types:
Accumulated earnings tax
Personal holding company tax
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11. Accumulated Earnings Tax
Slide 7-11
Tax imposed upon corporation if a corporation accumulates funds beyond reasonable need of the business
Tax imposed at the highest individual income tax rate in effect for the year
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12. Accumulated Earnings Tax Base
Slide 7-12
Tax imposed on after tax income reduced by
Any dividends paid during the period
Accumulated earnings tax credit
Amount needed by corporation to meet reasonable business needs
Never less than $ 250,000 except for personal service corporations
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13. Personal Holding Company Tax
Slide 7-13
Imposed at the highest individual tax rate on undistributed personal holding company taxable income
Corporation must be a personal holding company
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14. Personal Holding Company
Slide 7-14
60% of ordinary gross income from investment sources such as dividends, interest, rent and royalties
Five or fewer individuals own directly or indirectly more than 50% of stock during the last half of the year
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15. Undistributed Personal Holding Company Taxable Income
Slide 7-15
After-tax ordinary income less dividends paid
Deficiency dividends can be paid to eliminate the tax
McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

16. Partnership Distributions
Slide 7-16
Partnership Distributions
Two types:
Current distribution – reduces partner’s capital account
Liquidating distribution- extinguishes partner’s interest in partnership
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17. Cash Distributions Generally nontaxable
Slide 7-17
Generally nontaxable
Exception: cash distribution in excess of partner’s outside basis
Distributions reduce outside basis
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18. Property Distributions-Accounting Treatment
Slide 7-18
Gain or loss recognized on distribution to extent property exceeds or is less than fair market value.
Gain or loss allocated to all partners
Partner’s capital account reduced by fair market value of distribution
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19. Property Distributions- Tax Consequences
Slide 7-19
Generally nontaxable to partner
No gain or loss recognized to partnership
Partner’s basis in property is same as partnership’s basis in property
If basis of property is greater than recipient partner’s outside basis, basis of property to partner is outside basis of partnership. Outside basis become zero
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20. S Corporation Distributions
Slide 7-20
Generally nontaxable as long as does not exceed shareholder’s basis in stock
Cash distribution decreases shareholder’s basis in S corporation stock
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21. Special Rules for S Corporations with Earnings and Profits
Slide 7-21
Only applies to S corporations that were formerly C corporations
Special rules do not apply if C corporation had no earnings and profits when S election made or all earnings and profits distributed
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22. S Corporations with E and P
Slide 7-22
Cash distributions nontaxable to extent do not exceed accumulated adjustments account (AAA)
Any amount in excess of AAA treated as a taxable dividend to extent of earnings and profits
Any amount in excess of earnings and profits is a nontaxable return of capital up to shareholder’s basis in stock
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23. Accumulated Adjustments Account
Slide 7-23
Represents undistributed S corporation earnings
Cash distributions reduce account but not below zero
Losses reduce AAA
Any distribution during a loss year is deemed made before account is decreased for the loss
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24. C Corporation Conversions
Slide 7-24
S corporations reverting to C corporations have a favorable transition rule on distributions
Any distribution made within one year of conversion is nontaxable as long as AAA not exceeded
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25. Property Distributions
Slide 7-25
Generally C corporation rules apply to S corporations making these distributions
Gains but not losses recognized
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