1. ©2010 Pearson Education, Inc. Publishing as Prentice Hall

2. NONLIQUIDATING DISTRIBUTIONS (1 of 2)
Nonliquidating distributions in general
Earnings and profits (E&P)
Nonliquidating property distributions
Stock dividends and stock rights
Stock redemptions
Preferred stock bailouts
Stock redemptions by related corps
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3. NONLIQUIDATING DISTRIBUTIONS (2 of 2)
Tax planning
Compliance and procedural considerations
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4. Nonliquidating Distributions in General (1 of 2)
Dividend distributions
A distribution of property based upon a corporation’s earnings & profits (E&P)
Property includes
Money, securities and other assets
Does not include stock or stock rights of distributing corp
Dividends treated as ordinary income by shareholder (taxed at 15% through 2010)
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5. Nonliquidating Distributions in General (2 of 2)
Earnings and profits (E&P)
E&P not defined in the Code
E&P consists of current & accumulated
Distributions are based upon current E&P first & accumulated E&P second
Distributions in excess of E&P are considered a return of capital
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6. Earnings and Profits Current E&P (1 of 2)
E&P computed on annual basis at end of tax year
Generally E&P based on corp’s economic income instead of taxable income
Adjustments to taxable income for permanent & timing differences including use of different depreciation methods
Refer to Table 1
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7. Earnings and Profits Current E&P (2 of 2)
Taxable income
+ Excluded taxable income
+ Taxable income deferred to another year
+/- Inc & deduct recomputed under E&P rules
+ Deductions disallowed for E&P
- Nondeductible items that reduce E&P
= Current E&P (or current E&P deficit)
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8. Earnings and Profits Current vs. Accumulated E&P (1 of 3)
Current E&P (CE&P) computed on last day of the corp’s tax year
Distributions first from CE&P
Distributions greater than CE&P
CE&P allocated to distributions pro rata regardless of payment date
Then AE&P (only if positive) allocated to distributions in chronological order
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9. Earnings and Profits Current vs. Accumulated E&P (2 of 3)
Distributions greater than E&P
Cannot create an E&P deficit
Distributions in excess of all E&P is a return of capital to shareholders and reduce shareholders’ basis in stock
Distributions in excess of basis result in a gain (usually capital gain)
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10. Earnings and Profits Current vs. Accumulated E&P (3 of 3)
If CE&P is positive and beginning AE&P is a deficit
Distributions will produce ordinary income to shareholder until CE&P reaches zero
CE&P allocated on a pro-rata basis
Deficit in CE&P transferred to AE&P before classifying distributions
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11. Nonliquidating Property Distributions
Shareholder consequences
Corporation’s consequences
Example 15
Example 16
Distribution’s effect on E&P
Constructive dividends
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12. Shareholder Consequences
In non-cash distributions, amount of income equal to FMV of property received minus liabilities assumed
Amount of distribution cannot be <$0
Shareholder’s basis in non-cash property is FMV on distribution date
Holding period of property begins day after distribution date
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13. Corporation’s Consequences
Appreciated non-cash property produces gain as if corp sold property for FMV on distribution date
Loss recognition NOT permitted
If liabilities exceed FMV, then FMV is assumed to be no less than amount of the liability
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14. Example 15 Corporate Gain/Loss on Property Distribution
FMV of land $60,000
Adjusted basis ,000
Capital Gain 40,000
FMV of land $12,000
Adjusted Basis 20,000
No loss recognition by corporation
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15. Example 16 Corporate Gain and Shareholder Basis
FMV of land $25,000
Mortgage ,000
Adjusted basis ,000
Capital Gain ,000
FMV cannot be less than liability
Shareholder’s basis $35,000
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16. Distribution’s Effect on E&P (1 of 2)
Gain on non-cash distribution increases Current E&P
E&P is reduced by
Amount of cash distributed
Greater of FMV or adjusted basis of property distributed minus liability assumed by shareholder
Tax liability on gain recognized
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17. Distribution’s Effect on E&P (2 of 2)
E&P is reduced by (continued)
Principal amount of the corporation’s own notes, bonds, debentures or other obligations distributed to shareholders
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18. Constructive Dividends (1 of 3)
IRS or courts recharacterize payments to shareholder where substance of transaction is a dividend
All or part of income recharacterized as a dividend
Need not be pro-rata distribution
May be intentional way to bail out E&P without triggering dividend treatment
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19. Constructive Dividends (2 of 3)
Tax consequences
Corporation denied deduction on benefit given to shareholder
Dividend income to shareholder for benefit received
Excessive compensation
Ordinary income to shareholder
May not treated as a dividend due to maximum 15% tax rate on dividends
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20. Constructive Dividends (3 of 3)
Examples
“Loans” to shareholders
Excessive rent paid to shareholder
Payments for shareholder’s benefit
Bargain purchase
Use of corporate property
Excessive compensation
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21. Stock Dividends & Stock Rights Nontaxable Stock Dividends
Tax-free distribution of additional shares of stock to existing shareholder
If shares identical, basis allocated by dividing old basis by total shares held
If shares different, basis allocated between old and new shares in proportion to FMV on distribution date
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22. Stock Dividends & Stock Rights Nontaxable Stock Rights
Tax-free distribution of right to purchase add’l shares of stock unless proportionate interest changes or could change
If the value of right <15% of underlying stock, basis of right is zero
If value 15% of underlying stock, basis allocated based on relative FMV
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23. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Stock Dividends & Stock Rights Taxable Stock Dividends and Stock Rights
Distribution amount = FMV of stock or rights on distribution date
Dividend to extent of E&P
Recipient takes FMV as basis
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24. Stock Redemptions (1 of 2)
Acquisition by a corporation of its own stock in exchange for property
Shareholder consequences
Attribution rules
Substantially disproportionate redemptions
Complete termination of shareholder’s interest
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25. Stock Redemptions (2 of 2)
Redemptions not essentially equivalent to a dividend
Partial liquidations
Redemptions to pay death taxes
Redeeming corporation consequences
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26. Shareholder Consequences
Sale treatment produces capital gain or loss
Dividend treatment produces ordinary income on entire distribution
Generally taxed at 15% (through 2010)
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27. §318 Attribution Rules (1 of 2)
Family attribution
Spouse, children, grandchildren, & parents
Stock cannot be reattributed to another family member
Attribution from entities
Proportionate ownership for stock owned by or for partnership, estate, or trust
Proportionate ownership for stock owned by C corp only for s/h owning  50%
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28. §318 Attribution Rules (2 of 2)
Attribution to entities
Stock owned by partners or beneficiaries considered owned by partnership, estate, or trust
Stock owned by  50% shareholder of C corp considered owned by corp
Option attribution
Option owner treated as owning stock
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29. Substantially Disproportionate Redemptions (1 of 2)
After the redemption, the s/h
Owns < 50% of voting power of all classes of stock
Owns < 80% of his/her percentage ownership of voting stock before the redemption
Owns < 80% of his/her percentage ownership of common stock before the redemption
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30. Substantially Disproportionate Redemptions (2 of 2)
Redemptions receiving sale treatment
Complete termination of interest
Not essentially equivalent to dividend
Partial liquidation of corp to a non-corporate shareholder
Made in order to pay death taxes
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31. Complete Termination of Interest
Redemption of shareholder’s entire interest corporation consisting of nonvoting stock
Normally would not qualify because no reduction in voting power occurs
Family attribution rules may be waived to allow complete termination to qualify
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32. Redemptions not Essentially Equivalent to a Dividend (1 of 2)
Facts and circumstances test
No safe harbor or mechanical test
Generally applies to
Redemptions of nonvoting preferred stock if no common stock owned
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33. Redemptions not Essentially Equivalent to a Dividend (2 of 2)
Generally applies to (continued)
Redemptions resulting in substantial reduction in shareholder’s right to vote and exercise control, participate in earnings, or share in assets upon liquidation
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34. Partial Liquidations (1 of 2)
Corp discontinues one line of business
Distributes assets to shareholders
Continues other line(s) of business
Determined at corporate level
Must be bona fide business contraction
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35. Partial Liquidations (2 of 2)
Tax consequences to shareholders
Noncorp shareholder treats redemption as a sale
Corp treats as a dividend unless redemption meets one of other tests for sale treatement.
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36. Effect of Redemptions on Distributing Corporation
Sale treatment may produce gains but no losses
E&P must be reduced by
Full amount for dividends (if dividend) OR
Proportionate amount for sale treatment after adjusting for gains net of taxes
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37. Preferred Stock Bailouts
§306 in general
Dispositions of §306 stock
Redemptions of §306 stock
Exceptions to §306 treatment
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38. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
§306 in General (1 of 2)
§306 stock defined
Stock other than common stock
Issued on a tax free basis
Substantially same as a stock dividend
Sale results in ordinary income equal to FMV of stock
Limited by corporation’s E&P at distribution date
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39. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
§306 in General (2 of 2)
If no Current or Accumulated E&P in issue year, §306 does not apply
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40. Dispositions of §306 stock
Dividend income to the extent of E&P in year of redemption
Amounts in excess are considered a return of capital
Amounts recovered in excess of basis are capital gains
Any unrecovered basis is added to remaining common stock
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41. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Redemptions of §306 stock
Same dividend treatment as sale of §306 stock
Corporation’s E&P reduced by amount realized
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42. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Exceptions to §306
§306 does not apply in the following circumstances
Complete termination of interest
Complete redemption of all holdings
Redemption in a partial liquidation
Gift transfer (stock remains tainted)
No tax avoidance as a principal purpose
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43. Stock Redemptions by Related Corporations
A sale of a corp’s stock by controlling shareholder to a second corp controlled by same shareholder treated as a redemption
§304 applies to both
brother-sister and
parent-subsidiary controlled groups
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44. Brother-Sister Controlled Groups
Redemption is by the corp buying stock from the shareholder
If a dividend, E&P of acquiring corp and then the issuing corp (if necessary) is reduced
Basis of redeemed stock added to basis of stock held in acquiring corp
©2010 Pearson Education, Inc. Publishing as Prentice Hall

45. Parent-Subsidiary Controlled Group
Sale of parent stock by shareholder to subsidiary
If a dividend, E&P of sub and then parent are both available
Shareholder’s basis in remaining parent stock increased by basis of stock redeemed by subsidiary
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46. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Tax Planning (1 of 2)
Avoiding unreasonable compensation
Hedge agreement
S/h-employee agrees to repay any portion of salary IRS disallows as unreasonable
Bootstrap acquisitions
S/h sells part of stock to purchaser, then has corp redeem seller’s remaining shares
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47. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Tax Planning (2 of 2)
Timing of distributions
Make distributions when corp has little or no E&P so distributions treated as return of capital
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48. Compliance and Procedural Considerations
Corporate reporting of nondividend distributions
Agreement to terminate interest under §302(b)(3)
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49. ©2010 Pearson Education, Inc. Publishing as Prentice Hall