1. Chapter 4: Corporate Nonliquidating Distributions

2. Nonliquidating DISTRIBUTIONS (1 of 2)
Nonliquidating distributions in general
Computing current E&P
Current vs. accumulated E&P
Nonliquidating property distributions
Constructive dividends

3. NONLIQUIDATING DISTRIBUTIONS (2 of 2)
Stock dividends and stock rights
Stock redemptions
Preferred stock bailouts
Redemptions by related corporations

4. Nonliquidating Distributions (1 of 2)
Dividend distributions
A distribution of property based upon a corporation’s earnings & profits
Property includes money, securities & other assets
Does not include stock or stock rights of distributing corp
Dividends treated as ordinary income by s/h (generally taxed at 15%)

5. Nonliquidating Distributions (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

6. Computing 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 C4-1

7. Computing Current E&P (2 of 2)
Taxable income
+ Inc. excluded from TI but incl. in E&P
+ TI deferred to later year, but included in E&P in current year
+/-Inc. & ded that must be recomputed when computing E&P
+ Deductions for TI not allowed in for E&P
- Nondeduct exp/loss for TI that reduce E&P
= Current E&P (or current E&P deficit)

8. Current vs Accumulated E&P (1 of 3)
Current E&P computed on last day of the corp’s tax year
Distributions greater than CE&P
CE&P allocated to distributions pro rata regardless of payment date
Then Accumulated E&P allocated to distributions in chronological order

9. 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 s/h and reduce s/h’s basis in stock.
Distributions in excess of basis result in a gain (usually capital gain)

10. 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

11. Consequences of Nonliquidating Distributions
Shareholder consequences
Corporation’s consequences
Example C4-15
Example C4-16
Distribution’s effect on E&P

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
S/h’s basis in non-cash property is FMV on distribution date
Holding period of property begins day after distribution date

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

14. Example C4-15 FMV of land $60,000 Adjusted basis 20,000
Capital Gain 40,000
FMV of land $12,000
Adjusted Basis 20,000
No loss recognition by corporation

15. Example C4-16 FMV of land $25,000 Mortgage 35,000
Adjusted basis ,000
Capital Gain ,000
Shareholder’s basis $35,000

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

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

18. Constructive Dividends (1 of 2)
Most likely in closely held corps
Indirect payment made to a s/h without formal board action
Economic benefit provided to a s/h
Intentionally avoiding dividend status
Deduct. for excessive comp no longer constructive div due to max 15% tax on div, but corp still denied deduct.

19. Constructive Dividends (2 of 2)
Examples
“Loans” to shareholders
Excessive rent paid to shareholder
Payments for shareholder’s benefit
Bargain purchase
Use of corporate property

20. Stock Dividends & Stock Rights (1 of 2)
Tax-free distribution of additional shares of stock to existing s/h
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

21. Stock Dividends & Stock Rights (2 of 2)
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

22. Stock Redemptions
Acquisition by a corporation of its own stock in exchange for property
Shareholder consequences
Attribution rules
Redemptions qualifying for sale treatment
Substantially disproportionate redemptions
Redeeming corporation consequences

23. Shareholder Consequences
Sale treatment produces capital gain or loss
Dividend treatment produces ordinary income on entire distribution
Generally taxed at 15%

24. §318 Attribution Rules (1 of 2)
Family attribution
Spouse, children, grandchildren, & parents
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%

25. §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% s/h of C corp considered owned by corp
Option attribution

26. Redemptions Qualifying for Sale Treatment
Substantially disproportionate
Complete termination of interest
Not essentially equivalent to a dividend
Partial liquidation of corp to a non-corporate shareholder
Made in order to pay death taxes

27. Substantially Disproportionate Redemptions
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

28. Redeeming Corporation Consequences
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

29. Preferred Stock Bailouts
§306 in general
Shareholder consequences
Exceptions to §306

30. §306 in General §306 stock defined
Stock other than common stock
Issued on a tax free basis, then sold
Ordinary income equal to FMV of stock limited by corporation’s E&P at distribution date
If no Current or Accumulated E&P in issue year, §306 does not apply

31. Shareholder Consequences
Dividend income to the extent of CE&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

32. Exceptions to §306 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

33. Redemptions by Related Corporations
A sale of a corp’s stock by controlling s/h to a second corp controlled by same s/h treated as a redemption
§304 applies to both
brother-sister and
parent-subsidiary controlled groups

34. 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

35. Parent-Subsidiary Controlled Group
Sale of parent stock by s/h to sub
If a dividend, E&P of sub and then parent are both available
S/h’s basis in remaining parent stock increased by basis of stock redeemed by subsidiary

36. End of Chapter 4
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