1
Chapter 4,
Corporate Non-liquidating
Distributions
2
NON-LIQUIDATING
DISTRIBUTIONS (1 of 2)
?Non-liquidating distributions in general
?Computing current E&P
?Current vs,accumulated E&P
?Non-liquidating 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
Non-liquidating
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 by s/h
5
Non-liquidating
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 the 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 3)
? Taxable income
? Plus
– Income excluded from taxable income but
included in E&P
– Income deferred to a later year when
computing taxable income but included in E&P
in the current year
? Continued on the next slide
8
Computing Current E&P
(3 of 3)
? Plus or minus
– Income & deduction items that must be
recomputed when computing E&P
? Plus
– Deductions that reduce taxable income but are
not allowed in computing E&P
? Minus
– Expenses & losses that are not deductible in
computing taxable income but that reduce E&P
? Equals current E&P (or current E&P deficit)
9
Current vs Accumulated
E&P (1 of 2)
?Current E&P computed on last day
of the corp’s tax year
?Distributions in excess of CE&P are
–allocated pro rata to CE&P regardless
of payment date
–then deducted from Accumulated
E&P in chronological order
10
Current vs Accumulated
E&P (2 of 2)
?Distributions in excess of E&P
–Cannot create an E&P deficit
–Normally produce ordinary income to
s/h
–If CE&P is positive and beginning
AE&P is a deficit,distributions will
produce ordinary income to s/h until
CE&P reaches zero
11
Consequences of Non-
liquidating 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 C 4-15
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
15
Example C 4-16
FMV of land $25,000
Mortgage 35,000
Adjusted basis 20,000
Capital Gain 15,000
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
minus liability assumed of property
distributed
–Tax liability on gain recognized
17
Distribution’s Effect on E&P
(2 of 2)
?E&P is reduced by
–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
19
Constructive Dividends
(2 of 2)
?Examples
–“Loans” to shareholders
–Excessive compensation
–Excessive rent paid to s/hareholder
–Payments for shareholder’s benefit
–Bargain purchase
–Use of corporate property
20
Stock Dividends &
Stock Rights (1 of 2)
?Stock dividends
–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)
?Stock rights
–Tax-free distribution of right to purchase
additional shares of stock unless
proportionate interest changes or could
change
–If the value of right <15% of underlying
stock,basis of right is zero
22
Stock Redemptions
? Acquisition by a corporation of its own
stock in exchange for property
? Shareholder consequences
? Redeeming corporation consequences
? Redemptions qualifying for sale treatment
? Attribution rules
? Substantially disproportionate redemptions
23
Shareholder Consequences
?Sale treatment produces capital
gain or loss
?Dividend treatment produces
ordinary income
24
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
25
Redemptions Qualifying for
Sale Treatment
?Substantially disproportionate
?Complete termination of interest
?Not essentially equivalent to a
dividend
?Partial liquidation of corp to a non-
corp s/h
?Made in order to pay death taxes
26
§ 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%
27
§ 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
28
Preferred Stock Bailouts
?§ 306 in general
?Shareholder consequences
?Exceptions to § 306
29
§ 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
30
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
31
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
32
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
33
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
34
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
35
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Chapter 4,
Corporate Non-liquidating
Distributions
2
NON-LIQUIDATING
DISTRIBUTIONS (1 of 2)
?Non-liquidating distributions in general
?Computing current E&P
?Current vs,accumulated E&P
?Non-liquidating 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
Non-liquidating
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 by s/h
5
Non-liquidating
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 the 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 3)
? Taxable income
? Plus
– Income excluded from taxable income but
included in E&P
– Income deferred to a later year when
computing taxable income but included in E&P
in the current year
? Continued on the next slide
8
Computing Current E&P
(3 of 3)
? Plus or minus
– Income & deduction items that must be
recomputed when computing E&P
? Plus
– Deductions that reduce taxable income but are
not allowed in computing E&P
? Minus
– Expenses & losses that are not deductible in
computing taxable income but that reduce E&P
? Equals current E&P (or current E&P deficit)
9
Current vs Accumulated
E&P (1 of 2)
?Current E&P computed on last day
of the corp’s tax year
?Distributions in excess of CE&P are
–allocated pro rata to CE&P regardless
of payment date
–then deducted from Accumulated
E&P in chronological order
10
Current vs Accumulated
E&P (2 of 2)
?Distributions in excess of E&P
–Cannot create an E&P deficit
–Normally produce ordinary income to
s/h
–If CE&P is positive and beginning
AE&P is a deficit,distributions will
produce ordinary income to s/h until
CE&P reaches zero
11
Consequences of Non-
liquidating 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 C 4-15
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
15
Example C 4-16
FMV of land $25,000
Mortgage 35,000
Adjusted basis 20,000
Capital Gain 15,000
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
minus liability assumed of property
distributed
–Tax liability on gain recognized
17
Distribution’s Effect on E&P
(2 of 2)
?E&P is reduced by
–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
19
Constructive Dividends
(2 of 2)
?Examples
–“Loans” to shareholders
–Excessive compensation
–Excessive rent paid to s/hareholder
–Payments for shareholder’s benefit
–Bargain purchase
–Use of corporate property
20
Stock Dividends &
Stock Rights (1 of 2)
?Stock dividends
–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)
?Stock rights
–Tax-free distribution of right to purchase
additional shares of stock unless
proportionate interest changes or could
change
–If the value of right <15% of underlying
stock,basis of right is zero
22
Stock Redemptions
? Acquisition by a corporation of its own
stock in exchange for property
? Shareholder consequences
? Redeeming corporation consequences
? Redemptions qualifying for sale treatment
? Attribution rules
? Substantially disproportionate redemptions
23
Shareholder Consequences
?Sale treatment produces capital
gain or loss
?Dividend treatment produces
ordinary income
24
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
25
Redemptions Qualifying for
Sale Treatment
?Substantially disproportionate
?Complete termination of interest
?Not essentially equivalent to a
dividend
?Partial liquidation of corp to a non-
corp s/h
?Made in order to pay death taxes
26
§ 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%
27
§ 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
28
Preferred Stock Bailouts
?§ 306 in general
?Shareholder consequences
?Exceptions to § 306
29
§ 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
30
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
31
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
32
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
33
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
34
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
35
Comments or questions about PowerPoint Slides?
Email Richard Newmark at Dr.Newmark@PhDuh.com
