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CHAPTER 19 CORPORATIONS: DISTRIBUTIONS NOT IN COMPLETE LIQUIDATION LECTURE NOTES CORPORATE DISTRIBUTIONS—OVERVIEW 1. Distributions by a corporation to its shareholders are presumed to be dividends unless the parties can prove otherwise. Section 316 makes such distributions dividend income to the shareholder to the extent of E & P of the distributing corporation (accumulated since 2. Distributions not taxed as dividends (because of insufficient E & P) are nontaxable to the extent of the shareholder’s stock basis and will reduce that basis accordingly. Any excess of the distribution over the shareholder’s basis usually is a capital gain. EARNINGS AND PROFITS (E & P)—§ 312 3. E & P, though similar in concept to “retained earnings,” is computed differently. Retained earnings computation is based on financial accounting rules while E & P is determined using tax law. A few of the differences are as follows.a. Stock a. b. E & P is reduced only by straight-line depreciation unless the corporation uses a depreciation method such as “units of production” or “machine hours.” c. E & P may be affected by gains and losses from property transactions only to the extent they are recognized for tax purposes (e.g., like-kind exchanges are not 4. E & P is the factor that fixes the upper limit on the amount of dividend income a share- holder must recognize. It represents the corporation’s economic ability to pay a dividend without impairing its capital. 19-1
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19-2 2009 Comprehensive Volume/Instructor's Guide with Lecture Notes 5. Additions to taxable income to compute E & P. a. All tax-exempt income items such as municipal bond interest, excluded life insurance proceeds (in excess of cash surrender value). b. Dividends not taxed due to the dividends received deduction. c. Federal income tax refunds for taxes paid in prior years. d. Domestic production activity deduction (DPAD). 6. Subtractions from taxable income to compute E & P. a. Nondeductible related party losses. b. Excess capital losses. c. Federal income taxes paid. d. Fines and penalties. e. Expenses incurred to produce tax-exempt income f. Key employee life insurance premiums in excess of increases in cash surrender value. 7. Timing adjustments. a. Some E & P adjustments shift a transaction’s impact from the year it is included in taxable income to the year it has an economic effect on a corporation. b.
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