Chapter 5.pptx - Chapter 5 Nonliquidating Distributions Ownership Interest Rights Shareholders are entitled to 1 exercise control via voting 2 share in

Chapter 5.pptx - Chapter 5 Nonliquidating Distributions...

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Unformatted text preview: Chapter 5 Nonliquidating Distributions Ownership Interest Rights Shareholders are entitled to: 1) exercise control via voting 2) share in the corporation’s distributed earnings 3) share in net assets upon liquidation Types of Distributions Redemption Liquidating distribution Reorganization Nonliquidating distribution – preserve the double tax IRC Sec. 301 Property includes $, securities & any other property Except stock in the distributing corporation IRC Sec. 301 rules only apply to distributions made WITH RESPECT to the distributing corporation’s stock Employment or lender relationships don’t count IRC Sec. 301(c) IRC Sec. 301(c)(1) – includible in shareholder’s gross income as dividend income IRC Sec. 301(c)(2) – applied against & reduce the shareholder’s adjusted basis in the stock IRC Sec. 301(c)(3) – treated as gain from the sale or exchange of property IRC Sec. 316 Dividend means any distribution of property made by a corporation to its shareholders – IRC Sec. 316(a)(1) - Out of its earnings and profits accumulated after February 28, 1913, or IRC Sec. 316(a)(2) - Out of its E&P of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. Dividend Treatment Entirely a dividend – includible in shareholder’s gross income Partially a dividend – portion of which is not, is applied against & reduces the shareholder’s stock adjusted basis (tax-free recovery of investment) Not a dividend – gain from the sale or exchange of property Nimble Dividend Shareholder A contributes $100 to form corp; corp then distributes $100 Same example except corp earns $100 in Yr #1 Same example except corp lost $80 in Yr #1 and earns $50 in Yr #2 Timing & Character The corporation’s dividend accelerate the shareholder’s liability for tax upon his share of profit When a distribution is made not out of E&P, shareholders receive a tax-free recovery of capital without disposing shares Qualified dividend treatment Extraordinary dividends IRC Sec. 301(d) The basis of property received in a distribution to which subsection (a) applies shall be the fair market value of such property. E&P – Upward Adjustments Items that were excluded from taxable income, but must be added back for E&P purposes – exempt income, DRD, etc. Items that involves differences in timing for E&P, installment method gain, accelerated vs. straight-line depreciation E&P – Downward Adjustments Adjustments reflect expenses that deplete economic resources but are otherwise nondeductible for tax purposes Federal income tax M&E expenses Penalties Disallowed capital losses Dividends-Received Deduction For tax years beginning after December 31, 2017, the dividends received deduction is 50 percent of the dividends received, if the recipient corporation owns less than 20 percent of the dividend paying corporation. The deduction increases to 65 percent of the dividends received[3] if the recipient corporation owns 20 percent or more of the distributing corporation. Ownership is determined by the amount of voting power and value the receiving corporation owns in the paying corporation. Dividends-Received Deduction For tax years beginning before 2018, the dividends received deduction is 70 percent of the dividends received, or 80 percent of the dividends received if the recipient corporation owns at least 20 percent of the distributing corporation. If the recipient and payor corporations are members of the same affiliated group, the DRD is 100% of the qualifying dividends. S Corporations are not entitled[6] to any dividends received deduction Consolidated Return In keeping with the “single entity” theory, both the dividend income under IRC Sec. 301(c)(1) and the capital gain under IRC Sec. 301(c)(3) are deferred through a corresponding negative adjustment to the distribute corporation’s basis in stock in the distributing corporation DRD – Additional Rules For tax-exempt distributing corporation, IRC Sec. 246(a) denies the DRD Corporations purchase stock for their investment portfolios with borrowed funds – IRC Sec. 246A restricts the IRC Sec. 243 deduction in the case of dividends on debt-financed portfolio stock IRC Sec. 311 – In-Kind Distributions IRC Sec. 311(a) – No gain or loss shall be recognized to a corporation on the distribution with respect to its stock IRC Sec. 311(b) – Fair market value of such property exceeds its adjusted basis; said gain shall be recognized to the distributing corporation IRC Sec. 312 – Effect on E&P (a) prohibits the corporation from creating a deficit in E&P (b)(1) requires the distributing corporation to increase E&P by the excess of FMV over distributed property adjusted basis (b)(2) must decrease E&P to reflect the distribution; in the case of appreciated property, substitute the words “FMV” for “adjusted basis” Distributions Involving Liabilities Shareholder Tax Consequences – Net valued of the distribution after taking the liability into account; fair market value basis What if the distributed property debt exceeds the fair market value of the property? Distributions Involving Liabilities (Cont’d) Corporation Tax Consequences – amount realized to the corporation upon the distribution includes liabilities taken on by the shareholders When liabilities exceed fair market value, gain to corporation is the excess of liabilities over adjusted basis Constructive Dividends Deemed dividend treatment Usually involves salaries in excess of what is reasonable; excess may be viewed as a constructive dividend Salary expense vs. dividend distributions ...
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