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Chapter 10 - Chapter 10 Corporations Earnings Profits and...

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Chapter 10 Corporations: Earnings & Profits and Distributions Taxable Dividends Distributions from corporate earnings and profits (E & P) o Treated as a dividend distribution Taxed as ordinary income or as preferentially taxed dividend income Distributions in excess of E & P o Nontaxable to extent of shareholder’s basis (i.e., a return of capital) Excess distribution over basis is capital gain Earnings & Profits No definition of E & P in Code Similar to Retained Earnings (financial reporting), but often not the same E & P represents: o Upper limit on amount of dividend income recognized on corporate distributions o Corporation's economic ability to pay dividend without impairing capital Calculating Earnings & Profits Calculation generally begins with taxable income, plus or minus certain adjustments o Add previously excluded items and certain deductions to taxable income including: Muni bond interest Excluded life insurance proceeds Federal income tax refunds Dividends received deduction Domestic production activities deduction Calculation generally begins with taxable income, plus or minus certain adjustments (cont’d) o Subtract certain nondeductible items: Related-party losses Expenses incurred to produce tax-exempt income Federal income taxes paid Key employee life insurance premiums (in excess of increase in cash surrender value) Fines, penalties, and lobbying expenses Certain E & P adjustments shift effect of transaction from the year of inclusion in or deduction from taxable income to year of economic effect, such as: o Charitable contribution carryovers o NOL carryovers o Capital loss carryovers Gains and losses from property transactions o Generally affect E & P only to extent recognized for tax purposes o Thus, gains and losses deferred under the like-kind exchange provision and deferred involuntary conversion gains do not affect E & P until recognized
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Other adjustments o Accounting methods for E & P are generally more conservative than for taxable income, for example: Installment method is not permitted Alternative depreciation system required § 179 expense must be deducted over 5 years Percentage of completion must be used (no completed contract method) Examples of E & P Adjustments Effect on taxable income for E & P: Transaction Add Subtract Tax-exempt income X Life insurance proceeds X Deferred installment gain X Excess charitable contribution X Ded. of prior excess contribution X Federal income taxes X Officer’s life insurance premium X Accelerated depreciation X
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