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lecture3 - Week Three Corporate Non-liquidating...

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Week Three Corporate Non-liquidating Distributions Distributions with Respect to Stock ¶15,001 Dividend Distributions The tax status of cash or property distributions depends upon the distributing corporation’s earnings and profits (E&P). A distribution is considered to be a dividend to the extent of the corporation’s current and accumulated E&P. Distributions first come out of current E&P and then accumulated E&P. Distributions in excess of E&P are returns of capital that reduce the shareholder’s basis in the stock. Once basis is reduced to zero, then any excess is treated as gain on the sale of the stock. ¶15,011 Earnings and Profits (E&P) E&P is not defined in the Internal Revenue Code. However, Code Sec. 312 provides a list of how certain transactions affect E&P. A new corporation begins with no E&P. Current E&P is computed annually. Each year it is added to accumulated E&P. However, it first is reduced by distributions made during the year. A negative current E&P would reduce accumulated E&P. Also, distributions in excess of current E&P reduce accumulated E&P by such excess. Finally, distributions can never make E&P negative; they can only reduce it to zero. Current E&P is computed annually. A series of adjustments are made to the corporation’s taxable income to determine current E&P. These adjustments can be broadly classified as: (A) Items that are excluded from both taxable income and E&P (e.g., contributions to capital). (B) Items that are not deductible, but that reduce E&P (e.g., federal income taxes). (C) Items that are exempt from income, but that increase E&P (e.g., tax-exempt municipal bond interest). (D) Items that are deductible for taxable income, but not from E&P (e.g., capital loss carryovers). (E) Items that are deferred to later tax years, but that increase E&P (e.g., deferred gain on installment sale). Distributions are deemed to be made from current E&P first and then from accumulated E&P since March 1, 1913. Several possible situations arise. (1) Current E&P is positive and the distributions are less than current E&P. All distributions are taxable as dividends, even if accumulated E&P is negative.
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(2) Current and accumulated E&P are positive. The distributions are greater than current E&P but not greater than the sum of current and accumulated E&P. Current E&P is allocated to each distribution as follows: Current E&P / Total Distributions = Percent of each distribution out of current E&P All distributions are taxable as dividends. (3) Current and accumulated E&P are positive. The distributions are greater than current E&P and greater than the sum of current and accumulated E&P. Current E&P and accumulated E&P are allocated as in (2) above. However, in this case, part of the distributions will be a return of capital. (4) Current E&P is positive, accumulated E&P is negative, and the distributions are greater than current E&P. Current E&P is allocated to each distribution as mentioned above. Each distribution is taxable as a dividend to the extent of this allocation.
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