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Unformatted text preview: CHAPTER 5 CORPORATIONS: EARNINGS & PROFITS AND DIVIDEND DISTRIBUTIONS LECTURE NOTES SUMMARY OF CHANGES IN THE CHAPTER The following are notable changes in the chapter from the 2008 Edition. For major changes, see the Preface to the Instructors Edition of the text. News Boxes Replaced Global Tax Issues item titled Dividend Tax Cut Creates International Loophole with a new article titled E & P in Controlled Foreign Corporations . Replaced Tax in the News titled Ex-Adelphia Executives Indicted with a new article titled The Case of the Disappearing Dividend Tax . Revised Global Tax Issues Deemed Dividends from Controlled Foreign Corporations . Text Changes Tax rate for dividends and capital gains for some taxpayers is 0% for 2008 - 2010. CORPORATE DISTRIBUTIONSOVERVIEW 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 1913) or to the extent of E & P for the current year. 2. Distributions not taxed as dividends (because of insufficient E & P) are nontaxable to the extent of the shareholders stock basis and will reduce that basis accordingly. Any excess of the distribution over the shareholders 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. 5-1 5-2 2009 Annual Edition/Instructors Guide with Lecture Notes a. Stock dividends do not decrease E & P but they do decrease retained earnings. 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 recognized for taxable income determination or for E & P purposes). 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 corporations economic ability to pay a dividend without impairing its capital. Computation of E & P 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....
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- Spring '11