chp7.class.notes.12

chp7.class.notes.12 - Tax 3011 Chapter 7 Class Notes 1 The...

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Tax 3011 Chapter 7 Class Notes 1) The Basic Tax Law Framework That Applies To Property Distributions a) If the tax law characterizes the distribution as a dividend, the corporation cannot deduct the amount paid in computing its taxable income. b) The shareholder is subject to tax on the gross amount of the dividend received. c) The nondeductibility of the distribution by the corporation, coupled with the taxation of the distribution to the shareholder, creates double taxation of the corporation’s income, first at the corporate level and then at the shareholder level. d) The double taxation of distributed corporate income is a fundamental principle of the U.S. income tax system, having been made part of the tax code in 1913. e) The recipient of a dividend or payment in exchange for corporate stock (stock redemption ) generally receives preferential tax treatment on the distribution, in the form of a reduced tax rate or as a tax-free return of capital or both. (NOTE: A redemption is a two-way street corporation “redeems” shares and gives shareholder something in exchange.) f) The reduction in the tax rate applied to dividends and capital gains received by individuals (generally 15 percent) has reduced, but not eliminated, the motivation for taxpayers to engage in creative tax strategies to avoid this second level of tax. g) If the distribution can instead be characterized as salary, bonus, interest, or rent, the corporation usually can deduct the amount paid in computing its taxable income, unless the Internal Revenue Service (IRS) asserts the distribution is a constructive dividend . h) The recipient includes the amount in gross income as ordinary income and pays tax on the amount at his or her marginal tax rate. i) In the case of a distribution treated as compensation, the corporation and the shareholder employee also must pay employment taxes on the distribution. 2) Computing Earnings And Profits And Determining The Dividend Amount Received By A Shareholder a) Overview of the Shareholder Taxation of Corporate Dividends (We discussed the 3-step i) When a corporation distributes property to shareholders in their capacity as shareholders, the tax consequences of the distribution to the shareholder can be summarized as follows: (1) The portion of the distribution that is a dividend is included in gross income. (2) The portion of the distribution that is not a dividend reduces the shareholder’s tax basis in the corporation’s stock (that is, it is a nontaxable return of capital). (3) The portion of the distribution that is not a dividend and is in excess of the shareholder’s stock tax basis is treated as gain from sale or exchange of the stock (capital gain). ii) Corporate distributions of “property” usually take the form of cash, but they can
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chp7.class.notes.12 - Tax 3011 Chapter 7 Class Notes 1 The...

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