Distributions to shareholders generally receive preferential tax treatment: Dividends must be included in gross income (albeit generally taxed at a lower tax rate). What amount of the 2011 distributions is classified as dividend income to Locke’s shareholders? Determining the Dividend Example 2 Current E&P = (,000,000) Accumulated E&P = ,000,000 The corporation distributes M on July 1. Stock Redemptions Form of a Stock Redemption A redemption occurs when a corporation acquires its stock from a shareholder in exchange for property It does not matter if the acquired stock is canceled, retired, or held as treasury stock.
Distributions may result in a tax-free return of capital. Framework for Property Distributions Payments to shareholders are deductible by the corporation if the payment relates to services provided by the shareholder (such as salary, bonus, interest, or rent). In 2011, Kent made a nonliquidating distribution of property with an adjusted basis of 0,000 and a fair market value of 0,000 to Reed, its sole shareholder. AE&P as of July 1 = M ½(M) = 0,000^ 0,000 is a treated as a dividend to the extent of the AE&P that is available to pay out on the date of distribution. A redemption may result in a dividend to the shareholder or may be treated as a sale or exchange of the redeemed shares if certain requirements are met.
If these payments are unreasonable, then the unreasonable (excessive) portion may be treated as a constructive dividend and the payment is no longer deductible. $(57,000) Ordering of E&P Distributions Positive Current E&P and Positive Accumulated E&P Positive current E&P, negative accumulated E&P Negative current E&P, positive accumulated E&P Negative current E&P, negative accumulated E&P Determining the Dividend Taxable dividend 85. The following information pertains to Kent: Reed’s basis in Kent stock at January 1, 2011 0,000 Accumulated earnings and profits at January 1, 2011 125,000 Current earnings and profits for 2011 60,000 What was taxable as dividend income to Reed for 2011? ^ E&P should be apportioned on a daily basis, but for our purposes you can use months. Individuals prefer exchange treatment because of the ability to recover their stock basis. Stock ownership tests must be met for treatment as substantially disproportionate under Sec.
Learning Objectives Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder Compute a corporation’s earnings and profits and calculate the dividend amount received by a shareholder Identify situations in which a corporation may be deemed to have paid a “constructive dividend” to a shareholder Comprehend the basic tax rules that apply to stock dividends Learning Objectives Comprehend the different tax consequences that can arise from stock redemptions Contrast a partial liquidation with other types of stock redemptions and describe the difference in tax consequences to the shareholders Framework for Property Distributions Corporations cannot deduct dividend distributions and this creates the “double taxation” of the corporation’s income. For 2011, Locke had current earnings and profits of ,000 and made two ,000 cash distributions to its shareholders, one in April and one in September of 2011. This is because CE&P is measured as of the close of the taxable year without regard to what it was on the actual date of distribution.
Stock Redemptions Stock Redemptions Tax Consequences to the Distributing Corporation If the redemption is a dividend, then E&P is reduced by the cash and fair market value of other property distributed. Spartan redeems all of Shareholder A’s stock on July 1 for ,000.
Cable reported the following items on its current year tax return: Taxable income ,000 Federal income taxes paid 5,000 Current year charitable contributions in excess of 10% limitation 1,000 Net capital loss for current year 2,000 What is Cable’s accumulated earnings and profits at the end of the year? On the date of the distribution, the following data were available: Adjusted basis of land $ 6,500 Fair market value of land 14,000 Mortgage on land 5,000 For the year ended December 31, 2011, Gelt had earnings and profits of ,000 without regard to the dividend distribution. Stock dividends are generally nontaxable to shareholders if two conditions are met: Made with respect to common stock and Pro rata (proportionate interests maintained) Stock Dividend In January 2012, Joan Hill bought one share of Orban Corp. On March 1, 2012, Orban distributed one share of preferred stock for each share of common stock held. On March 1, 2012, Joan’s one share of common stock had a fair market value of 0, while the preferred stock had a fair market value of 0. After the distribution of the preferred stock, Joan’s bases for her Orban stocks are Common Preferred a. Accordingly, Pike will distribute cash of 0,000 in redemption of all of the stock owned by Mark. Ownership is determined using the §267(c) attribution rules.
,000 Example 1 Current E&P = ,000,000 Accumulated E&P = (0,000) The corporation distributes M on July 1.
On June 30, 2011, Ral Corporation had earnings and profits of 0,000. At the beginning of the year, Westwind, a C corporation, had a deficit of ,000 in accumulated earnings and profits. Tour Corp., which had earnings and profits of 0,000, made a nonliquidating distribution of property to its shareholders in 2012. Cher assumes a 0 mortgage attached to the property. Under §311(b)(1), Sunny Corporation reports a gain of 0 on the distribution (0 FMV - 0 AB). Three types of redemptions are treated as exchanges by determining the effect of the redemption on the redeemed shareholder: Redemptions that are Substantially Disproportionate are treated as sales. 318 must be used: Family attribution (spouse, children, grandchildren, parents) Attribution from entities to owners or beneficiaries Attribution from owners or beneficiaries to entities Option attribution Stock Redemptions Example A shareholder owns 60 of the corporation’s 100 shares of voting common stock before the redemption.
On that date, it sold a plot of land to a noncorporate stockholder for $50,000. $30,000 Overview of distributions: The portion of a distribution that is a dividend is included in the shareholder’s gross income. For the current year, Westwind reported earnings and profits of $15,000. What was the amount of Westwind’s accumulated earnings and profits deficit at year-end? This property, which had an adjusted basis of $30,000 and a fair market value of $20,000 at date of distribution, did not constitute assets used in the active conduct of Tour’s business. Determining the Dividend Example 2 Cher Holder receives a property distribution from Sunny Corporation with a fair value of $200. Redemptions in Complete Redemption of all of the Stock of the Corporation Owned by the Shareholder Redemptions that are not Essentially Equivalent to a Dividend Stock Redemptions Stock Redemption 92. What percentage ownership test(s) must be met for the shareholder to receive exchange treatment under §302(b)(2)?