#11712 - Nonliquidating Distributions - Corporate Tax (Duke Zelenak)

Section 316(a) defines a dividend as any distribution of property made by a corporation to its shareholders out of accumulated earnings and profits, or current earnings and profits.

1. 301(c)(1) when a corporation makes distribution, first treated as dividend to the extent of E&P. (taxed at capital gain rate, 15% or 20%, cannot be deducted by capital loss)

2. 302(c)(2) if it exceeds E&P, then a tax-free recovery of SH’s stock basis. (0%)

3. 301(c)(3) if it still exceeds basis, treated as capital gain. (actual capital gain, taxed at capital gain rate, 15% or 20%, this can be deducted by capital loss)

Earnings and Profits

1. Start with taxable income

2. Add back certain excluded items

   1. Municipal interest

3. Add back certain deductible items

   1. Section 243 dividends received deductions

4. Subtract certain nondeductible items

   1. Federal income tax

   2. capital losses in excess of capital gains

5. Make timing adjustments

   1. +ACRS- alternative (Alternative depreciation system)

      1. Straight line method

      2. Use class life

Problem on 158:

1. taxable income 8,450

   1. +: 27.5

      1. 20 gross profit

      2. 2.5 LTCG

      3. 5 dividends (Section 243 - when a corporation receives dividends from another corporation)

         1. More than 80% of IBM: 100% dividends deduction

         2. 20%- 80% of IBM: 80% dividends deduction

         3. Less than 20%: 70% dividends deduction

   2. -: 19.05

      1. 10.25 salaries

      2. 2.8 ACRS

      3. 2.5 LTCL only deductible against LTCG

      4. 3.5 Section 243 deduction of 70% of dividends

2. E&P: 13,450

   1. 8450

   2. +3000, §103 interest

   3. +3500, §243 dividend (70%)

   4. -800, Federal income tax

   5. -2,500, LTCL

   6. +1800 ACRS adjustment

      1. ACRS: 14000*20%*2(double)*1/2(first year in use, use the half year convention)=2800

      2. Alternative: 14000*1/7(using class life)*1/2(first year in use, use half year convention)=1000

Dividends defined

1. Section 316(a): dividend means any distribution of property made by a corporation to its shareholders out of its E&P accumulated after Feb. 28, 1913, or

2. Current EP: earnings and profits of the taxable year computed as of the close of the taxable year without diminution by reason of any distribution made during the year, and without regard to the amount of earnings and profits at the time the distribution was made.

If Current E&P< Distributions

1. Current E&P allocated to distribution= Amount of distribution*total current E&P/total distributions

2. Accumulated E&P are allocated on a first come first served basis

3. If the corporation has a current loss but has accumulated earnings and profits from prior years, it will be necessary to determine the amount of accumulated earnings and profits available on the date of distribution. Unless the loss can be earnmarked to a particular period, the current deficit is prorated to the date of the distribution.

Problems on 162-63: 10,000 basis

1. 5000 current EP; 0 accumulated EP; this year pays out 17,500 distribution

   1. 5000 dividend (Out of current EP, without diminution)

   2. 10,000 recovery of basis

   3. 2500 capital gain

   4. 312 (a)(1): Accumulated EP at the beginning of the next year

      1. Current Acc EP: 0

      2. + current EP: 5000

      3. - distributions to the extent that it wipes out all acc EP: 5000 (instead of 17,500)

         1. In other words, this is the same as deducting the amount of dividends (which is 5000)

2. 15,000 acc EP deficit, 10,000 current EP, 10,000 distribution

   1. 10,000 dividends (out of current EP)

   2. Accumulated EP at the beginning of the next year

      1. Current acc EP: -15,000

      2. + Current EP: 10,000

      3. - distributions to the extent that it wipes out all acc EP: 0 (instead of 10,000) then -5,000

         1. Policy argument: dividends distributed should be used to reduce acc EP. Therefore, should deduct 10,000, then -15,000 (Zelenak prefers this result)

3. 10,000 acc EP; 4,000 current EP; 7/1 A sells of stock for 15,000 to B; 4/1, 10,000 distribution to Ann; 10/1, 5000 distribution to A, another 5000 to B

   1. Current E&P allocated to distribution= Amount of distribution*total current E&P/total distributions

   2. Accumulated EP, timing matters, first come first served

   3. 4/1 distribution to A: 2,000 coming out of current EP, 8,000 coming out of acc EP (Accumulated E&P are allocated on a first come first served basis)

      1. All of this distribution is dividend

   4. 10/1 distribution to A: 1000 coming out of current EP, 1000 coming out of acc EP (simultaneous, so it’s divided)

      1. 2000 dividend

      2. A still has 5000 basis (sell half to B), therefore 3000 basis recovery

   5. 10/1 distribution to B: 1000 coming out of current EP, 1000 coming out of acc EP (simultaneous, so it’s divided)

      1. 2000 dividend, 3000 recovery of capital.

4. 10,000 acc EP, -10,000 current EP, other facts are the same as in c.

   1. All distributions will come out of acc EP

   2. Current EP losses will be prorated

   3. 4/1:

      1. 10,000 acc EP

      2. -2500 prorated loss

      3. = 7500

      4. Therefore, 7500 dividends, other 2500 basis recovery, remaining basis 10000-2500=7500 (hasn’t sold the shares yet)

      5. Acc EP immediately reduced by distribution coming out of EP.

      6. Now the acc EP is 0.

      7. Acc EP at the beginning of next year is -7500 (further reduced by prorated loss)

   4. 10/1:

      1. A’s remaining basis is 7500/2=3750

         1. Recovery of basis 3750

         2. 1750 capital gain

      2. B has basis of 15,000

         1. All 5000 recovery of basis

For SH, just as if SH received a cash distribution equal to the FMV of the property.

For corporation: Section 311(a)(2) a corporation generally does not recognize gain or loss on a nonliquidating distribution of property. This rule is practically repealed by 311(b), see below.

Section 311(b) - gain is recognized: if a corporation distributes appreciated property in a nonliquidating distribution, it must recognize gain = FMV- Basis.

1. Gain goes into current EP

Corporation’s acc earnings and profits at the beginning of next year

1. Start with old acc EP

2. Add current EP at the current year

3. Deduct: Section 312(a)(3) reduce accumulated E&P by the basis of the distributed property

   1. Section 312 (b)(2) for appreciated property, E&P reduced by FMV

   2. Regulation 1.312-3, for property subject to liability assumed by SH, the decrease of 312(b)(2) is reduced by liability assumed.

Problems on 167-68: Z 8000 basis in 100% stocks of Corporation S; S has 25k acc EP, 0 current EP.

1. S distributes inventory 20K FMV, 11k basis.

   1. For Corporation S, gain of 9k. 311(b)

      1. Current EP increase to 9k.

   2. For Z, 20k distribution, in dividends (coming out of EP)

   3. Corporation’s acc EP at the beginning of the next year

      1. Old 25k acc EP

      2. + 9k current EP

      3. -20 k section 312 (b)(2)

      4. = 14k

2. S has 0k acc EP, 0 current EP

   1. For Corporation S, gain of 9k. 311(b)

      1. Current EP increase to 9k.

   2. For Z, 20k distribution: Section 301

      1. 9k dividends coming out of current EP

      2. 8k basis reduction

      3. 3k capital gain

   3. Corporation’s acc EP at the beginning of the next year

      1. Old 0k acc EP

      2. + 9k current EP

      3. -20 k section 312 (b)(2) to the extent that it wipes out all acc EP.

         1. = deduct the amount of dividends

      4. = 0

3. S distributes land 20K FMV, 11k basis; subject to 16k mortgage

   1. For Corporation S, gain of 9k. 311(b). Mortgage does not matter here.

      1. Current EP increase to 9k.

   2. For Z, 4k distribution (reduced by liability assumed): Section 301

      1. 4k dividends coming out of current EP

      2. Basis of the land is now 20k??

   3. Corporation’s acc EP at the beginning of the next year

      1. Old 25k acc EP

      2. + 9k current EP

      3. -(20 k-16k) Regulation 1.312-3

         1. That is, decrease...