| Corporation K distributed an airplane to its sole shareholder, Mr. P. On the date of distribution, the airplane had a fair market value of $50,000 and an adjusted basis to Corporation K of $12,000. What is Corporation K’s recognized gain on the distribution? |
ection 311(b) requires a corporation to recognize gain to the extent the FMV of property distributed exceeds the adjusted basis of such property.
FMV of property distributed | $50,000 |
Less: Adjusted basis | (12,000) |
Gain recognized under Sec. 311(b) | $38,000 |
| Bob, Inc., a calendar-year corporation that began doing business 10 years ago, had $35,000 in accumulated earnings and profits on January 1 of this year. Bob had an operating loss of $60,000 for the first 6 months of this year but had $10,000 in earnings and profits for the entire year. Bob made a distribution of $25,000 cash to its shareholders on April 1 this year. What is the amount of Bob’s accumulated earnings and profits at the close of business on December 31? |
| Determination must first be made as to whether or not the cash distribution is a dividend. Section 316 defines a dividend as a distribution of earnings and profits. Regulation 1.316-1(a)(1)(ii) states that current E&P is to be computed at the end of the tax year without regard to distributions during the year. At December 31 of this year, Bob has a current E&P of $10,000 and accumulated E&P of $35,000. The cash distribution comes first from current E&P ($10,000 – $10,000 = $0), with the balance from accumulated E&P, thereby leaving a $20,000 balance ($35,000 – $15,000). |
Foghorn Corporation, an accrual-method taxpayer, had accumulated earnings and profits of $75,000 as of December 31, Year 1. For the Year 2 tax year, Foghorn’s books and records reflect the following:
Taxable income per return | $175,000 |
Tax-exempt interest received | 2,000 |
Federal income taxes | 60,000 |
Business meals in excess of 50% limitation | 4,000 |
Contributions in excess of limitation | 1,000 |
Based on the above, what is the amount of Foghorn Corporation’s accumulated earnings and profits as of December 31, Year 2?
Calculation of E&P begins with taxable income according to the tax return. Tax-exempt income is added to the taxable income, and nondeductible expenditures are subtracted, e.g., federal income taxes, charitable contributions in excess of the 25% limitation, and excess business meals.
Acc. E&P at December 31, Year 1 | $ 75,000 |
Taxable income for Year 2 | 175,000 |
Add: Tax-exempt interest | 2,000 |
Deduct: Excess contributions | (1,000) |
Excess business meals | (4,000) |
Federal income taxes | (60,000) |
Acc. E&P at December 31, Year 2 | $187,000 |
| The Smart Corporation distributes an office building to Collin, a shareholder of the corporation. The fair market value of the building exceeds its basis to the corporation. Which of the following statements is true with regard to this transaction? |
| If a corporation distributes property other than its own obligations to a shareholder and the property’s fair market value exceeds corporation’s adjusted basis, the property is treated as sold at the time of distribution. The corporation recognizes gain on the excess of the FMV over the adjusted basis of the property. |
| The Richards Corporation distributed an airplane to its only shareholder, Bob. The airplane had a FMV of $75,000 and an adjusted basis to the Richards Corporation of $50,000. The airplane was subject to a secured loan of $90,000, which Bob assumed. What is the Richards Corporation’s gain (loss) on the distribution? |
Section 311(b) requires a corporation to recognize gain to the extent the FMV of property distributed exceeds the adjusted basis of the property. If liabilities exceed basis, FMV is treated as not less than the liabilities assumed or acquired by the shareholder [Sec. 311(b)(2)]. Therefore, the FMV is treated as $90,000.
FMV of property distributed | $ 90,000 |
Less: Adjusted basis | (50,000) |
Gain recognized under Sec. 311(b) | $ 40,000 |
| Hampshire, Inc., a calendar-year taxpayer, had an accumulated earnings and profits balance at the beginning of Year 1 of $20,000. During Year 1, Hampshire distributed $30,000 to its sole individual shareholder. On December 31, Year 1, Hampshire reported taxable income of $50,000, reported federal income taxes of $7,500, and had tax-exempt interest on municipal bonds of $2,500. What is Hampshire, Inc.’s accumulated earnings and profits balance at the beginning of Year 2? |
Taxable income is the starting point for computing E&P. Appropriate adjustments are made for E&P for items that are not used to compute taxable income.
Beginning E&P | $ 20,000 |
Distribution to shareholder | (30,000) |
Taxable income | 50,000 |
Federal income taxes | (7,500) |
Tax-exempt interest | 2,500 |
Ending E&P | $ 35,000 |
Badger Corporation has $64,000 of earnings and profits before accounting for the following distributions to its sole shareholder:
Cash | $25,000 |
Real estate: Adjusted basis | 70,000 |
Fair market value | 98,000 |
Subject to a mortgage of | 40,000 |
The shareholder assumes the $40,000 mortgage on the property. Without considering federal income taxes, what is the net reduction to Badger’s earnings and profits?
| E&P are increased by current E&P and decreased by the corporation’s distributions to its shareholders. Distributions of cash decrease E&P by the value distributed ($25,000). A distribution of appreciated property increases E&P by the gain recognized on the distribution ($28,000) and decreases E&P by the FMV of the property ($98,000) less any liability assumed by the shareholder ($40,000). Therefore, Badger’s E&P will have a net reduction of $55,000 ($25,000 + $98,000 – $28,000 – $40,000). |
| On July 1, Year 1, VAL, a calendar-year C corporation, distributed an auto used 100% in its business to its sole shareholder. At the time of the distribution, the auto, which originally cost $18,000, had an adjusted basis of $6,000 and a fair market value of $5,000. No liabilities were attached to the auto. No other distributions were made during Year 1. As of January 1, Year 1, VAL’s accumulated earnings and profits were $(5,000). For Year 1, VAL’s earnings and profits were $8,000. By what amount will VAL reduce its earnings and profits as a result of the distribution of the auto? |
| In the case of distributed property that is not appreciated property, E&P are reduced by the property’s basis. However, the distribution cannot create negative E&P. In determining whether negative E&P are created, first look to current year’s E&P. Since the distributed property’s basis ($6,000) is less than current year’s E&P ($8,000), no deficit in E&P is created. Thus, E&P are reduced by the full $6,000. |
| Ambassador Matinee Company distributed a dividend in the form of land to its sole shareholder. The land has a fair market value of $50,000 and an adjusted basis of $10,000. Assuming that the corporation has sufficient earnings and profits and ignoring the potential tax effect of any taxes on the distribution, the net effect of the transaction on earnings and profits is |
| When appreciated property is distributed, the corporation recognizes a gain equal to the excess of the FMV of the property over the adjusted basis. The E&P are increased by the recognized gain ($40,000) and decreased by the FMV of the property distributed ($50,000). Therefore, the net effect of the distribution is a decrease of $10,000. |
Which of the following is applicable regarding the proper treatment of a distribution of
appreciated property by a corporation?
A corporation will recognize a gain on the distribution of property if the FMV of the
property is more than its basis. This is generally the same treatment received if the
property were sold. However, for this purpose, the FMV of the property is greater than
the actual FMV, or the amount of any liabilities a shareholder assumed connected to the
distribution of property.
The Englander Company bought land two years ago for $20,000. The property is now
worth $24,000 although the corporation still owes $15,000 on its purchase. The
company makes a non-liquidating distribution of this property to one of its
stockholders who also accepted the obligation for the debt. What is the tax effect to
Englander of making this distribution?
For the non-liquidating distribution of property by a corporation, the corporation must
report the transfer as if the property had been sold and the money conveyed as a
dividend. The form of the dividend should not change the tax implications. Although the
property had originally cost $20,000, it could have been sold for $24,000 and a gain of
$4,000 incurred. The company could have then taken $15,000 of that amount to pay off
the liability with the remaining $9,000 paid to the owner as a dividend. Giving the
property directly to the owner should not change that tax effect; the gain is $4,000 as if
the property had been sold
Walnut, Inc. is a C corporation which was started in 2000. At the beginning of the current year,
Walnut, Inc. has accumulated earnings and profits of $100,000. During the current year Walnut,
Inc. makes a $5,000 distribution to its 100% shareholder in the first month of each quarter. At the
end of the current year, Walnut, Inc. had $150,000 in gross income and $140,000 in allowable
expenses from ordinary business operations. Walnut, Inc. also received $5,000 in fully tax-exempt
interest from state bonds. What part of the second quarter distribution is treated as a distribution
of accumulated earnings and profits?
f a corporation’s current year earnings and profits (figured as of the close of the year without
reduction for any distributions made during the year) are less than the total distributions made
during the year, part or all of each distribution is treated as a distribution of accumulated earnings
and profits; however, if there is not enough current year E&P a portion of AE&P allocates to each
distribution throughout the year. Accumulated earnings and profits are earnings and profits the
corporation accumulated before the current year.
Current year E&P is the taxable income of the corporation with certain adjustments, including an
increase for tax-exempt interest. Current year E&P is $15,000 ($10,000 in taxable income and tax-free
income of $5,000). The total distributions are $20,000 (quarterly installments of $5,000); therefore
the remaining $5,000 is from accumulated E&P. Each distribution is considered to have this same
proportion (75% E&P, 25% AE&P). The question asks for the second quarter portion which is AE&P. The
pro-rata distribution from AE&P is $1,250 per quarter.
| Vernon Corporation, a calendar-year C corporation, had accumulated earnings and profits of $100,000 as of January 1, Year 1. Vernon had a deficit in earnings and profits for Year 1 of $140,000. Vernon distributed $35,000 to its shareholders on July 1, Year 1. Vernon Corporation’s accumulated earnings and profits as of December 31, Year 1, are |
When a distribution is made during the course of the year, the earnings and profits must be prorated for the year to reflect the accumulated earnings and profits balance on the date of the distribution. Because the distribution occurred on July 1, the accumulated earnings and profits was $30,000 [$100,000 – (6 months ÷ 12 months × $140,000)]. The $35,000 distribution reduces the E&P balance to zero. The accumulated earnings and profits balance as of December 31, Year 1, is a $70,000 deficit or the remainder of the current earnings and profits deficit ($0 current E&P balance after distribution – $70,000 deficit E&P balance from July 1 to December 31).
Grafton Company, formed 20 years ago by its current shareholders, is a calendar-year taxpayer. Grafton had accumulated earnings and profits of $120,000 as of December 31 of the current year. During the current year, Grafton made distributions to each of its shareholders as follows:
What is the amount of total income from the above distribution that Mr. Stone should report from Grafton Company? |
A corporate distribution is taxable to the recipient to the extent it comes from accumulated or current earnings and profits. Any remaining distribution is treated as a return of capital. Because the distribution exceeded the accumulated earnings and profits, only a pro rata share of the distribution is considered income. Therefore, Mr. Stone should report $72,000 of dividend income ($90,000 ÷ $150,000 × $120,000).
| Corporation K distributed a parcel of real estate, which had an adjusted basis to the corporation of $50,000 and a fair market value of $75,000, to a shareholder. The property was subject to a mortgage of $80,000, which was assumed by the shareholder. What is Corporation K’s recognized gain (loss) on the distribution to the shareholder? |
Section 311(b) requires a corporation to recognize gain to the extent the FMV of property distributed exceeds the adjusted basis of such property. If liabilities exceed basis, FMV is treated as not less than the liabilities assumed or acquired by the shareholder [Sec. 311(b)(2)]. Therefore, the FMV is treated as $80,000.
FMV of property distributed | $ 80,000 |
Less: Adjusted basis | (50,000) |
Gain recognized under Sec. 311(b) | $ 30,000 |
| Elk Corporation, a calendar-year C corporation, had accumulated earnings and profits (E&P) of $60,000 as of January 1, Year 1, the beginning of its tax year. Elk had an operating loss of $70,000 for the first 6 months of Year 1 but had E&P of $6,000 for the entire Year 1 tax year. Elk distributed $15,000 to its shareholders on July 1, Year 1. What portion of the $15,000 distribution would be an ordinary dividend? |
First, it must be determined whether the cash distribution is a dividend. Sec. 316 defines a dividend as a distribution of earnings and profits (E&P). Reg. 1.316-1(a)(1)(ii) states that the current E&P is to be computed at the end of the tax year without regard to distributions during the year. On December 31, Elk has a current E&P of $6,000 and an accumulated E&P of $60,000. The cash distribution comes first from the current E&P ($6,000 – $6,000 = $0), with the balance from accumulated E&P, thereby leaving a $51,000 balance ($60,000 – $9,000). All $15,000 of the distribution is dividend income.
| Adam Corporation is a calendar-year C corporation that had accumulated earnings and profits of $30,000 as of January 1, Year 1. On April 1, Year 1, Adam distributed $55,000 in cash to its sole shareholder. For Year 1, Adam had earnings and profits of $20,000. The shareholder’s adjusted basis in the stock of Adam was $12,000 before the distribution. What are the shareholder’s ordinary dividend income and the return of capital due to this distribution? | ||||||||||||||||||||||||
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A corporate distribution is a dividend that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from accumulated or current E&P of a corporation. To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder to the extent of the shareholder’s basis in the stock. The distribution of $55,000 cash exceeds the corporation’s total E&P of $50,000 ($30,000 accumulated + $20,000 current). Therefore, $50,000 of the distribution is dividend income, and the remaining $5,000 is a return of capital.
On July 1, Year 1, VAL, a calendar-year C corporation, distributed an auto used 100% in its business to its sole shareholder. At the time of the distribution, the auto, which originally cost $18,000, had an adjusted basis of $6,000 and a fair market value of $5,000. No liabilities were attached to the auto. No other distributions were made during Year 1. As of January 1, Year 1, VAL’s accumulated earnings and profits were $(5,000). For Year 1, VAL’s earnings and profits were $8,000. By what amount will VAL reduce its earnings and profits as a result of the distribution of the auto?
In the case of distributed property that is not appreciated property, E&P are reduced by the property’s basis. However, the distribution cannot create negative E&P. In determining whether negative E&P are created, first look to current year’s E&P. Since the distributed property’s basis ($6,000) is less than current year’s E&P ($8,000), no deficit in E&P is created. Thus, E&P are reduced by the full $6,000. |
Rose Corporation is a calendar-year filing corporation that had accumulated earnings and profits of $5,000 at the end of Year 1. At the end of Year 2, Rose Corporation had current-year earnings and profits of $1,000. On December 31, Year 2, Rose Corporation distributed to sole shareholder Paul Rose an automobile purchased for $10,000 with a fair market value of $8,000. Paul Rose assumed a liability on the automobile of $1,000. What amount of dividend paid to Paul Rose must Rose Corporation report as an ordinary dividend in Box 1a of Form 1099-DIV?
Because Rose Corporation only has $6,000 ($5,000 + $1,000) in current and accumulated earnings and profits, only $6,000 of the distribution can be considered a dividend for tax purposes.
The Cole Corporation distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. What gain, if any, must Cole recognize?
A corporation recognizes the gain realized on the distribution of appreciated property on the amount the fair market value of the property exceeds the adjusted basis. Gain is not recognized on the distribution of cash; therefore, Cole must recognize a gain of $10,000 ($60,000 FMV – $50,000 adjusted basis).
| Walnut, Inc., is a C corporation that was started 10 years ago. At the beginning of the current year, Walnut has accumulated earnings and profits of $100,000. During the current year, Walnut makes a $5,000 distribution to its 100% shareholder in the first month of each quarter. At the end of the current year, Walnut had $150,000 in gross income and $140,000 in allowable expenses from ordinary business operations. Walnut also received $5,000 in fully tax-exempt interest from state bonds. What part of the second quarter distribution is treated as a distribution of accumulated earnings and profits? |
Distributions are deemed to come from current E&P and then from accumulated E&P if the current E&P are insufficient. The amount of the distribution from accumulated earnings and profits is calculated as follows:
Gross income | $150,000 |
Add: Tax-exempt income | 5,000 |
Total income | $155,000 |
Less: Annual expenses | (140,000) |
Total annual current E&P | $ 15,000 |
Current earnings and profits ÷ 4 quarters | |
= $3,750 current E&P/quarter | |
Amount of distributions per quarter | $ 5,000 |
Less: Amount of distribution from current E&P | (3,750) |
Amount of distribution from accumulated E&P | $ 1,250 |
A distribution of stock or rights to acquire stock in the distributing corporation is not included in the recipient’s gross income unless
Usually, a shareholder does not include a distribution of stock or rights to acquire stock in gross income unless it is (1) a distribution in lieu of money, (2) a disproportionate distribution, (3) a distribution on preferred stock, (4) a distribution of convertible preferred stock, or (5) a distribution of common and preferred stock, resulting in receipt of preferred stock by some shareholders and common stock by other shareholders.
| Heritage Corporation distributed an antique automobile to Rene, its sole shareholder. On the date of distribution, the automobile had a fair market value of $30,000 and an adjusted basis to Heritage of $22,000. What is the amount of Heritage Corporation’s recognized gain on the distribution? |
If a corporation distributes property other than its own obligations to a shareholder and the property’s FMV exceeds the corporation’s adjusted basis, the property is treated as sold at the time of distribution. The corporation recognizes gain on the excess of the FMV over the adjusted basis of the property.
FMV of property distributed | $30,000 |
Less: Adjusted basis | (22,000) |
Gain recognized under Sec. 311(b) | $ 8,000 |
| The Richards Corporation distributed an airplane to its only shareholder, Bob. The airplane had an FMV of $75,000 and an adjusted basis to the Richards Corporation of $50,000. The airplane was subject to a secured loan of $90,000, which Bob assumed. What is the Richards Corporation’s gain (loss) on the distribution? |
Section 311(b) requires a corporation to recognize gain to the extent the FMV of property distributed exceeds the adjusted basis of the property. If liabilities exceed basis, FMV is treated as not less than the liabilities assumed or acquired by the shareholder [Sec. 311(b)(2)]. Therefore, the FMV is treated as $90,000.
FMV of property distributed | $ 90,000 |
Less: Adjusted basis | (50,000) |
Gain recognized under Sec. 311(b) | $ 40,000 |
| Ambassador Matinee Company distributed a dividend in the form of land to its sole shareholder. The land has a fair market value of $50,000 and an adjusted basis of $10,000. Assuming that the corporation has sufficient earnings and profits and ignoring the potential tax effect of any taxes on the distribution, the net effect of the transaction on earnings and profits is |
As of January 1, Year 1, Braddock, a calendar-year, accrual-method corporation, had accumulated earnings and profits of $225,000. For its Year 1 tax year, Braddock’s books and records reflect the following:
Calculation of E&P begins with adding taxable income according to the tax return. Nondeductible expenditures are subtracted from taxable income, e.g., federal income taxes, political contributions, excess business meals, and demolition expenses. Dividend distributions also decrease E&P.
E&P at January 1, Year 1 | $225,000 |
Taxable income for Year 1 | 150,000 |
Deduct: Excess business meals | (3,500) |
Political contributions | (25,000) |
Federal income taxes | (41,750) |
Dividends | (25,000) |
Demolition expense | (90,000) |
E&P at January 1, Year 2 | $189,750 |
Camden, Inc., a calendar-year C corporation that began conducting business 20 years ago, had accumulated earnings and profits (E&P) of $20,000 as of January 1 of the current year. On October 1 of the current year, Camden distributed $25,000 in cash to Beaufort, Camden’s sole shareholder. Camden had a $20,000 deficit in E&P for the current year. Beaufort had an adjusted basis of $8,000 in his stock before the distribution. What are the amounts of Beaufort’s ordinary dividend income and capital gain as of the date of the distribution?
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When a distribution is made during the course of the year and an E&P deficit exists, the E&P must be prorated to reflect the accumulated E&P balance on the date of the distribution. Because the distribution occurred on October 1, the accumulated E&P were $5,000 {$20,000 – [$20,000 × (9 months ÷ 12 months)]}. A corporate distribution is a “dividend” that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated E&P of a corporation. To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Therefore, Beaufort will recognize $5,000 of ordinary income, $8,000 as a return of capital, and a $12,000 capital gain from the distribution.
The following information is available from the records of Emute, Inc. Compute current-year earnings and profits.
Taxable income, Form 1120 | $50,000 |
Federal income taxes paid | $7,500 |
Nondeductible portion of meals | $500 |
Excess of capital losses over capital gains | $1,000 |
Earnings and profits (E&P) are designed to measure a corporation’s true ability to pay a dividend to its shareholders. In computing E&P, certain adjustments are made to taxable income (TI). One such adjustment is subtracting from TI expenses and losses that are nondeductible. Accordingly, current E&P are calculated as follows:
Taxable income | $50,000 |
Less: | |
Federal income taxes paid | (7,500) |
Nondeductible meals | (500) |
Excess capital losses | (1,000) |
Current E&P | $41,000 |
| The West Corporation distributes property with a basis of $1,000 and a fair market value of $4,000 subject to a liability of $6,000 to Jeff, a shareholder. What is the gain or loss, if any, the West Corporation must recognize as a result of the distribution? |
A corporation recognizes the gain realized on the distribution of appreciated property on the amount the fair market value of the property exceeds the adjusted basis. If a liability attached to a distributed asset exceeds the FMV of the asset, the selling price is equal to the amount of the liability. The West Corporation must recognize a gain of $5,000, the difference between the amount of the liability and the basis of the property.
Which of the following statements regarding corporate distributions is false?
| Orville Corporation had earnings and profits of $82,000 for the current year before distribution of dividends. On December 31 of the current year, the company distributed inventory with a fair market value of $16,000 and an adjusted basis of $12,000 as a dividend to its sole individual shareholder, Wilbur. The corporation values its inventory by the first-in, first-out method. Assume the corporate tax rate is 21%. What is the earnings and profits balance at the end of the current year? |
The general rule under Sec. 311(a) is that a corporation recognizes no gain or loss on the distribution of property with respect to its stock. An exception to this nonrecognition principle is the distribution of property with an FMV in excess of its basis. A gain is recognized to the extent of such excess. Thus, Orville Corporation must recognize a $4,000 gain ($16,000 – $12,000) and pay $840 ($4,000 × .21) in taxes on the gain [Sec. 311(b)]. Section 312(b) provides that, when appreciated assets are distributed, earnings and profits are increased by the excess of fair market value over the adjusted basis of the assets and decreased by the fair market value.
E&P before distribution | $82,000 |
Increase by gain recognized ($16,000 – $12,000) | 4,000 |
Decrease by FMV | (16,000) |
Decrease by federal income taxes paid | (840) |
E&P after distribution | $69,160 |
| For 10 years, Ben has owned all 100 outstanding shares of N and M Corporation’s stock. Ben’s basis for the stock is $50,000. In the current year, N and M has earnings and profits of $100,000. The corporation redeemed 25 shares of Ben’s stock for $75,000 in the current year. How will Ben report this? |
Because Ben owns 100% of the stock before and after the redemption, the transaction is a dividend to the extent that N and M Corporation has earnings and profits. Because the distribution ($75,000) is less than earnings and profits ($100,000), the entire amount is taxable as a dividend.
| Corporation H, a calendar-year, accrual-basis taxpayer, distributed shares of Corporation B stock to H’s employees in lieu of salaries. The salary expense would have been deductible as compensation if paid in cash. On the date of the payment, H’s adjusted basis in Corporation B stock was $15,000 and the stock’s fair market value was $85,000. What is the tax effect to Corporation H? |
Under Sec. 83(a), the employee includes in income the fair value of property received for services. Under Sec. 83(h), the employer is allowed a deduction for the amount the employee must include in income when the employee includes it in income. However, when property other than cash is distributed in exchange for services, the employer must recognize a gain on the deemed sale. Since the employees will include the $85,000 FMV of shares in income, Corporation H may deduct the $85,000. However, H must also recognize a $70,000 gain ($85,000 FMV – $15,000 adjusted basis) on the deemed sale.
Ball, a calendar-year C corporation, had accumulated earnings and profits of $50,000 as of January 1, Year 1. Ball had a deficit in earnings and profits for Year 1 of $65,000. Ball distributed $25,000 to its shareholders on July 1, Year 1. What is the amount of Ball Corporation’s accumulated earnings and profits as of December 31, Year 1?
When a distribution is made during the course of the year, the E&P must be prorated for the year to reflect the accumulated E&P balance on the date of the distribution. Because the distribution occurred on July 1, the accumulated E&P was $17,500 [$50,000 – (6 months ÷ 12 months × $65,000)]. The $25,000 distribution reduces the E&P balance to zero. The accumulated E&P balance as of December 31, Year 1, is a $32,500 deficit, or the remainder of the current E&P deficit.
Healey, Inc., owned a parcel of undeveloped land with an adjusted basis of $10,000, an attached liability of $4,000, and a fair market value of $15,000. In Year 1, this land was distributed by Healey to its sole shareholder, who also assumed the liability. Healey will recognize how much of a gain in this distribution?
Badger Corporation has $64,000 of earnings and profits before accounting for the following distributions to its sole shareholder:
Cash | $25,000 |
Real estate: Adjusted basis | 70,000 |
Fair market value | 98,000 |
Subject to a mortgage of | 40,000 |
The shareholder assumes the $40,000 mortgage on the property. Without considering federal income taxes, what is the net reduction to Badger’s earnings and profits?
E&P are increased by current E&P and decreased by the corporation’s distributions to its shareholders. Distributions of cash decrease E&P by the value distributed ($25,000). A distribution of appreciated property increases E&P by the gain recognized on the distribution ($28,000) and decreases E&P by the FMV of the property ($98,000) less any liability assumed by the shareholder ($40,000). Therefore, Badger’s E&P will have a net reduction of $55,000 ($25,000 + $98,000 – $28,000 – $40,000).
Yappa Corporation distributed depreciable personal property having a fair market value of $9,500 to its shareholders. The property had an adjusted basis of $2,000 to the corporation. Yappa had correctly deducted $7,000 in depreciation on the property. What is the amount of Yappa’s ordinary income due to this distribution?
Section 311(b) requires that gain on the distribution of appreciated property be recognized as if the property had been sold. Therefore, Yappa will recognize $7,500 ($9,500 fair market value – $2,000 basis) of total gain. Of this gain, $7,000 will be ordinary income as a result of Sec. 1245 depreciation recapture.
Core Corporation reported current earnings and profits of $250,000. It distributed a building, with an adjusted basis to Core of $170,000 and a fair market value of $230,000, to its sole shareholder. The building had a mortgage of $90,000, which the shareholder will assume. What is the amount of the dividend received by the shareholder?
Section 301(b)(1) provides that the distribution to a shareholder is equal to the fair market value of the property distributed. Under Sec. 301(b)(2)(A), this amount must be decreased by any liabilities assumed by the shareholder or to which the property is subject. The distribution to the shareholder is $140,000 ($230,000 FMV – $90,000 liability).
Under Sec. 316, a distribution is a dividend to the extent that it comes from earnings and profits. The earnings and profits would be increased by the gain (net of tax) on the distribution. Gain is recognized to the extent the FMV of the building exceeds the adjusted basis [Sec. 311(b)], or $60,000. In any event, the corporation has at least $250,000 of earnings and profits. Therefore, the entire $140,000 is a dividend.
During the current calendar year, the Lance Corporation made a $40,000 cash distribution to its sole shareholder. Lance’s current-year earnings and profits (as of the close of the year and without reduction for distributions during the year) is $25,000. Accumulated earnings and profits is $10,000. What amount of dividend should be reported on Form 1099-DIV issued to the shareholder for the current year?
The amount of a distribution is a dividend to the extent, first, of any current E&P, and then, of any accumulated E&P. The first $25,000 of the distribution comes from current E&P, and the next $10,000 of the distribution comes from accumulated E&P; therefore, Lance Corporation must report $35,000 of dividend on its Form 1099-DIV.
| Michael Corporation is a calendar-year corporation that had accumulated earnings and profits of $32,000 as of January 1, Year 1. Michael Corporation had a deficit in earnings and profits for Year 1 of $40,000 and distributed $15,000 to one of its shareholders, Mr. Scott, on July 1, Year 1. The adjusted basis of Mr. Scott’s stock before the distribution was $2,000. What are Mr. Scott’s ordinary dividend income and his capital gain as of the date of the distribution? | ||||||||||||||||||||||||
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When a distribution is made during the course of the year, the E&P must be prorated to reflect the accumulated E&P balance on the date of the distribution. Because the distribution occurred on July 1, the accumulated E&P were $12,000 {$32,000 – [$40,000 × (6 months ÷ 12 months)]}. A corporate distribution is a “dividend” that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated E&P of a corporation. To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Therefore, Mr. Scott will recognize $12,000 of ordinary income, $2,000 as a return of capital, and a $1,000 capital gain from the distribution.
| On July 1 of the current year, Rose Corp., a calendar-year C corporation, distributed an auto used 100% in its business to its sole shareholder. At the time of the distribution, the auto, which originally cost $24,000, had an adjusted basis of $14,000 and a fair market value of $9,000. There were no liabilities attached to the auto. No other distributions were made during the year. As of January 1, Rose’s accumulated earnings and profits were a deficit of $8,000. For the year, Rose’s earnings and profits were $16,000. By what amount will Rose reduce its earnings and profits as a result of the distribution of the auto? |
In the case of distributed property that is not appreciated property, earnings and profits are reduced by the property’s basis. However, the distribution cannot create negative earnings and profits. In determining whether negative earnings and profits are created, first look to current year’s earnings and profits. Since the distributed property’s basis, $14,000, is less than the current year’s earnings and profits of $16,000, no deficit in earnings and profits is created. Thus, earnings and profits are reduced by the full $14,000. |
Gold Corporation distributes land with a fair market value of $25,000 to its sole shareholder Donna Gold, who assumes the mortgage on the land of $35,000. This land had an adjusted basis to Gold Corporation of $20,000. Gold Corporation must recognize how much of a gain on this distribution?
| James Corporation made various payments and transfers to and for its shareholders, Rob and Jim, during the year. Which of the following is NOT a reportable distribution? (Assume sufficient earnings and profits.) |
Reasonable salaries are not distributions. However, if a portion of the salary is deemed to be excessive and therefore unreasonable, the excess would be a distribution. The salaries are an expense of the corporation.
Margaret Corporation had suffered losses in its earlier years, up through Year 1, but Year 2 was profitable. Margaret Corporation has current earnings and profits for Year 2 tax year of $15,000 and accumulated earnings and profits for prior years of $(14,000). An IRS audit of Year 2 determined that the shareholder benefited from constructive dividends from personal use of corporate vehicles and equipment. The amount agreed on for the constructive dividend was $12,000. There were no other dividends or distributions. Which of the following is true?
A corporate distribution is a dividend that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated earnings and profits of a corporation. Distributions that must be included in gross income include constructive dividends. To the extent the distribution exceeds current and accumulated earnings and profits, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Since Margaret Corporation has current earnings and profits of $27,000 ($15,000 + $12,000 reversed deductions), the dividend of $12,000 is fully taxable. Remember that the disallowance of the expense increases current earnings and profits by $12,000.
| Ten years ago, Mr. P purchased stock for $1,000. Last year, he received a return of capital of $800 and reduced the basis of his stock by that amount. This year, he received another return of capital, amounting to $300, which reduced the basis of his stock to zero. At no time did the corporation have earnings and profits. He would report the $100 that was in excess of his basis as | |
A corporate distribution is a dividend that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated earnings and profits of a corporation. To the extent the distribution exceeds current and accumulated earnings and profits, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Mr. P’s capital gain is long term because he held the stock for more than 1 year.
A corporate distribution is a dividend that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated earnings and profits of a corporation. To the extent the distribution exceeds current and accumulated earnings and profits, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Mr. P’s capital gain is long term because he held the stock for more than 1 year.
If a corporation distributes property other than its own obligations to a shareholder and the property’s fair market value exceeds the corporation’s adjusted basis, the property is treated as sold at the time of distribution. The corporation recognizes gain on the excess of the FMV over the adjusted basis of the property. |
| If a corporation makes a below-market loan to a shareholder, the corporation generally is deemed to make a payment to the shareholder for federal tax purposes. This deemed payment is treated as a(n) |
A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate (AFR). If a below-market loan other than a gift loan or demand loan is received, the recipient is treated as receiving an additional payment (as a dividend, etc.) on the date the loan is made equal to the forgone interest on the loan. This amount is then treated as transferring the amount back to the lender as interest. These transfers are considered to occur annually, generally on December 31. The amount received by a shareholder from the corporation is treated as a dividend.
Rose Corporation, a calendar-year corporation, had accumulated earnings and profits of $40,000 as of January 1, Year 1. However, for the first 6 months of Year 1, Rose had an operating loss of $36,000 and finished the year with a total net operating loss for Year 1 tax year of $55,000. Rose distributed $15,000 to its shareholders on July 1, Year 1. Which of the following is true?
When a distribution is made during the course of the year, the E&P must be prorated to reflect the accumulated E&P balance on the date of the distribution. Because the distribution occurred on July 1, the accumulated E&P were $12,500 {$40,000 – [$55,000 × (6 months ÷ 12 months)]}. A corporate distribution is a dividend that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated E&P of a corporation. To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Therefore, each shareholder will recognize $12,500 of ordinary income.
| Arena, Inc., decided to distribute shares of its own stock to its employees at year end as a reward for a profitable year. Each employee was to receive 10 shares with a fair market value of $100 per share. Employees were offered a choice of cash or the stock dividend. What is the tax effect to the employees of this distribution? |
Each employee has taxable compensation of $1,000 ($100 per share × 10 shares). The amount of compensation is either the amount of cash they receive or the fair market value of the stock they receive. |
| A distribution of taxable stock rights or dividends generally is treated the same as |
If the distribution of a stock dividend or stock right is taxable when received, the basis is the fair market value on the date of distribution. When the dividend is taxable, there is no tracking of the holding period for the underlying stock. The holding period begins the day following the acquisition date.
Bob, Inc., a calendar-year corporation that began doing business 10 years ago, had $35,000 in accumulated earnings and profits on January 1 of this year. Bob had an operating loss of $60,000 for the first 6 months of this year but had $10,000 in earnings and profits for the entire year. Bob made a distribution of $25,000 cash to its shareholders on April 1 this year. What is the amount of Bob’s accumulated earnings and profits at the close of business on December 31?
Determination must first be made as to whether or not the cash distribution is a dividend. Section 316 defines a dividend as a distribution of earnings and profits. Regulation 1.316-1(a)(1)(ii) states that current E&P is to be computed at the end of the tax year without regard to distributions during the year. At December 31 of this year, Bob has a current E&P of $10,000 and accumulated E&P of $35,000. The cash distribution comes first from current E&P ($10,000 – $10,000 = $0), with the balance from accumulated E&P, thereby leaving a $20,000 balance ($35,000 – $15,000).
| Corporation D sold equipment used in its business to its sole shareholder Mr. B for $13,000. On the date of the sale, the fair market value of the equipment was $16,000, and D’s adjusted basis was $11,000. Corporation D also canceled a $4,000 debt of Mr. B. What is the amount of the dividend received by Mr. B, assuming Corporation D has current year earnings and profits of $250,000? |
A constructive distribution will be treated as a dividend for tax purposes if sufficient E&P are available. A bargain purchase of corporate property by shareholders is such a transaction [Reg. 1.301-1(j)]. Under Sec. 301(b)(1), the amount of a distribution to a distributee is the fair market value of the property distributed. The difference between the fair market value and the amount paid by the shareholder is treated as a constructive distribution. Cancellation of debt is also a constructive dividend.
FMV of equipment | $ 16,000 |
Less: Amount paid | (13,000) |
Plus: Cancellation of debt | 4,000 |
Distribution | $ 7,000 |
To the extent the distribution comes from earnings and profits, it is treated as a dividend [Sec. 316(a)]. Since Corporation D had sufficient E&P, the entire $7,000 distribution is considered a dividend.
| Corporation K distributed an airplane to its sole shareholder, Mr. P. On the date of distribution, the airplane had a fair market value of $50,000 and an adjusted basis to Corporation K of $12,000. What is Corporation K’s recognized gain on the distribution? |
Section 311(b) requires a corporation to recognize gain to the extent the FMV of property distributed exceeds the adjusted basis of such property.
FMV of property distributed | $50,000 |
Less: Adjusted basis | (12,000) |
Gain recognized under Sec. 311(b) | $38,000 |
Foghorn Corporation, an accrual-method taxpayer, had accumulated earnings and profits of $75,000 as of December 31, Year 1. For the Year 2 tax year, Foghorn’s books and records reflect the following:
Taxable income per return | $175,000 |
Tax-exempt interest received | 2,000 |
Federal income taxes | 60,000 |
Business meals in excess of 50% limitation | 4,000 |
Contributions in excess of limitation | 1,000 |
Based on the above, what is the amount of Foghorn Corporation’s accumulated earnings and profits as of December 31, Year 2?
Calculation of E&P begins with taxable income according to the tax return. Tax-exempt income is added to the taxable income, and nondeductible expenditures are subtracted, e.g., federal income taxes, charitable contributions in excess of the 25% limitation, and excess business meals.
Acc. E&P at December 31, Year 1 | $ 75,000 |
Taxable income for Year 2 | 175,000 |
Add: Tax-exempt interest | 2,000 |
Deduct: Excess contributions | (1,000) |
Excess business meals | (4,000) |
Federal income taxes | (60,000) |
Acc. E&P at December 31, Year 2 | $187,000 |
Corporation T, with earnings and profits of $60,000, distributed cash of $20,000 and property with a fair market value of $25,000 and an adjusted basis of $30,000 to its corporate shareholders. What is the amount of the distribution received by the shareholders?
Section 301(b) provides that the amount distributed to a shareholder (corporate or noncorporate) is equal to the amount of money received, plus the fair market value of other property received. Corporation T distributed cash of $20,000 plus property with a fair market value of $25,000. Hence, the corporate shareholders will recognize a distribution of $45,000.
| Which of the following statements regarding distributions of stock is NOT true? |
Distributions of stock and stock rights are generally not treated as property.
Olympic Corporation distributed real estate with a FMV of $500,000 to its sole shareholder, Joshua. Olympic’s basis in the real estate is $400,000. What is the tax effect of the distribution to Olympic and what is Joshua’s basis in the real estate?
Section 301(b) provides that the amount distributed to a shareholder (corporate or noncorporate) is equal to the amount of money received, plus the fair market value of other property received. Additionally, Sec. 311(b) provides that if a corporation distributes property to a shareholder and the FMV is greater than the adjusted basis, the gain shall be recognized by the distributee corporation. |
| Corporation V, a calendar-year C corporation that began conducting business 25 years ago, had accumulated earnings and profits of $15,000 as of January 1 of the current year. On October 1, V distributed $20,000 in cash to its sole shareholder, Mr. Edward. V had a $16,000 deficit in earnings and profits for the current year. Mr. Edward had an adjusted basis of $5,000 in his stock before the distribution. What is the amount of Mr. Edward’s ordinary dividend income and capital gain as of the date of the distribution? | |||||||||||||||||||||||||
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When a distribution is made during the course of the year and an earnings and profits deficit exists at the end of the year, the earnings and profits must be prorated to reflect the accumulated earnings and profits balance on the date of the distribution. Because the distribution occurred on October 1, the accumulated earnings and profits were $3,000 [$15,000 – (9 months ÷ 12 months × $16,000)]. A corporate distribution is a “dividend” that must be included in the recipient’s gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated earnings and profits of a corporation. To the extent the distribution exceeds current and accumulated earnings and profits, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Therefore, Mr. Edward will recognize $3,000 of ordinary income, $5,000 as a return of capital, and $12,000 as a capital gain from the distribution.
