| Heron, Inc., made a distribution of real estate with a FMV of $100,000 to its only shareholder, Jennifer, on December 31, Year 1. Heron’s basis in the property was $60,000. Current year earnings and profits of Heron (before the distribution) is $10,000, and it has accumulated $20,000 earnings and profits from prior years. Jennifer’s basis in her Heron stock is $5,000. What will be the tax effect to Jennifer? |
The $100,000 distribution of an asset with a $60,000 basis will create a $40,000 gain. The $40,000 gain will be added to current earnings and profits. Thus, dividend income would be $70,000 because of the earnings and profits ($10,000 + $40,000 + $20,000). 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 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, Jennifer will treat $5,000 of the $30,000 excess ($100,000 property distribution – $70,000 current and accumulated E&P) as return of capital and $25,000 of the excess as a capital gain.
| 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.
| 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. |
| 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 |
The following information pertains to Lamb Corp.:
Accumulated earnings and profits at | |
January 1 of the current year | $ 60,000 |
Earnings and profits for the current year | 80,000 |
Cash distributions to shareholders | |
during the current year | 180,000 |
What is the total amount of distributions taxable as dividend income to Lamb’s shareholders in the current 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 accumulated or current 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. Since Lamb Corporation had only $140,000 ($60,000 + $80,000) of earnings and profits, the distribution will be taxed as a dividend only to the extent of the $140,000. |
| Charles Watson owns 100% of the outstanding shares of Watson Corporation. He acquired these shares 7 years ago for $5,000. Watson Corporation had total earnings and profits at the end of the current year of $10,000. On December 31 of the current year, Watson Corporation distributed $8,000 in cash and property with a fair market value of $7,000 to Charles. In the current year, how much in capital gain must he report from this distribution? |
| 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 $15,000 cash and property exceeds the corporation’s total E&P of $10,000. Therefore, $10,000 of the distribution is dividend income, and the remaining $5,000 is a return of capital. |
| 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.
| 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 current E&P is to be computed at the end of the tax year without regard to distributions during the year. At December 31, Elk has a current E&P of $6,000 and accumulated E&P of $60,000. The cash distribution comes first from 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. |
