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1 Chapter 4: Corporate Nonliquidating Distributions.

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Presentation on theme: "1 Chapter 4: Corporate Nonliquidating Distributions."— Presentation transcript:

1 1 Chapter 4: Corporate Nonliquidating Distributions

2 2 Nonliquidating DISTRIBUTIONS (1 of 2)  Nonliquidating distributions in general  Computing current E&P  Current vs. accumulated E&P  Nonliquidating property distributions  Constructive dividends

3 3 NONLIQUIDATING DISTRIBUTIONS (2 of 2)  Stock dividends and stock rights  Stock redemptions  Preferred stock bailouts  Redemptions by related corporations

4 4 Nonliquidating Distributions (1 of 2)  Dividend distributions  A distribution of property based upon a corporation’s earnings & profits  Property includes money, securities & other assets  Does not include stock or stock rights of distributing corp  Dividends treated as ordinary income by s/h (generally taxed at 15%)

5 5 Nonliquidating Distributions (2 of 2)  Earnings and profits (E&P)  E&P not defined in the Code  E&P consists of current & accumulated  Distributions are based upon current E&P first & accumulated E&P second  Distributions in excess of E&P are considered a return of capital

6 6 Computing Current E&P (1 of 2)  E&P computed on annual basis at end of tax year  Generally E&P based on corp’s economic income instead of taxable income  Adjustments to taxable income for permanent & timing differences including use of different depreciation methods  Refer to Table C4-1

7 7 Computing Current E&P (2 of 2) Taxable income +Inc. excluded from TI but incl. in E&P +TI deferred to later year, but included in E&P in current year +/-Inc. & ded that must be recomputed when computing E&P +Deductions for TI not allowed in for E&P -Nondeduct exp/loss for TI that reduce E&P =Current E&P (or current E&P deficit)

8 8 Current vs Accumulated E&P (1 of 3)  Current E&P computed on last day of the corp’s tax year  Distributions greater than CE&P  CE&P allocated to distributions pro rata regardless of payment date  Then Accumulated E&P allocated to distributions in chronological order

9 9 Current vs Accumulated E&P (2 of 3)  Distributions greater than E&P  Cannot create an E&P deficit  Distributions in excess of all E&P is a return of capital to s/h and reduce s/h’s basis in stock.  Distributions in excess of basis result in a gain (usually capital gain)

10 10 Current vs Accumulated E&P (3 of 3)  If CE&P is positive and beginning AE&P is a deficit  Distributions will produce ordinary income to shareholder until CE&P reaches zero  CE&P allocated on a pro-rata basis

11 11 Consequences of Nonliquidating Distributions  Shareholder consequences  Corporation’s consequences  Example C4-15  Example C4-16  Distribution’s effect on E&P

12 12 Shareholder Consequences  In non-cash distributions, amount of income equal to FMV of property received minus liabilities assumed  Amount of distribution cannot be <$0  S/h’s basis in non-cash property is FMV on distribution date  Holding period of property begins day after distribution date

13 13 Corporation’s Consequences  Appreciated non-cash property produces gain as if corp sold property for FMV ondistribution date  Loss recognition NOT permitted  If liabilities exceed FMV, then FMV is assumed to be no less than amount of the liability

14 14 Example C4-15 FMV of land $60,000 Adjusted basis 20,000 Capital Gain 40,000 FMV of land$12,000 Adjusted Basis 20,000 No loss recognition by corporation

15 15 Example C4-16 FMV of land$25,000 Mortgage 35,000 Adjusted basis 20,000 Capital Gain 15,000 Shareholder’s basis$35,000

16 16 Distribution’s Effect on E&P (1 of 2)  Gain on non-cash distribution increases Current E&P  E&P is reduced by  Amount of cash distributed  Greater of FMV or adjusted basis of property distributed minus liability assumed by shareholder  Tax liability on gain recognized

17 17 Distribution’s Effect on E&P (2 of 2)  E&P is reduced by (continued)  Principal amount of the corporation’s own notes, bonds, debentures or other obligations distributed to shareholders

18 18 Constructive Dividends (1 of 2)  Most likely in closely held corps  Indirect payment made to a s/h without formal board action  Economic benefit provided to a s/h  Intentionally avoiding dividend status  Deduct. for excessive comp no longer constructive div due to max 15% tax on div, but corp still denied deduct.

19 19 Constructive Dividends (2 of 2)  Examples  “Loans” to shareholders  Excessive rent paid to shareholder  Payments for shareholder’s benefit  Bargain purchase  Use of corporate property

20 20 Stock Dividends & Stock Rights (1 of 2)  Stock dividends  Tax-free distribution of additional shares of stock to existing s/h  If shares identical, basis allocated by dividing old basis by total shares held  If shares different, basis allocated between old and new shares in proportion to FMV on distribution date

21 21 Stock Dividends & Stock Rights (2 of 2)  Stock rights  Tax-free distribution of right to purchase add’l shares of stock unless proportionate interest changes or could change  If the value of right <15% of underlying stock, basis of right is zero  If value  15% of underlying stock, basis allocated based on relative FMV

22 22 Stock Redemptions  Acquisition by a corporation of its own stock in exchange for property  Shareholder consequences  Attribution rules  Redemptions qualifying for sale treatment  Substantially disproportionate redemptions  Redeeming corporation consequences

23 23 Shareholder Consequences  Sale treatment produces capital gain or loss  Dividend treatment produces ordinary income on entire distribution  Generally taxed at 15%

24 24 §318 Attribution Rules (1 of 2)  Family attribution  Spouse, children, grandchildren, & parents  Attribution from entities  Proportionate ownership for stock owned by or for partnership, estate, or trust  Proportionate ownership for stock owned by C corp only for s/h owning  50%

25 25 §318 Attribution Rules (2 of 2)  Attribution to entities  Stock owned by partners or beneficiaries considered owned by partnership, estate, or trust  Stock owned by  50% s/h of C corp considered owned by corp  Option attribution

26 26 Redemptions Qualifying for Sale Treatment  Substantially disproportionate  Complete termination of interest  Not essentially equivalent to a dividend  Partial liquidation of corp to a non- corporate shareholder  Made in order to pay death taxes

27 27 Substantially Disproportionate Redemptions  After the redemption, the s/h  Owns < 50% of voting power of all classes of stock  Owns < 80% of his/her percentage ownership of voting stock before the redemption  Owns < 80% of his/her percentage ownership of common stock before the redemption

28 28 Redeeming Corporation Consequences  Sale treatment may produce gains but no losses  E&P must be reduced by  Full amount for dividends (if dividend) OR  Proportionate amount for sale treatment after adjusting for gains net of taxes

29 29 Preferred Stock Bailouts  §306 in general  Shareholder consequences  Exceptions to §306

30 30 §306 in General  §306 stock defined  Stock other than common stock  Issued on a tax free basis, then sold  Ordinary income equal to FMV of stock limited by corporation’s E&P at distribution date  If no Current or Accumulated E&P in issue year, §306 does not apply

31 31 Shareholder Consequences  Dividend income to the extent of CE&P in year of redemption  Amounts in excess are considered a return of capital  Amounts recovered in excess of basis are capital gains  Any unrecovered basis is added to remaining common stock

32 32 Exceptions to §306  Complete termination of interest  Complete redemption of all holdings  Redemption in a partial liquidation  Gift transfer (stock remains tainted)  No tax avoidance as a principal purpose

33 33 Redemptions by Related Corporations  A sale of a corp’s stock by controlling s/h to a second corp controlled by same s/h treated as a redemption  §304 applies to both  brother-sister and  parent-subsidiary controlled groups

34 34 Brother-Sister Controlled Groups  Redemption is by the corp buying stock from the shareholder  If a dividend, E&P of acquiring corp and then the issuingcorp (if necessary) is reduced  Basis of redeemed stock added to basis of stock held in acquiring corp

35 35 Parent-Subsidiary Controlled Group  Sale of parent stock by s/h to sub  If a dividend, E&P of sub and then parent are both available  S/h’s basis in remaining parent stock increased by basis of stock redeemed by subsidiary

36 36 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business

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