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Distributions to Business Owners
8 Chapter Distributions to Business Owners Key Words / Outline
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C Corporations Subject to double taxation
Distributions out of earnings and profits taxable to shareholders as dividends Dividends now taxable at maximum rate of 15%
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Earnings and Profits Two types:
Current Earnings and profits Accumulated Earnings and profits Any payment out of either account will result in a taxable dividend to the shareholder
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Current Earnings and Profits
Any distribution not in excess of current earnings and profits is a dividend Negative accumulated earnings and profits ignored if current earnings and profits positive
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Accumulated Earnings and Profits
Current earnings and profits reduced by dividends added into accumulated earnings and profits If current earnings and profits is negative, it is netted from accumulated earnings and profits to determine if a distribution is a dividend
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Nondividend Distributions
Any distribution in excess of earnings and profits Treated as a return of capital to extent of stock basis Stock basis must be reduced by nontaxable portion Any excess is capital gain
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Property Distributions
Distributions of appreciated property cause a corporation to recognize gain Current earnings and profits also increased as a result of the gain recognized Earnings and profits reduced by fair market value of appreciated property distributed Losses not recognized on distributions of depreciated property Earnings and profits decreased by adjusted basis of depreciated property
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Stock Dividends Distributions of additional shares of stock
Generally nontaxable to shareholder Will be treated as a taxable distribution if shareholders can choose between stock and cash
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Constructive Dividends
Payments or transfers for the benefit of the shareholders Treated as taxable distributions Examples: Corporation pays personal expenses Use of corporate property for personal purposes Unreasonable compensation to shareholder/employee
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Penalty Taxes Designed to prevent conversion of ordinary income into capital gain by appreciation of corporate stock Types: Accumulated earnings tax Personal holding company tax
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Accumulated Earnings Tax
Tax imposed upon corporation if a corporation accumulates funds beyond reasonable need of the business Tax imposed at a 15% rate
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Accumulated Earnings Tax Base
Tax imposed on after tax income reduced by Any dividends paid during the period Accumulated earnings tax credit Amount needed by corporation to meet reasonable business needs Never less than $250,000 except for personal service corporations
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Personal Holding Company Tax
Imposed at the highest individual tax rate on undistributed personal holding company taxable income Currently maximum rates for both corporations and individuals is 35% so no incentive to shelter corporate income from tax at individual rates Corporation must be a personal holding company
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Personal Holding Company
60% of ordinary gross income from investment sources such as dividends, interest, rent and royalties Five or fewer individuals own directly or indirectly more than 50% of stock during the last half of the year
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Undistributed Personal Holding Company Taxable Income
After-tax ordinary income less dividends paid Deficiency dividends can be paid to eliminate the tax
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Partnership Distributions
Two types: Current distribution – reduces partner’s capital account Liquidating distribution – extinguishes partner’s interest in partnership
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Cash Distributions Generally nontaxable
Exception: cash distribution in excess of partner’s outside basis Distributions reduce outside basis
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Property Distributions-Accounting Treatment
Gain or loss recognized on distribution to extent property exceeds or is less than fair market value. Gain or loss allocated to all partners Partner’s capital account reduced by fair market value of distribution
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Property Distributions-Tax Consequences
Generally nontaxable to partner No gain or loss recognized to partnership Partner’s basis in property is same as partnership’s basis in property If basis of property is greater than recipient partner’s outside basis, basis of property to partner is outside basis of partnership. Outside basis become zero
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S Corporation Distributions
Generally nontaxable as long as does not exceed shareholder’s basis in stock Cash distribution decreases shareholder’s basis in S corporation stock
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Special Rules for S Corporations with Earnings and Profits
Only applies to S corporations that were formerly C corporations Special rules do not apply if C corporation had no earnings and profits when S election made or all earnings and profits distributed
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S Corporations with E and P
Cash distributions nontaxable to extent do not exceed accumulated adjustments account (AAA) Any amount in excess of AAA treated as a taxable dividend to extent of earnings and profits Any amount in excess of earnings and profits is a nontaxable return of capital up to shareholder’s basis in stock
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Accumulated Adjustments Account
Represents undistributed S corporation earnings Cash distributions reduce account but not below zero Losses reduce AAA Any distribution during a loss year is deemed made before account is decreased for the loss
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C Corporation Conversions
S corporations reverting to C corporations have a favorable transition rule on distributions Any distribution made within one year of conversion is nontaxable as long as AAA not exceeded
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Property Distributions
Generally C corporation rules apply to S corporations making these distributions Gains but not losses recognized
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