Chapter 4: Corporate Nonliquidating Distributions

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Chapter 4Corporate NonliquidatingDistributions
Chapter 4 Corporate Nonliquidating Distributions
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Nonliquidating DISTRIBUTIONS (1 of 2)

• Nonliquidating distributions in general
• Computing current EP
• Current vs. accumulated EP
• Nonliquidating property distributions
• Constructive dividends

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NONLIQUIDATING DISTRIBUTIONS (2 of 2)

• Stock dividends and stock rights
• Stock redemptions
• Preferred stock bailouts
• Redemptions by related corporations

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Nonliquidating Distributions (1 of 2)

• Dividend distributions
• A distribution of property based upon a
  corporations 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)

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Nonliquidating Distributions (2 of 2)

• Earnings and profits (EP)
• EP not defined in the Code
• EP consists of current accumulated
• Distributions are based upon current EP first
  accumulated EP second
• Distributions in excess of EP are considered a
  return of capital

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Computing Current EP(1 of 2)

• EP computed on annual basis at end of tax year
• Generally EP based on corps economic income
  instead of taxable income
• Adjustments to taxable income for permanent
  timing differences including use of different
  depreciation methods

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Current vs Accumulated EP (1 of 3)

• Current EP computed on last day of the corps
  tax year
• Distributions greater than CEP
• CEP allocated to distributions pro rata
  regardless of payment date
• Then Accumulated EP allocated to distributions
  in chronological order

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Current vs Accumulated EP (2 of 3)

• Distributions greater than EP
• Cannot create an EP deficit
• Distributions in excess of all EP is a return of
  capital to s/h and reduce s/hs basis in stock.
• Distributions in excess of basis result in a gain
  (usually capital gain)

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Current vs Accumulated EP (3 of 3)

• If CEP is positive and beginning AEP is a
  deficit
• Distributions will produce ordinary income to
  shareholder until CEP reaches zero
• CEP allocated on a pro-rata basis

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Consequences of Nonliquidating Distributions

• Shareholder consequences
• Corporations consequences
• Example C4-15
• Example C4-16
• Distributions effect on EP

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Shareholder Consequences

• In non-cash distributions, amount of income equal
  to FMV of property received minus liabilities
  assumed
• Amount of distribution cannot be lt0
• S/hs basis in non-cash property is FMV on
  distribution date
• Holding period of property begins day after
  distribution date

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Corporations Consequences

• Appreciated non-cash property produces gain as if
  corp sold property for FMV on distribution date
• Loss recognition NOT permitted
• If liabilities exceed FMV, then FMV is assumed to
  be no less than amount of the liability

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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

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Example C4-16

• FMV of land 25,000
• Mortgage 35,000
• Adjusted basis 20,000
• Capital Gain 15,000
• Shareholders basis 35,000

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Distributions Effect on EP(1 of 2)

• Gain on non-cash distribution increases Current
  EP
• EP 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

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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.

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Constructive Dividends(2 of 2)

• Examples
• Loans to shareholders
• Excessive rent paid to shareholder
• Payments for shareholders benefit
• Bargain purchase
• Use of corporate property

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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

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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

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Shareholder Consequences

• Sale treatment produces capital gain or loss
• Dividend treatment produces ordinary income on
  entire distribution
• Generally taxed at 15

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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

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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

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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

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Substantially Disproportionate Redemptions

• After the redemption, the s/h
• Owns lt 50 of voting power of all classes of
  stock
• Owns lt 80 of his/her percentage ownership of
  voting stock before the redemption
• Owns lt 80 of his/her percentage ownership of
  common stock before the redemption

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End of Chapter 4
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