actg 451 chapter 15

What is the tax treatment of dividend distribution?

contingent upon the distributing corporation’s earnings and profit

When are distributions considered dividends?

to the extent of the corporation’s current and accumulated earnings and profit

When are distributions considered return of capital?

distributions in excess of earnings and profit

Explain the tax consequences of dividends

must report as income in the year they are received

Explain the tax consequences of returns of capital

• reduce the shareholder’s adjusted basis in the stock

• once the adjusted basis is reduced to 0, any excess is treated as gain on the sale of the stock

What are earnings and profit?

a measure of a corporation’s economic capacity to pay a dividend

How are earnings and profit distributed?

first to current earnings and profit, then to accumulated earnings and profit

What is the measure of a cash distribution?

amount of cash distributed

What is the measure of a property distribution?

• FMV at date of distribution

• if there is a liability, then it is FMV minus the liability

• measure can never be less than 0

• basis in property received is FMV

What are constructive dividends?

• occurs when no actual cash or property dividend has been declared or paid

• can result from a variety of transactions (intentional or unintentional)

What are commonly encountered constructive dividends?

• unreasonable compensation

• corporate payment of shareholder liabilities

• shareholder loans

• corporate loans

• free personal use of corporate property

• bargain sales and rentals to shareholders

• premium sales and rentals to the corporation

When are stock dividends not taxable?

if shareholders receive stock in proportion to their ownership interest

What happens if the stock dividend is not taxable?

total basis of old stock is allocated between old and new stock based on their relative FMVs

What is the tax consequence of a taxable stock dividend?

shareholder has income to extent of corporation’s current and accumulated earnings and profit

What is the shareholder’s adjusted basis of a taxable stock dividend?

the FMV on distribution date

Explain disproportionate distribution

occurs if shareholders’ ownership interest in firm is different after distribution

Explain the taxability of stock rights

• proportionate distributions of stock rights are nontaxable

• disproportionate distributions of stock rights are taxable

What are stock rights?

holder has the option to acquire new shares of stock in a corporation within a defined period and at a specific price

What are stock redemptions?

occurs when corporation acquires its stock from its shareholders in return for cash or property

Explain the surrender of stock

• may be treated as sale or exchange

• may be classified as a dividend to extent of redeeming corporation’s earnings and profit

Explain Code Sec. 303

governs the treatment of redemptions of stock to cover death taxes and expenses

Explain the limitations of proceeds under Code Sec. 303

limited to sum of estate, inheritance, legacy, or succession taxes imposed (including interest) and funeral and administrative expenses

Explain the requirements of Code Sec. 303

• distribution must be in redemption of a shareholder’s stock

• stock being redeemed must be included in the decedent’s gross estate for federal estate tax purposes

• value must exceed 35% of adjusted gross estate

How do you calculate adjusted gross estate under Code Sec. 303?

gross estate less the sum of:

• funeral expenses

• administrative expenses

• claims against the estate

• unpaid mortgages and other indebtedness

• loss incurred by the estate

Explain the 35%-rule exception under Code Sec. 303

applies to an estate that includes stock of two or more corporations