Evaluate Corporate Distributions And Redemptions
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CPA Tax Compliance & Planning (TCP) › Evaluate Corporate Distributions And Redemptions
A C corporation distributes $50,000 cash to a shareholder. The corporation has current E&P of $30,000 and accumulated E&P of $10,000. How much of the distribution is treated as a dividend?
$10,000 - only accumulated E&P is available for dividends.
$40,000 - distributions are first characterized as dividends to the extent of current E&P ($30,000) plus accumulated E&P ($10,000).
$30,000 - only current E&P determines dividend treatment.
$50,000 - the entire distribution is a dividend regardless of E&P.
Explanation
Distributions are dividends to the extent of E&P - current ($30,000) plus accumulated ($10,000) = $40,000 dividend; remaining $10,000 is return of capital then capital gain. Answer A is correct.
A shareholder receives a corporate distribution of $20,000 when the corporation has no E&P and the shareholder's basis is $15,000. The tax treatment is:
$20,000 capital gain since the distribution exceeds the shareholder's basis.
$15,000 ordinary income and $5,000 capital gain.
$20,000 ordinary income since all distributions are taxable.
$15,000 return of capital (reducing basis to zero), and $5,000 capital gain.
Explanation
Without E&P, the distribution reduces basis ($15,000) and any excess ($5,000) is capital gain. Answer C is correct.
Qualified dividends received by individual taxpayers are taxed at:
Ordinary income rates (up to 37%).
Preferential rates of 0%, 15%, or 20% depending on the taxpayer's taxable income - the same rates as long-term capital gains.
The corporate tax rate of 21%.
A flat 15% rate for all taxpayers.
Explanation
Qualified dividends are taxed at long-term capital gain rates (0%, 15%, or 20%). Answer B is correct.
A corporation redeems all stock from a shareholder in a complete termination of interest. Under Section 302(b)(3), the tax treatment is:
Capital loss if the redemption price is below the shareholder's basis.
Sale or exchange treatment - the shareholder recognizes capital gain or loss equal to the difference between the amount received and the adjusted basis of the redeemed shares.
Ordinary dividend income to the extent of E&P.
Tax-free return of capital up to the shareholder's basis.
Explanation
Complete termination under Section 302(b)(3) qualifies as a sale or exchange - capital gain or loss treatment. Answer C is correct.
A corporation distributes property with an FMV of $60,000 and adjusted basis of $40,000 to shareholders. The corporation must:
Recognize a $20,000 ordinary loss on the distribution.
Recognize $20,000 of gain as if the property had been sold at FMV - corporations recognize gain (but not loss) on distributions of appreciated property.
Recognize no gain or loss since the property is distributed, not sold.
Reduce its E&P by the adjusted basis of the distributed property.
Explanation
Under Section 311(b), corporations recognize gain on appreciated property distributions. The gain is $60,000 - $40,000 = $20,000. Answer D is correct.
Following a property distribution, the distributing corporation's E&P is adjusted by:
Increasing E&P by the gain recognized on the distribution.
Reducing E&P by the adjusted basis of the distributed property.
No E&P adjustment is needed for property distributions.
For appreciated property, E&P is first increased by the gain recognized under Section 311(b), then reduced by the net FMV of the distributed property (FMV minus liabilities assumed by the shareholder) under Section 312; for property distributed at or below basis, E&P is reduced by the adjusted basis (not FMV).
Explanation
Under Section 312, the E&P adjustment for a property distribution involves two steps when the property is appreciated: (1) E&P is increased by the gain recognized under Section 311(b) (the corporation recognizes gain as if it sold the property at FMV); then (2) E&P is reduced by the net FMV of the distributed property (FMV minus any liabilities the shareholder assumes). If the property is not appreciated (distributed at or below adjusted basis), E&P is reduced by the adjusted basis rather than FMV. Answer A is correct. Reducing E&P by adjusted basis alone (B) does not capture the net FMV rule for appreciated property. Increasing E&P by the gain recognized (C) is only one step of the two-step adjustment. No adjustment (D) is incorrect.
A stock dividend distributed by a corporation is generally:
Taxable only if the shareholder has a choice to receive cash or stock.
Tax-free to shareholders when the dividend is pro-rata and does not change proportionate interests in the corporation.
Taxable at the preferential qualified dividend rate.
Taxable to shareholders at the FMV of the stock received.
Explanation
A pro-rata stock dividend is generally tax-free since proportionate interests don't change. Answer C is correct.
A partial liquidation under Section 302(b)(4) is treated as a sale or exchange. Partial liquidations occur when:
The corporation's assets decrease by more than 50% during the year.
The corporation is in financial distress and must liquidate some assets.
The corporation distributes proceeds from the termination of a business or a genuine contraction of the corporation's business - limited to non-corporate shareholders.
The corporation redeems less than 100% of a shareholder's stock.
Explanation
Partial liquidation requires a genuine contraction of the business and applies only to non-corporate shareholders. Answer B is correct.
The excess of a distribution over E&P is treated as:
A capital gain automatically.
A return of capital reducing the shareholder's stock basis - if the distribution exceeds basis, the excess is capital gain.
Ordinary income to the shareholder.
Tax-exempt income.
Explanation
Distributions exceeding E&P first reduce basis (tax-free return of capital), and any amount exceeding basis is capital gain. Answer D is correct.
A corporation has current E&P of negative $20,000 and accumulated E&P of positive $50,000. It distributes $40,000 to a shareholder. The dividend amount is:
$0 - current year losses eliminate all dividend treatment.
$30,000 - accumulated E&P ($50,000) reduced by the current year deficit ($20,000) = $30,000 net E&P.
$50,000 - accumulated E&P determines dividend amount.
$40,000 - distributions are dividends up to the amount distributed.
Explanation
Net available E&P = $50,000 - $20,000 = $30,000. The $40,000 distribution is $30,000 dividend and $10,000 return of capital. Answer A is correct.