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.
$50,000 - the entire distribution is a dividend regardless of E&P.
$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.
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 return of capital (reducing basis to zero), and $5,000 capital gain.
$15,000 ordinary income and $5,000 capital gain.
$20,000 ordinary income since all distributions are taxable.
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:
A flat 15% rate for all taxpayers.
Ordinary income rates (up to 37%).
The corporate tax rate of 21%.
Preferential rates of 0%, 15%, or 20% depending on the taxpayer's taxable income - the same rates as long-term capital gains.
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:
Ordinary dividend income to the extent of E&P.
Tax-free return of capital up to the shareholder's basis.
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.
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:
Reduce its E&P by the adjusted basis of the distributed property.
Recognize a $20,000 ordinary loss on the distribution.
Recognize no gain or loss since the property is distributed, not sold.
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.
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:
No E&P adjustment is needed for property distributions.
Increasing E&P by the gain recognized on the distribution.
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).
Reducing E&P by the adjusted basis of the distributed property.
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 to shareholders at the FMV of the stock received.
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 only if the shareholder has a choice to receive cash or stock.
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 redeems less than 100% of a shareholder's stock.
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.
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 return of capital reducing the shareholder's stock basis - if the distribution exceeds basis, the excess is capital gain.
Tax-exempt income.
A capital gain automatically.
Ordinary income to the shareholder.
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:
$30,000 - accumulated E&P ($50,000) reduced by the current year deficit ($20,000) = $30,000 net E&P.
$40,000 - distributions are dividends up to the amount distributed.
$0 - current year losses eliminate all dividend treatment.
$50,000 - accumulated E&P determines dividend amount.
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.