Corporate nonliquidating

ANSWER Distributions are treated as follows: (1) dividends to the extent of corporate E&P, (2) return of capital to the extent of the shareholder s stock basis, and (3) gain from the sale of stock.When a corporation makes a nonliquidating distribution to a shareholder, the shareholder must answer the following three questions: What is the amount of the distribution?

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In addition, the distributing corporation must answer the following two questions: What are the amount and character of gain or loss the corporation must recognize?

What effect does the distribution have on the distributing corporation s earnings and profits (E&P) account?

Earnings and profits are discussed in the next section of this chapter.

Section 317(a) defines property broadly to include money, securities, and any other property except stock or stock rights of the distributing corporation.

Ellen and Bob each recognize $40,000 (0.50 $80,000) of dividend income.

This portion of the distribution reduces Gamma s E&P to zero.To some extent, E&P measures a corporation s economic ability to pay dividends to its shareholders.Distributions are presumed to be made out of the corporation s E&P unless the corporation reports no E&P.The additional ,000 that each shareholder receives is first treated as a return of capital and then as a capital gain.The following table summarizes the calculations: Corporate Nonliquidating Distributions Corporations 4-3 Ellen Bob Total Distribution ,000 ,000 0,000 Dividend income a (40,000) (40,000) (80,000) Remaining distribution ,000 ,000 $ 40,000 Return of capital b (20,000) (10,000) (30,000) Capital gain c $ 0 ,000 $ 10,000 a Smaller of E&P allocable to the distribution or the amount of the distribution.TYPICAL MISCONCEPTION Because E&P is such an important concept in many corporate transactions, one would assume that corporations know exactly what their E&P is.

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