CCH Federal Taxation Comprehensive Topics Chapter 15 Corporate Nonliquidating Distributions ©2006,...

CCH Federal TaxationComprehensive Topics

Chapter 15Corporate Nonliquidating

Distributions

©2006, CCH, a Wolters Kluwer business4025 W. Peterson Ave.Chicago, IL 60646-6085800 248 3248www.CCHGroup.com

CCH Federal Taxation Comprehensive Topics 2 of 59

Chapter 15 Exhibits

Chapter 15, Exhibit Contents A

1. Effect of Operations on Owners—Comparison Among Entities

2. Effect of Nonstock Distributions on Owners—Comparison Among Entities

3. Effect of Nonstock Distributions on Entities—Comparison Among Entities

4. Effect of Taxable Stock Distributions on Shareholders

5. Effect of Identical, Nontaxable Stock Distributions on Shareholders

6. Effect of Nonidentical, Nontaxable Stock Distributions on Shareholders

7. Effect of Stock Redemptions on Shareholders

8. Effect of Stock Redemptions on Corporations

9. Effect of Complete Liquidations on Shareholders

10. Effect of Complete Liquidations on Corporations


Chapter 15 Exhibits

Chapter 15, Exhibit Contents B

11. Nonstock Distributions—Effect on Shareholders12. Earnings and Profits of C Corporations13. Nonstock Distributions—Effect on Corporation14. Nonstock Distributions—Examples 15. Stock Distributions16. Redemptions (Including Partial Liquidations)—Overview17. Redemptions (Including Partial Liquidations)—Tax Effect on

Shareholders18. Redemptions (Including Partial Liquidations)—Example on

Shareholder Effect19. Redemptions (Including Partial Liquidations)—Tax Effect on

Corporations20. Redemptions (Including Partial Liquidations)—Example on

Corporate Effect

CCH Federal Taxation Comprehensive Topics 4 of 59Chapter 15, Exhibit 1a

Effect of Operations on Owners—Comparison Among Entities

Operating Item C Corps S Corps Partnerships

Undistributed income

No tax to shareholder

Current tax Current tax

Current losses:

General

No deduction to shareholder

Current deduction

Current deduction

Limit N/A Outside basis at risk

Outside basis at risk

Character conduit

No Yes (Code Sec. 1366(b))

Yes

CCH Federal Taxation Comprehensive Topics 5 of 59Chapter 15, Exhibit 1b

Operating Item C Corps S Corps Partnerships

Owner’s basis:

General

Constant (unaffected by corporate activity)

Adjusted annually

Adjusted annually

Effect of entity debt

None None (neither basis nor AAA affected; only at-risk amount)

Outside basis AND at-risk amount affected (Code Sec. 752)

Effect of Operations on Owners—Comparison Among Entities


Effect of Nonstock Distributions on Owners—Comparison Among Entities

C and S Corporations Partnerships

How is “amount distributed” to owners computed?

FMV of all property received by shareholder –Corporate debt assumed by shareholder

Cash + Debt relief[i.e., for purposes of determining gain, only cash + debt relief are subject to capital gains. Other property received by a partner is tax-free.]

Chapter 15, Exhibit 2a



What is the owners’ tax treatment for the “amount distributed?”

C Corps.

1. Ord. up to curr. E&P;

2. Ord. up to accum. E&P;

3. Tax-free up to outside

basis

4. Cap gain on remainder.

S Corps.

1. Tax-free up to the lesser

of: AAA Bal. Stock Basis

2. Ord. Up to accum. E&P from prior life as a C

corp. (if any)

3. Tax free up to any excess of stock basis over AAA balance

4. Capital Gain on

remainder

Cash + debt relief:

1. Tax-free up to outside basis;

2. Capital gain to a partner on the excess of cash or

debt relief in

excess of outside

basis. (Loss is never recognized.)

3. Other property: Tax-free.


Chapter 15, Exhibit 2b



What is the basis of property distributed to an owner?

Always FMV, even if an owner assumes corporate debt.

Same as the partnership’s inside basis. [However, if a partner’s outside basis is less than the partnership’s inside basis in property distributed to a partner, then the partner’s basis of property received is taken from his outside basis, not from the partnership’s inside basis. This makes sense, given that a partner’s outside basis must be reduced by the “amount” of distributions and that it cannot be negative.]


Chapter 15, Exhibit 2c


No

No gain or loss, unless it is part of a disguised sale. In a disguised sale, the partnership’s recognized gain or loss = (a) – (b), where:

(a) = FMV of property dist’d.

(b) = AB of property dist’d.

No

Gains: Yes (compute gain in the same way as if the property were sold)

Losses: No (except in complete liquidation)

Does an entity recognize gain or loss on the distribution of:

i) Cash or its own bonds to owners?

ii) Other property (other than its own stock)?

PartnershipsC and S Corporations

Effect of Nonstock Distributions on Entities—Comparison Among Entities




What is the character of the entity’s gain or loss on distribution of property to owners?

If owner owns 50%, then the character of the entity’s gain is the same as the character of the property distributed.

If owner owns > 50%, then the entity’s gain is ordinary.

Losses are not recognized.

The character of the partnership’s gain or loss on a disguised sale is the same as the character of the property before it is distributed.

Effect of Nonstock Distributions on Entities—Comparison Among Entities



Effect of Taxable Stock Distributions on Shareholders

Rules for Taxable Stock Dividends:

1. Upon receipt: Stock dividends are taxable as ordinaryincome at their fair market value (FMV).

2. Upon sale: Basis of taxable stock dividends = same amount as in (a) above; holding period begins on the day AFTER receipt (i.e., consistent with the general rule for holding period).



Example on Taxable Stock Dividends

Facts:

1. 1000 common stock (C/S) shares are purchased for $12,000 on March 31, 20x1.

2. On September 30, 20x1, a 20% taxable C/S dividend is received when the FMV is $20 per share.

3. On June 30, 20x2, the 200 new shares are sold for $30 per share

Question: Determine the tax treatment for the receipt and sale of the stock dividends.




Solution:

March 31, 20x1 receipt: $4,000 taxable dividend income.

$4,000 = $20/share x (1,000 old x 20%);

June 30, 20x2 sale: $2,000 short-term capital gain.

$2,000 = $6,000 sales proceeds - $4,000 basis of new shares.

(The beginning holding period date is October 1, 20x1, the day AFTER receipt of the stock dividend. A June 30, 20x2 sale results in a short-term holding period.)




Effect of Identical, Nontaxable Stock Distributions on Shareholders

Rules for Identical, Nontaxable Stock Dividends:

1. Upon receipt: Stock dividends are not taxable.

2. Upon sale: Allocate old basis over old and new shares using the following formula:

Basis per share = old basis (# old shares + # new shares)

(Holding period of original and new shares begins on day AFTER original acquisition.)



Example on Identical, Nontaxable Stock Dividends

Facts:

1. March 31, 20x1: 1000 common stock (C/S) shares are purchased for $12,000.

2. September 30, 20x1: a 20% nontaxable C/S dividend is issued.

3. June 30, 20x2: the 200 new shares are sold for $30 per share.

Question: Determine the tax treatment for the receipt and sale of the stock dividends.




Solution:

March 31, 20x1 receipt: The stock dividends are not taxable.

June 30, 20x2 sale: $4,000 long-term capital gain (6,000 – 2,000).

$2,000 basis of new shares = $10/share x 200 new shares, where

$10/share = [$12,000 (1,000 old shares + 200 new shares)];

(The beginning holding period date is 4/1/x1, the day AFTER receipt of the original stock. A 6/30/x2 sale results in a long-term holding period.)




Effect of Nonidentical, Nontaxable Stock Distributions on Shareholders

Rules for Nonidentical, Nontaxable Stock Dividends:

1. Upon receipt: Stock dividends are not taxable.

2. Upon sale: Allocate the original common stock (C/S) basis between the number of original C/S shares and the number of new preferred stock shares (P/S) using relative fair market values as of the date of receipt.

3. The holding period of the original C/S does not change (i.e., it begins on the day AFTER original acquisition). The holding period of the new P/S shares is the same as the C/S.



Example on Nontaxable, Nonidentical Stock Dividends

Facts:

1. March 31, 20x1: 1,000 C/S shares are purchased for $12,000.

2. September 30, 20x1: a 10% P/S dividend is issued when the fair market value of C/S and P/S shares is $16 and $80, respectively.

3. June 30, 20x2: the 1,000 C/S shares and 100 new P/S shares are sold for $20 per share and $100 per share, respectively.

Question: Determine the tax treatment for the receipt and sale of the stock.




Solution:March 31, 20x1 receipt: The stock dividends are not taxable.June 30, 20x2 sale of common stock: $14,000 long-term capital gain1. $14,000 capital gain: = (20,000 sales price – 8,000 adjusted basis).2. $8,000 AB = $12,000 x [(1,000 C/S shares x 16 per share] [16,000 + (100 P/S shares x 80 per P/S share)] 3. Long-term HP: The beginning holding period date is April 1, 20x1, the day AFTER

receipt of the original stock. A June 30, 20x2 sale results in a long-term holding period.

June 30, 20x2 sale of preferred stock: $6,000 long-term capital gain1. $6,000 capital gain: = 10,000 sales price – 4,000 adjusted basis).2. $4,000 AB = 12,000 x [(100 P/S shares x 80 per share] [16,000 + 8,000] 3. Long-term HP: The beginning holding period date is April 1, 20x1, the same as the

common stock. A June 30, 20x2 sale results in a long-term holding period.




Effect of Stock Redemptions on Shareholders

C Corps

1. Ord. up to curr. E&P;

2. Ord. up to accum. E&P;

3. Tax-free up to outside basis

4. Capital gain on remainder

Same as non-stock distributions, i.e.,What is the tax effect of redemptions on shareholders?

If dividend treatment:

CorporationsStock Redemptions




Stock Redemptions Corporations

What is the tax effect of redemptions on shareholders?

If sales treatment:

Capital gain/loss = (a) – (b) – (c):

(a) = Fair market value of property received

(b) = Corporate debt assumed

(c) = Basis of stock given up





Owner’s basis in unredeemed stock

Reduce aggregate basis by

(a) (b), where:

(a) = # shares redeemed

(b) = Total # shares owned before redemption





Owner’s basis and holding period of property received

1. Same as non-stock distributions , i.e., always use fair market value, even if an owner assumes corporate debt.

2. The holding period begins on the date after receipt.

Chapter 15, Exhibit 7d


Effect of Stock Redemptions on Corporations

No

Gains: Yes, computed as if the property were sold; Losses: No.

Does a corporation recognize gain or loss on redemption?

(a) If it distributes cash or its own bonds to owners?

(b) If it distributes other property to

its owners?

Chapter 15, Exhibit 8


Effect of Complete Liquidations on Shareholders

No gain or loss2. Parent owns 80% or more of subsidiary:

Yes, gains and losses are recognized, using the same formula as for redemptions with sales treatment, i.e., capital gain/loss = (a) – (b) – (c):

(a) = Fair market value of property received

(b) = Corporate debt assumed

(c) = Basis of stock given up

1. Parent owns less than 80% of subsidiary:

Does an owner recognize gain or loss in a complete liquidation?



Effect of Complete Liquidations on Corporations

Does a corporation recognize gain or loss in a complete liquidation?

1. Parent owns less than 80% of subsidiary:

Yes for gains AND losses, computed in the same way as if the property were sold

2. Parent owns 80% or more of subsidiary:

No gain or loss



Nonstock Distributions—Effect on Shareholders

What is the amount of distributions other than stock?

The amount of distribution other than stock of the corporation is: (a) – (b), where,(a) = The fair market value of all property received (other

than the common stock of the distributing corporation)(b) = Liabilities of the distributing corporation, both recourse and nonrecourse, assumed by the shareholder



Do shareholders of C corporations recognize income on nonstock distributions?

Yes, then yes, then no, then yes. That is, when a corporation distributes property other than its own stock to shareholders, the tax treatment to shareholders moves in different directions, according to the following pecking order:

Tier Distributions Other Than Stock, to the Extent of:

Tax Treatment to Shareholder

1st Current earnings & profits Ordinary income based on fair market value

2nd Accumulated earning & profits Ordinary income based on fair market value

3rd Shareholder’s basis in the stock Nontaxable return of capital

4th Any balance remaining Capital gain




What is a shareholder’s basis in the nonstock property distributed by the corporation?

Basis = Fair market value of the asset. The assumption of a liability does not affect basis.




Earnings and Profits of C Corporations

How are earnings and profits (E&P) determined?

Earnings and profits are determined as follows:

1. + Income or loss per accounting books.

2. +/– Schedule M-1 or M-3 reconciling items. Recall that the schedule lists the differences, both permanent and temporary, between accounting and tax income.

3. + Corporation’s gain recognized on distribution of appreciated property.

4. – Corporation’s gain recognized on distribution of appreciated property.

5. – Fair market value of stock dividends that are taxable to shareholders.

= Earnings and profits



Nonstock Distributions—Effect on Corporation

Does a corporation recognize a gain or loss on the distribution of cash or its own bonds?

No.



Does a corporation recognize a gain or loss on the distribution of an asset?Yes for gains (unlike partnerships), no for losses (similar to partnerships). A corporation is considered to have sold the property to the shareholder at the larger of FMV of the asset or the debt associated with the asset. Gain is computed as follows: Gain = [greater of (a) or (b)], minus (c), where, (a) = FMV of property distributed (b) = corporation’s debt relief (if any) (c) = corporations adjusted basis in the property distributedThe character of the gain is based on the character of the assets distributed. However if the shareholder owns > 50% of the o/s stock, the corporation’s gain is ordinary, regardless of the character of the assets.

Nonstock Distributions—Effect on Corporation



Nonstock Distributions—Examples

What is Fred’s basis in the land?3

If Fred the stockholder has a $20 basis in his X stock, what is the amount and character of his recognized gain?

2

What is the amount and character of the recognized gain to X Corp. as a result of this distribution?

1

Questions:

Facts:

1. X Corp. distributed land to Fred, a shareholder. The land had been held as investment by X for five years. At the time of the distribution, the land had a FMV of $60, a basis to X of $5, and was subject to a mortgage of $70.

2. X Corp.’s current and accumulated E&P was $2 and $18, respectively.

Nonstock Distributions where Mortgage > Fair Market Value of Property



Nonstock Distributions where Mortgage < Fair Market Value of Property

Facts:

Same as Example 1, except the land was subject to a mortgage of $10, not $70.

Questions:

1 What is the amount and character of the recognized gain to X Corp. as a result of this distribution?

2 If Fred the stockholder has a $20 basis in his X stock, what is the amount and character of his recognized gain?

3 What is Fred’s basis in the land?





Solutions to Examples 1 and 2

Example 1 (Mortgage > FMV): Example 2 (Mortgage < FMV):

Question Answer Computation Question Answer Computation

1 65 (> of 60 FMV or 70 Mtg.) - (5 Basis) = 65

1 55 (> of 60 FMV or 10 Mtg.) - (5 Basis) = 55

2 0 (Land FMV: $60) - (Land Mtg: $70) = (10) < 0

2 50 Illustrated on next slide

3 60 Always the FMV, regardless of mortgage.

3 60 Always the FMV, regardless of mortgage.



50Total amount distributed

Capital gain10Any balance remaining4.

Nontaxable return of capital20Shareholder’s basis in the stock

3.

Ordinary income based on FMV18Accumulated E&P2.

Ordinary income based on FMV2Current E&P1.

Tax Treatment to ShareholderDistributions to the Extent of:

Tier

Amount of distribution = $50

[(Land FMV: 60) - (Mortgage on Land: 10) = 50]

Example 2, Question 2 Computation




Stock Distributions

What types of stock distributions are taxable to shareholders?

Stock dividends are usually tax-free to the shareholder unless any one of the following exceptions occurs under Code Sec. 305(b):

1. In lieu of cash. Shareholders could have opted for cash, but instead chose stock.

2. Disproportionate distributions. (e.g., some shareholders receive property, others receive stock.)

3. Common/preferred. (e.g., some shareholders receive C/S dividends, others receive P/S.)

4. Dividends “of” convertible preferred stock.5. Dividends “of” preferred stock “on” preferred stock.



Exceptions 1 - 4 (from previous slide) are taxable because they allow the proportionate ownership mix of the shareholders to change. (Economic benefit doctrine applies.)

Exception 5 (from previous slide) is taxable because the recipients of preferred stock dividends get an increase in their priority claims (vis-à-vis common shareholders) against corporate net assets in event of liquidation. (Again, the economic benefit doctrine applies.)

Stock Distributions



Stock Distributions


Allocate old basis over old and new shares

Market value at date of receipt

Basis in new stock

Not taxable until soldOrdinary income based on market value at date of receipt

Tax effect

NontaxableTaxableShareholder treatment

No effect on E&PReduce E&P by market value

E&P

Never a gain or loss on distribution

Never a gain or loss on distribution

Tax effect

NontaxableTaxableCorporate Treatment

It depends on whether stock dividends are taxable or nontaxable:

What is the tax effect of stock dividends on the corporation and its shareholders?


Redemptions (Including Partial Liquidations)—Overview

What is a stock redemption?Stock is redeemed when a corporation acquires its own stock from a shareholder in exchange for cash or other property. Redemptions occur for numerous reasons, including:

1. To allow current shareholders to retain complete control of the corporation when one of them wishes to terminate her interest in the corporation.

2. To allow a shareholder to terminate her interest in the corporation when it is difficult to find an outside buyer (i.e., the corporation stock is not publicly traded).

3. To allow the corporation to “invest in itself” when future stock appreciation is anticipated.

4. To build up treasury stock for later distribution to employees as a performance incentive.



What is the tax effect of redemptions to the shareholder?

The tax effect depends on whether the shareholder is required to treat the distribution as:

1. Dividend treatment. Receipt of nonstock distributions treatment (i.e., cash or other property), and stock dividends other than those qualifying for sales treatment (discussed below); or,

2. Sale treatment. Sale of stock to the corporation.




A shareholder gets dividend treatment unless the redemptions cause one of the following 5 conditions to occur:

1. Terminate the shareholder’s entire interest.2. Are substantially disproportionate between shareholders. This condition exists if the

shareholder:(i) gives up over 20% of his voting and nonvoting common stock; AND(ii) owns less than 50% of total corporate voting stock after the redemption.

3. Are NOT essentially equivalent to a dividend. Congress is vague on this condition. The courts have held that this condition exists if there is a “business contraction”—a corporation liquidating a “segment” of an existing business, such as a product line. Distribution of “excess” inventory or unwanted assets does not count (i.e., IS essentially equivalent to a dividend).

4. Are from a shareholder, other than a corporation, in partial liquidation. This condition occurs if the corporation was actively engaged in two or more businesses over the past five years and decided to shut one down and distribute its assets. (Note that “3” above referred to a “segment” of a business, while “4” refers to an entire business.)

5. Are received by an estate to the extent of death taxes and administrative expenses.If one of these 5 conditions occurs, then the shareholder gets sale treatment.




Redemptions (Including Partial Liquidations)—Tax Effect on Shareholders

Dividend vs. Sales Treatment

Dividend Treatment Sale Treatment

1. Fair market value (FMV) of property received less any liability assumed is ordinary income to the extent of current E&P

Sale of stock:

FMV of property received

– Liability assumed by shareholder

– Basis of stock given up

= Capital gain or loss

2. Any balance in FMV – liability is OI to the extent of accumulated E&P

3. Any bal. is nontaxable recovery of capital to the extent of basis

4. Capital gain on any remaining balance





Basis in any unredeemed stock:

Aggregate basis in shareholder’s stock remains unchanged.

Aggregate basis is reduced by (a) (b), where:

(a) = # shares redeemed

(b) = total # shares before

redemption






Basis in property received:

Basis in property received is its FMV, without being reduced by any debt assumption

Same as dividend treatment






Holding period of property received:

HP of the property begins on the day after redemption

Same as dividend treatment




Redemptions (Including Partial Liquidations)—Example on Shareholder Effect

Facts:1. In 20x1, X Corporation has current E&P of $1,000,000.2. Emad owns 100 shares of X Corporation’s 1,000 shares outstanding.

His basis in the 100 shares is $100,000 and the shares had been held long-term.

3. On December 31, 20x1, X distributes land held for investment to Emad, and as part of the exchange, redeems 10 of Emad’s 100 shares.

4. On the date of redemption, the land had a FMV of $50,000 and a basis to X of $15,000. Also, the land was subject to a $20,000 mortgage that Emad assumed.

Questions:What are the tax consequences to Emad if the redemption is treated as a dividend? What if the redemption were treated as a sale?



Solution

If Dividend Treatment If Sale Treatment

Gain to shareholder $30,000 OI [$50,000 fair market value – $20,000 debt assumed by shareholder is ordinary income to the extent of current E&P]

$20,000 LTCG [$50,000 FMV] – ($20,000, debt assumed by shareholder) – (10% x 100,000, shareholder’s basis of redeemed shares)

Basis in 90 remaining shares $100,000 (unchanged after redemption)

$90,000 [$100,000 – (10% x $100,000)]

Basis in property received $50,000, its FMV ignoring debt assumption

$50,000, same as div. treatment

Holding period beg. date: January 1, 20x2, the day after redemption

January 1, 20x2, the day after redemption

Redemptions (Including Partial Liquidations)—Example on Shareholder Effect



Redemptions (Including Partial Liquidations)—Tax Effect on Corporations

What is the tax effect of redemptions to the corporation?

Gain or loss recognition: Under Code Sec. 311, losses are NOT recognized. However, gains are recognized based on: [Greater of (a) or (b)], less (c), where,

(a) = FMV of property transferred,

(b) = Debt relief, and

(c) = Adjusted basis of property transferred by the corporation to a shareholder to redeem her shares.

This formula applies to both the Dividend Treatment Method and the Sales Treatment Method. Of course, if the corporation pays cash, and has no debt relief, it recognizes no gain, since [FMV – AB of cash = 0].



Character of gainThe character of gain is based on the character of the property distributed (e.g., an inventory distribution creates OI if FMV > AB).




Redemption expenses incurred In general, the costs incurred by a corporation in the redemption of stock are NOT deductible. These costs, such as transfer fees and legal and accounting fees, must be capitalized but they are NOT amortizable. Generally, they are not deducted until complete liquidation.




Effect on E&P The effect on the corporation’s E&P depends on shareholder treatment. Shareholders treat the redemption as either:

1. Dividend treatment: Receipt of a dividend (i.e., in the form of cash or other property by the shareholder); or

2. Sale treatment: Sale of shareholder’s stock to the corporation.The effect on a corporation’s E&P is explained in the following slide, and the tax effect to shareholders is discussed after the next section.





[(f) = Greater of (i) or (ii), minus (iii), where

(i) = FMV of prop. distributed to S/H

(ii) = Debt relief; (iii) = (e) above

N/A (f)

Paid-in-

Capital:

(e) = (d) x [# redeemed shares # shares outstanding before redemption]

(cannot exceed the amount of the distribution)

Greater of (i) or (ii), where

(i) = FMV of prop. distributed to S/H

(ii) = Debt relief

(e)

E&P by:

= Adjusted E & P = Adjusted E & P (d) = (a)+(b)+(c)

Same as with dividend treatment. Corp. liabilities assumed by S/H (c)

E&P by:

Same as with dividend treatment.Corporate gain on property dist’n[Greater of FMV of property dist’d or debt relief; Less: Basis of property transferred]

(b)

E&P by:

Original E&P Original E&P(a)

If Sale Treatment to ShareholderIf Dividend Treatment to Shareholder Corp. Effect

Chapter 15, Exhibit 19e


Redemptions (Including Partial Liquidations)—Example on Corporate Effect

Facts (same as previous example but recapped below):

1. In 20x1, X Corporation has current E&P of $1,000,000.

2. Emad owns 100 shares of X Corporation’s 1,000 shares outstanding. His basis in the 100 shares is $100,000 and the shares had been held long-term.

3. On December 31, 20x1, X distributes land held for investment to Emad, and as part of the exchange, redeems 10 of Emad’s 100 shares.

4. On the date of redemption, the land had a FMV of $50,000 and a basis to X of $15,000. Also, the land was subject to a $20,000 mortgage that Emad assumed.

Question: What are the tax consequences to X Corp. if the redemption is treated as a dividend?



What if the redemption were treated as a sale?


Gain recognition: $35,000 LTCG on distribution of land [50,000 FMV – 15,000 corporate basis in land]

$35,000 LTCG on distribution of land [50,000 FMV – 15,000 corporate basis in land]





E&P: $1,000,000, unadjusted $1,000,000, unadjusted

Increase ( ) in E&P: by $35,000 [corporate gain on distribution]

by $35,000 [corporate gain on distribution]

Increase of E&P: by $20,000 [X Corp’s. debt relief]

by $20,000 [X Corp’s. debt relief]

Decrease ( ) in E&P: The greater of (i) or (ii), where

(i) = $50 FMV of property distributed to S/H

(ii) = $20 debt relief

by $10,550

[(10 shares 1,000 shares) x (1,000,000 + $35,000 + $20,000)]

E&P, adjusted: $1,005,000 [$1,000,000 + $35,000 + $20,000 - $50,000]

$1,044,450

[$1,000,000 + $35,000 +$20,000 – $10,550]





Paid-in-Capital N/A by $39,450, the greater of (i) or (ii), minus (iii), where,

(i) = $50 FMV of prop.

distributed to S/H

(ii) = $20 debt relief

(iii) = $10,550 reduction of E&P




Corporation’s Tax Accounting Entries Under Sales Treatment Method

Accounts Debit Credit

Land $15,000

Corporate liabilities $20,000

Retained earnings from gain on distribution of land

($50,000 – $15,000)

35,000

Retained earning from “debt relief income” 20,000

Retained earnings from E & P adjustment [(10 shares 1,000 shares) x ($1,000,000 + $35,000 + $20,000)]

10,550

Paid-in-Capital [$50,000 FMV – $10,550 reduction of E&P] 39,450

Total Debits and Credits $70,000 $70,000


Chapter 15, Exhibit 20e


Non-corporate shareholders tend to prefer sales treatment

because:

1. Gain is reduced by the basis of the stock redeemed; and

Gain is subject to the favorable capital gains rate.

Corporate shareholders tend to prefer dividend treatment

because:

70% to 100% of the dividend income can be offset by thedividend-received deduction (DRD), which is available only to corporate shareholders.


Chapter 15, Exhibit 20f

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