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Corporate
Distributions

Master how corporations distribute earnings to shareholders: dividends, stock redemptions, and liquidating distributions for CPA REG.

CPA Regulation (REG)

What Are Corporate Distributions?

A corporate distribution is any transfer of property (cash, stock, or other assets) from a corporation to its shareholders. The tax treatment depends on whether the corporation has Earnings and Profits (E&P).

Dividend
Distribution from current or accumulated E&P: taxable as ordinary income
Return of Capital
Exceeds E&P: reduces shareholder's stock basis (tax-free)
Capital Gain
Exceeds both E&P and basis: taxed as capital gain

Understanding Earnings & Profits

E&P is a tax concept (not GAAP retained earnings) that measures a corporation's economic ability to pay dividends. There are two types:

Current E&P
Computed annually, similar to taxable income but with adjustments (add back tax-exempt income, subtract federal taxes paid)
Accumulated E&P
Running total of all prior years' current E&P less prior distributions: the cumulative balance carried forward

E&P vs. Retained Earnings

E&P and GAAP retained earnings both track corporate profits, but they differ significantly in how they're calculated. E&P adjusts taxable income to reflect true economic capacity.

E&P (Tax) Retained Earnings (GAAP)
Starting point Taxable income Net income
Tax-exempt income Added back Already included
Federal income tax Subtracted Already deducted
Depreciation Straight-line / ADS Company's method
Purpose Dividend characterization Financial reporting

The Distribution Ordering Rule

Distribution Amount Step 1: Current E&P Taxable as Dividend Step 2: Accumulated E&P Taxable as Dividend Step 3: Reduce Stock Basis Return of Capital (Tax-Free) Capital Gain

The Dividend Formula

$$ \text{Dividend} = \min\!\Big(\text{Distribution},\;\text{Current E\&P} + \text{Accumulated E\&P}\Big) $$

$$ \text{Return of Capital} = \min\!\Big(\text{Excess over E\&P},\;\text{Stock Basis}\Big) $$

$$ \text{Capital Gain} = \text{Distribution} - \text{Dividend} - \text{Return of Capital} $$

Cash vs. Property Distributions

Cash Distribution Property Distribution
Amount to shareholder Cash received FMV of property (less liabilities)
Corp gain recognized? No Yes, if FMV > adjusted basis
Corp loss recognized? No No (losses disallowed)
E&P reduced by Cash amount FMV of property
Shareholder basis N/A FMV at distribution date

Property Distribution: E&P Impact

1
Increase E&P by the gain recognized on appreciated property: \( \text{FMV} - \text{Adjusted Basis} \)
2
Decrease E&P by the greater of FMV or adjusted basis of the distributed property
3
Net effect: E&P is reduced by the FMV of the property distributed (after accounting for the gain increase)

Stock Redemptions

A stock redemption occurs when a corporation buys back its own stock from a shareholder. The key question: is it treated as a sale/exchange (capital gain) or a distribution (dividend)?

Sale Treatment
Shareholder recognizes capital gain/loss: \( \text{Amount Received} - \text{Stock Basis} \)
Dividend Treatment
Entire amount is a distribution under Section 301 (dividend to extent of E&P)

Section 302 Qualifying Tests

1
Substantially disproportionate: After redemption, shareholder owns < 50% of voting power AND < 80% of pre-redemption voting percentage
2
Complete termination: Shareholder's entire interest is redeemed (family attribution can be waived)
3
Not essentially equivalent to a dividend: Results in a "meaningful reduction" in the shareholder's proportionate interest
4
Partial liquidation: Distribution is not essentially equivalent to a dividend (corporate-level test, non-corporate shareholders only)

Liquidating Distributions

When a corporation completely liquidates, both the corporation and the shareholder recognize gain or loss. This is governed by Sections 331 (shareholder) and 336 (corporation).

Corporation (Sec. 336)
Recognizes gain or loss on all distributed property as if sold at FMV
Shareholder (Sec. 331)
Treated as sale/exchange: \( \text{FMV Received} - \text{Stock Basis} = \text{Capital Gain/Loss} \)

Constructive Ownership Rules

Section 318 attribution rules are critical for stock redemptions. A shareholder is deemed to own stock held by related parties:

Family
Spouse, children, grandchildren, and parents (not siblings)
Entities
Proportionate ownership from partnerships, estates, trusts, and corporations (50%+ threshold for corps)
Options
Stock subject to an option is treated as owned by the option holder

How to Analyze a Distribution

1
Identify the type: Is it a regular distribution, stock redemption, or liquidating distribution?
2
Determine E&P: Calculate current E&P and accumulated E&P before the distribution
3
Apply the ordering rules: Dividend (from E&P) → Return of capital (reduce basis) → Capital gain (excess)
4
Check for property distributions: Did the corp recognize gain? Adjust E&P for gain before reducing for distribution
5
For redemptions: Apply Section 302 tests (consider constructive ownership). Pass = sale; fail = dividend

Example: Cash Distribution

XYZ Corp distributes \($20{,}000\) cash to its sole shareholder. Current E&P is \($8{,}000\), accumulated E&P is \($5{,}000\), and the shareholder's stock basis is \($4{,}000\).

1
Dividend from Current E&P: \($8{,}000\)
2
Dividend from Accumulated E&P: \($5{,}000\)
3
Total Dividend: \( \$8{,}000 + \$5{,}000 = \) \($13{,}000\)
4
Return of Capital: \( \$20{,}000 - \$13{,}000 = \$7{,}000 \), but limited to basis of \($4{,}000\)
5
Capital Gain: \( \$7{,}000 - \$4{,}000 = \) \($3{,}000\)

Example: Property Distribution

ABC Corp distributes land (FMV \($50{,}000\), adjusted basis \($30{,}000\)) to shareholder. E&P before distribution is \($60{,}000\).

1
Corp recognizes gain: \( \$50{,}000 - \$30{,}000 = \) \($20{,}000\) (treated as sold at FMV)
2
E&P increases by gain: \( \$60{,}000 + \$20{,}000 = \$80{,}000 \)
3
E&P decreases by FMV: \( \$80{,}000 - \$50{,}000 = \$30{,}000 \) remaining
4
Shareholder: Dividend of \($50{,}000\) (FMV). New basis in land = \($50{,}000\)

Common Mistakes

✕ Confusing E&P with Retained Earnings
E&P is a tax concept with specific adjustments. GAAP retained earnings cannot determine dividend status.
✕ Wrong E&P Ordering
Distributions come from current E&P first, then accumulated. Mixing this up changes the dividend amount.
✕ Forgetting Gain on Property Distributions
The corporation must recognize gain (not loss) when distributing appreciated property. This gain increases E&P before the reduction.

Question 1 of 5

A corporation distributes \($100{,}000\) to its sole shareholder. Current E&P is \($40{,}000\), accumulated E&P is \($25{,}000\), and the shareholder's stock basis is \($20{,}000\). What is the capital gain recognized?

Question 2 of 5

When a C corporation distributes appreciated property to a shareholder, what happens at the corporate level?

Question 3 of 5

Under Section 302, which of the following is NOT a test for treating a stock redemption as a sale or exchange?

Question 4 of 5

In a complete corporate liquidation under Section 331, how does the shareholder treat the liquidating distribution?

Question 5 of 5

Under Section 318 constructive ownership rules, stock owned by which of the following relatives is attributed to the taxpayer?