THE EXAM WILL COVER ONLY CHAPTER 7, AND PAGES 20 THROUGH 40 OF CHAPTER 8.
1. Distribution to SHRs is a dividend to extent of current (CEP) or accumulated (AEP) earnings and profits (E&P).
2. Distributions in excess of E&P are return of capital (ROC) until basis is zero, and then capital gain (CG).
3. Example: AEP 100,000, CEP 200,000, A/B of stock 25,000, distribution $330,000. Div 300,000 ROC 25,000 Cap Gain 5,000.
4. If CEP is positive and AEP is negative, distribution is a dividend to extent of CEP.
5. Same facts as #3 only AEP is (100,000) Div 200,000 (all from CEP) ROC 25,000 CG 105,000
6. If AEP is positive and CEP is negative, you determine the amount of the CEP deficit as of the distribution date and subtract it from the AEP to see if there are any AEP to support a dividend.
7. Same facts as #3 only CEP is (200,000) and distribution is on April 1 (91st day of year). Approximately $50,000 of deficit has been earned by April 1 (200,000 x (91/365) so we reduce AEP by 50,000 and remaining AEP is $50,000. Div 50,000 ROC 25,000 CG 255,000
8. E&P generally determined by impact on the corporation’s ability to pay a dividend. Start with taxable income, add back exempt income and things that were paper deductions (no cash out the door) such as the dividends received deduction etc) and deduct things that caused cash to go out the door but were not deductible such as federal taxes and fines, penalties etc. Know the timing rules for carryovers. When you have an excess deduction such as a capital loss or an NOL, the full amount reduces E&P in the year of the loss. When the carryover is used in a later year you need to add the used carryover back to E&P in that year because your starting point for the year in calculating E&P is taxable income which was reduced by the carryover. So if we don’t add the used carryover back we will be deducting it twice, once in the year it occurred and a second time in the year it is used. Read pages 7-7 and 7-8. There are 4 separate categories of additions, focus on the first three categories of additions, and the first 5 items under subtractions (through “current year net capital loss”).
9. Know the tax consequences to both the shareholder and the distributing corporation when property rather than cash is distributed. If property is distributed the corporation has gain (but not loss) as if the property were sold at its FMV. E.g. corporation distributed land with FMV $100,000 and A/B $15,000. Corporation has $85,000 gain. If the numbers were reversed no loss is allowed. On gain, corporation’s E&P goes up by the gain and down by the FMV of the property distributed. So E&P goes up by $85,000 and down by $100,000.
10. Shareholder has dividend (assuming sufficient E&P) equal to FMV of property distributed (less any liability the property is subject to). Basis in the property is FMV (ignoring the liability) and holding period is day after the distribution. Assume SHR gets property with FMV of $150,000 subject to liability of $30,000. The dividend is $120,000, but the basis of the property is $150,000.
11. Ignore Constructive Dividends, and Motivation to Pay Dividends, but know Stock Dividends. The general rule is a stock dividend is not taxable, and you spread the old A/B over the old and the new shares. Shareholder has 200 shares with total A/B of $110. He gets a 10% dividend so he receives 20 new shares. He now has 220 shares and the new shares get a basis of (20/220) x 110 = $10. A stock dividend will be taxable if any shareholder has a choice to take either stock or cash, even if all shareholders elect to take stock.
12. A redemption is a purchase by a corporation of its own stock from a shareholder. It will be treated as either a dividend or a capital gain to the shareholder depending on whether certain tests are met. If the tests are not met the gross amount