574 .

MODULE 36 TAXES: CORPORATE

$10,000 taxable as a dividend. The remaining $5,000 of CEP is then allocated to the $10,000 distribu-
tion to common shareholders, making only $5,000 taxable as a dividend.
EXAMPLE: A corporation has accumulated earnings and profits of $4;000 and current earnings and
profits of $20,000. During the current year its distributes $15,000 to its common shareholders in March,
and another $15,000 to its common shareholders in October. The $20,000 of CEP are allocated pro rata
to the two distributions, making $10,000 of the March distribution and $10,000 of the October distribu-
tion taxable as a dividend. The AEP of$4,000 are then allocated to the March distribution. As a result,
$14,000 of the March distribution and $10,000 of the October distribution are taxable as a dividend.
5. The distributing corporation recognizes gain on the distribution of appreciated property as if
such property were sold for its FMV. However, no loss can be recognized on the nonliquidating
distribution of property to shareholders.
EXAMPLE: A corporation distributes property with a FMV of $10,000 and a basis of $3,000 to a shareholder.
The corporation recognizes a gain of $10,000 - $3,000 = $7,000.
(1) If the distributed property is subject to a liability (or if the distributee assumes a liability) and
the FMV of the distributed property is less than the amount of liability, then the gain is the
dif-
ference between the amount ofliability and the property's basis.
EXAMPLE: A corporation distributes property with a FMV of $10,000 and a basis of $3,000 to a share-
holder, who assumes a liability of $12,000 on the property. The corporation recognizes a gain of $12,000-
$3,000 = $9,000.
(2) The type of gain recognized (e.g., ordinary, Sec. 1231, capital) depends on the nature of the
property distributed (e.g., recapture ~les may apply).
6. Earnings and profits
7. Current earnings and profits (CEP) are similar to book income, but are computed by making
adjustments to taxable income.
(1) Add=-rax-exempt income, dividends received deduction, excess of MACRS depreciation over
depreciation computed under ADS, etc.
(2) Deduct-federal income taxes, net capital loss, excess charitable contributions, expenses relat-
ing to tax-exempt income, penalties, etc.
8. Accumulated earnings and profits (AEF-) represent the sum of prior years' CEP, reduced by
dis-
tributions and net operating loss of prior years.
9. CEP are increased by the gain recognized on a distribution of appreciated property
(excess of
FMV over basis).
10. Distributions reduce ea'rnings and profits (but not below zero) by
(1) The amount of money
(2) The face amount (or issue price if less) of obligations of the distributing corporation, and
(3) The adjusted basis (or FMV if greater) of other property distributed
(4) Above reductions must be adjusted by any liability assumed by the shareholder, or the amount
of liability to which the property distributed is subject.
EXAMPLE: ZrCorp. has two 50% shareholders, B Corp. and Mr. C. Z Corp. distributes a parcel of land
(heldfor investment) to each shareholder. Each parcel of land has a FMV of $12,000 with a basis of$8,000
and each shareholder assumes a liability of $3,000 on the property received. Z Corp. will recognize a gain of
$4,000 on the distribution of each property.

Dividend ($12,000 - $3,000) . B Corp. Mr. C

Tax basis for property received $ 9,000 $ 9,000
Effect (before tax) on Z's earnings & profits: 12,000 12,000
Increased by gain (FMV-basis)
Increased by liabilities distributed 4,000 4,000
Decreased by FMV of property distributed 3,000 3,000
(12,000) (12,000)
11. Stock redemptions
12. A stock redemption is treated as an exchange, generally resulting in capital gain or loss treatment
to the shareholder if at least one of the following five tests is met. Constructive stock ownership
rules generally apply in determining whether the following tests are met:
(1) The redemption is not essentially equivalent to a dividend (this has been interpreted by Reve-
nue Rulings to mean that a redemption must reduce a shareholder's right to vote, share in