Key Takeaways
- Distributions are taxed as dividends to extent of E&P.
- Property distributions are valued at FMV.
- Corporation recognizes gain (not loss) on appreciated property distributions.
- Constructive dividends arise from improper benefits to shareholders.
- Distribution reduces E&P by the greater of FMV or adjusted basis.
- Stock dividends generally tax-free unless cash option exists.
Corporate Distributions & Dividends
Why This Matters for the Exam
Understanding how distributions are taxed is fundamental to C corporation taxation. The exam tests property distributions, constructive dividends, and the E&P effects.
Expect at least 3-4 questions on distributions.
Basic Distribution Rules
| Distribution | To Shareholder |
|---|---|
| To extent of E&P | Dividend (taxable) |
| Exceeds E&P, reduces basis | Return of capital (not taxable) |
| Exceeds E&P and basis | Capital gain |
Property Distributions
When a corporation distributes property (not cash):
| Element | Rule |
|---|---|
| FMV to shareholder | Shareholder receives FMV as dividend |
| Corporation's gain | Recognizes gain if FMV > basis |
| Corporation's loss | Cannot recognize loss |
| Shareholder's basis | FMV of property received |
Property Distribution Example
| Item | Amount |
|---|---|
| Property basis (corporation) | $30,000 |
| Property FMV | $50,000 |
| Corporate gain | $20,000 |
| Dividend to shareholder | $50,000 (if E&P sufficient) |
| Shareholder's basis | $50,000 |
Loss on Property Distribution
| Rule | Treatment |
|---|---|
| If FMV < Basis | Corporation cannot recognize loss |
| Shareholder receives | FMV as dividend |
| Basis to shareholder | FMV |
| Built-in loss | Lost forever |
E&P Effect of Distributions
| Distribution Type | E&P Reduced By |
|---|---|
| Cash | Amount distributed |
| Property | Greater of FMV or adjusted basis |
Constructive Dividends
Constructive dividends are benefits to shareholders that should have been treated as dividends:
| Constructive Dividend | Example |
|---|---|
| Unreasonable compensation | Excess salary to shareholder-employee |
| Bargain sale | Selling property to shareholder below FMV |
| Personal expenses | Corporation pays shareholder's personal bills |
| Below-market loans | Interest-free loans to shareholders |
| Personal use of property | Shareholder uses corporate property |
Constructive Dividend Consequences
| Party | Consequence |
|---|---|
| Shareholder | Dividend income |
| Corporation | May lose deduction (compensation) |
| Corporation | E&P reduced |
Stock Dividends
| Type | Tax Treatment |
|---|---|
| Common on common (no option) | Tax-free |
| Cash or stock option | Taxable |
| Preferred on common | Usually taxable |
| Disproportionate | Taxable |
Real-World Scenario
Scenario: A corporation with $100,000 E&P distributes property worth $80,000 (basis $50,000) to its sole shareholder.
- Corporate gain: $80,000 - $50,000 = $30,000.
- E&P effect: First, increase E&P by $30,000 gain = $130,000. Then decrease by $80,000 distribution = $50,000.
- Shareholder: $80,000 dividend (all from E&P).
- Shareholder basis in property: $80,000.
On the Exam
Expect 3-4 questions on distributions, typically:
- Property Questions: "Corporation distributes appreciated property. What gain?"
- Constructive Dividend Questions: "Which is a constructive dividend?"
- E&P Questions: "How does distribution affect E&P?"
The key is to remember: Property = FMV. Corp recognizes gain (not loss). Constructive dividends = hidden benefits. E&P reduced by greater of FMV or basis.
Corp has $50k E&P, distributes $80k to shareholder with $20k basis. How is it taxed?
Corporation distributes property with basis $40k, FMV $70k. What is corporate gain?
Which is a constructive dividend?