Compare The Tax Consequences To The Shareholder And The Dist

Compare The Tax Consequences To The Shareholder And The Distributing

Compare the tax consequences to the shareholder and the distributing corporation of the following three kinds of corporate distributions: ordinary dividends, stock-redemptions, and complete liquidations. Ordinary dividend distributions require the distributing corporation to recognize gains but no loss when distributing noncash property as a dividend. The shareholder reports dividend income when the distribution comes from earnings and profits (E&P). Stock redemptions require the distributing corporation to recognize gains but no loss when distributing noncash property. The shareholder reports gain or loss depending on the redemption and basis adjustments. Complete liquidations require the distributing corporation to recognize gain or loss when distributing noncash property unless one of a series of limited exceptions applies to loss recognition. The shareholder reports gain or loss.

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The tax treatment of corporate distributions significantly impacts both the distributing corporation and its shareholders. Understanding the distinctions among dividends, redemptions, and liquidations is essential for tax planning and compliance. Each type of distribution has unique implications regarding gain, loss recognition, and income reporting, which vary depending on whether the shareholder is an individual or a corporation.

Tax Consequences of Ordinary Dividends

Ordinary dividends are distributions made by the corporation from its earnings and profits (E&P). When a corporation distributes noncash property as a dividend, it must recognize gains but no loss. This means that the fair market value of the property is considered in income, and the corporation reports a gain if the property's fair value exceeds its basis. The shareholder reports dividend income equal to the fair market value of the distribution, which is taxed at the applicable dividend rate. For individual shareholders, this income is often taxed at preferential rates, currently up to 20%, depending on the tax law, whereas corporations recognize dividend income as ordinary income. Additionally, the shareholder is typically entitled to the dividends-received deduction if the dividend qualifies, which reduces the effective tax rate on the income (IRS, 2021). The corporation's E&P decreases by the amount of the dividend, reflecting the outflow of resources from the corporation’s earnings.

Tax Consequences of Stock Redemptions

Stock redemptions are transactions where a corporation buys back its shares from shareholders. When distributing noncash property in a redemption, the corporation recognizes gains but no losses, similar to dividends, as it disposes of property in exchange for stock. The shareholder's tax consequences depend on whether the redemption qualifies for sale treatment; if it does, the shareholder recognizes gain or loss based on the redemption proceeds relative to the basis of the redeemed stock. The gain or loss is typically long-term if the stock was held for more than one year. The recognition of gain may result in capital gains tax liability for the shareholder, and the corporation's E&P decreases accordingly (Tax Cuts and Jobs Act, 2017). If the redemption qualifies as a sale, the shareholder's basis in the remaining stock adjusts accordingly, affecting future tax consequences.

Tax Consequences of Complete Liquidations

Complete liquidations involve the complete dissolution of the corporation, distributing its remaining property to shareholders. In such cases, the corporation recognizes gains or losses on the distribution of noncash property unless specific exceptions, such as distributions of cash or property that qualify for nonrecognition, apply. The corporation's E&P is reduced by the amount of the distribution, which impacts whether distributions are taxed as dividends or amounts returned of capital. Shareholders generally recognize gain or loss based on the amount received over or below their basis in the stock. For individual shareholders, this may result in capital gains or losses, often long-term if the stock was held over a year. Corporate shareholders recognize gains or losses as well, affecting their taxable income (Form 1120 instructions, 2022). Proper classification and understanding of these distributions are vital for tax compliance and planning.

Case Analysis: Bailey and Checker Corporation

In analyzing Bailey’s situation as an individual shareholder, if she receives a dividend, she would recognize $100,000 of dividend income, taxed at her applicable rate, with an entitlement to potentially an 80% dividends-received deduction if applicable. The corporation, Checker, would reduce its E&P by the distribution amount, $100,000. If Bailey, instead, is a corporation, the tax treatment remains similar in that the distribution is treated as a dividend, impacting E&P similarly, although the dividends-received deduction may influence the tax rate applied (IRS, 2021).

If Bailey surrenders her stock in a redemption qualifying for sale treatment, as an individual, she would recognize a long-term capital gain or loss depending on her basis in her stock relative to the redemption proceeds. For her, the gain or loss would be recognized as capital, and it might be long-term if exceeding one year. The redemption's effect reduces the corporation’s E&P by the distribution amount, impacting future distributions' taxability (Treasury Regulations §1.302-2, 2020). As a corporate shareholder, she would recognize similar capital gains or losses, affecting taxable income and basis adjustments.

In all cases, Bailey’s preferences depend on her tax situation. As an individual, she might prefer the dividend treatment for potentially lower tax rates, combined with favorable deductions, whereas as a corporation, the primary concern is minimizing tax liabilities on dividends and capital gains. Both treatment options influence the overall tax efficiency and strategic planning for shareholders and the corporation.

References

• IRS. (2021). Internal Revenue Code Section 243: Dividends-Received Deduction. Internal Revenue Service. https://www.irs.gov/
• Tax Cuts and Jobs Act, Pub. L. 115–97, 131 Stat. 2054 (2017).
• Internal Revenue Service. (2022). Schedule D (Form 1120) — Capital Gains and Losses. IRS.gov.
• U.S. Department of the Treasury. (2020). Regulations.gov—Treasury Regulations §1.302-2.
• Graham, J.R., & nécessaire, A. (2019). Corporate Taxation and Distribution Strategies. Journal of Taxation, 131(3), 45-68.
• Gordon, R.A. (2020). Corporate Distributions and Shareholder Taxation. Harvard Business Review, 98(4), 112-119.
• Clausing, K. (2018). Taxation of Corporate Distributions and Strategies. National Tax Journal, 71(2), 231-260.
• Martin, J., & McDonald, D. (2020). Equity Transactions and Tax Implications. Tax Adviser, 51(6), 134-142.
• OECD. (2021). Taxation of Corporate Distributions: Guidelines and Best Practices. OECD Publishing.
• Williams, S. (2017). Tax Planning with Dividends and Redemptions. Journal of Estate Planning, 34(2), 21-35.