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Liquidating and nonliquidating distribution

Any amount of the distribution remaining after exhaustion of the earnings and profits is applied (as in the case of a corporation having no earnings and profits), first against the shareholder`s remaining basis, and then as gain from the sale or exchange of the stock. Under Section 1366(f), if corporate-level taxes are imposed by Section 1374 or 1375, the ,000 gain (and accompanying basis ad­justment) is reduced by any such taxes.

Distributions from earnings and profits do not reduce the stock basis. Other Implications The Section 1363(d) treatment of a distribution of appreciated Section 38 property effects an early disposition (triggering investment tax credit (ITC) recapture) if it occurs prior to the expiration of the estimated life used in computing the ITC.

Any ITC recapture occurring at the S corporation level will reduce its accumulated earnings and profits pursuant to Section 1371(d)(3).

This article demon­strates how to ensure that such distributions do not cause unexpected tax results.

As a result of the fact that the maximum corporate tax rate exceeds the maximum individual rate for the first time in seventy-three years, there is renewed interest in "pass- through" entities (i.e., S corporations and partnerships) as tax-favored ways of conducting a business.

Further, if appreciated depreciable property is distributed to a share­holder owning 50 percent or more of the S corporation`s stock, Section 1239 requires that the portion of the corporate gain attribut­able to the distribution received by such shareholder be reclassified as ordinary income.

As with partnerships, an S corporation`s taxable gains usually pass through to its owners and avoid double taxation.

S corpora­tions typically are more expensive to organize and require greater attention to the maintenance of corporate formalities than is required with partnerships.

However, the corporate form usually provides owners with a greater degree of insulation from business liabilities than does the partnership form.In addition, under Section 1368(c), if the S corpora­tion has accumulated earnings and profits, the distribution is a tax free return against the shareholder`s stock basis only to the extent of the corporation`s "accumulated adjustments account" (i.e., over­simplifying, the accumulation of the net taxable income generated by the entity reduced, but not below zero, by distributions to sharehold­ers during the period covered by the S election under Section 1368(e)). On the other hand, if the beginning accumulated adjustments account had been [[

However, the corporate form usually provides owners with a greater degree of insulation from business liabilities than does the partnership form.

In addition, under Section 1368(c), if the S corpora­tion has accumulated earnings and profits, the distribution is a tax free return against the shareholder`s stock basis only to the extent of the corporation`s "accumulated adjustments account" (i.e., over­simplifying, the accumulation of the net taxable income generated by the entity reduced, but not below zero, by distributions to sharehold­ers during the period covered by the S election under Section 1368(e)). On the other hand, if the beginning accumulated adjustments account had been $0, the distribu­tion in excess of such account is $10,000, which would produce divi­dend income to each shareholder of $2,500.

Any amount of the distribution in excess of the lesser of (1) the accumulated adjustments account or (2) the adjusted basis of the stockholder`s stock is taxed to the shareholder as a dividend up to the amount of the earnings and profits of the corporation. In this event, the decrease to each shareholder`s stock basis resulting from the distribution would be only $10,000, so that the shareholder`s ending basis would be $10,000.

However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.

In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.

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However, the corporate form usually provides owners with a greater degree of insulation from business liabilities than does the partnership form.In addition, under Section 1368(c), if the S corpora­tion has accumulated earnings and profits, the distribution is a tax free return against the shareholder`s stock basis only to the extent of the corporation`s "accumulated adjustments account" (i.e., over­simplifying, the accumulation of the net taxable income generated by the entity reduced, but not below zero, by distributions to sharehold­ers during the period covered by the S election under Section 1368(e)). On the other hand, if the beginning accumulated adjustments account had been $0, the distribu­tion in excess of such account is $10,000, which would produce divi­dend income to each shareholder of $2,500.Any amount of the distribution in excess of the lesser of (1) the accumulated adjustments account or (2) the adjusted basis of the stockholder`s stock is taxed to the shareholder as a dividend up to the amount of the earnings and profits of the corporation. In this event, the decrease to each shareholder`s stock basis resulting from the distribution would be only $10,000, so that the shareholder`s ending basis would be $10,000.However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.Basis adjustments to shareholders` stock are determined under Section 1367(a). If X distributes undivided interests in appreciated property worth $50,000 (with a basis of $10,000) pro rata to its four 25 percent shareholders. The four shareholders each receive a basis in the distributed property of $12,500.The gain recognized by the S corporation passes through to the shareholders and increases the bases of their corporate stock. Assuming no other gain or loss recognition by X for the year, its accumulated adjustments account is increased from $10,000 to $50,000 and decreased by the $50,000 dis­tribution to net out at $0 at year-end.In addition to taking advantage of the lower rates for indi­viduals, the pass-through entity eliminates double taxation associated with the payment of dividends from C corporations.Although both S corporations and partnerships are now tax-favored entities, there are differences between the two.Such distributions may indicate that more than one class of stock is involved, which could invalidate the corporation`s S election.Although regulations have not been proposed with respect to the single class of stock requirement, a pattern of discriminatory dispro­portionate distributions indicates that the corporation has more than one class of stock and each class has different rights with respect to the corporation`s profits and assets.

]], the distribu­tion in excess of such account is ,000, which would produce divi­dend income to each shareholder of ,500.Any amount of the distribution in excess of the lesser of (1) the accumulated adjustments account or (2) the adjusted basis of the stockholder`s stock is taxed to the shareholder as a dividend up to the amount of the earnings and profits of the corporation. In this event, the decrease to each shareholder`s stock basis resulting from the distribution would be only ,000, so that the shareholder`s ending basis would be ,000.However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.Basis adjustments to shareholders` stock are determined under Section 1367(a). If X distributes undivided interests in appreciated property worth ,000 (with a basis of ,000) pro rata to its four 25 percent shareholders. The four shareholders each receive a basis in the distributed property of ,500.The gain recognized by the S corporation passes through to the shareholders and increases the bases of their corporate stock. Assuming no other gain or loss recognition by X for the year, its accumulated adjustments account is increased from ,000 to ,000 and decreased by the ,000 dis­tribution to net out at [[

However, the corporate form usually provides owners with a greater degree of insulation from business liabilities than does the partnership form.

In addition, under Section 1368(c), if the S corpora­tion has accumulated earnings and profits, the distribution is a tax free return against the shareholder`s stock basis only to the extent of the corporation`s "accumulated adjustments account" (i.e., over­simplifying, the accumulation of the net taxable income generated by the entity reduced, but not below zero, by distributions to sharehold­ers during the period covered by the S election under Section 1368(e)). On the other hand, if the beginning accumulated adjustments account had been $0, the distribu­tion in excess of such account is $10,000, which would produce divi­dend income to each shareholder of $2,500.

Any amount of the distribution in excess of the lesser of (1) the accumulated adjustments account or (2) the adjusted basis of the stockholder`s stock is taxed to the shareholder as a dividend up to the amount of the earnings and profits of the corporation. In this event, the decrease to each shareholder`s stock basis resulting from the distribution would be only $10,000, so that the shareholder`s ending basis would be $10,000.

However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.

In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.

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However, the corporate form usually provides owners with a greater degree of insulation from business liabilities than does the partnership form.In addition, under Section 1368(c), if the S corpora­tion has accumulated earnings and profits, the distribution is a tax free return against the shareholder`s stock basis only to the extent of the corporation`s "accumulated adjustments account" (i.e., over­simplifying, the accumulation of the net taxable income generated by the entity reduced, but not below zero, by distributions to sharehold­ers during the period covered by the S election under Section 1368(e)). On the other hand, if the beginning accumulated adjustments account had been $0, the distribu­tion in excess of such account is $10,000, which would produce divi­dend income to each shareholder of $2,500.Any amount of the distribution in excess of the lesser of (1) the accumulated adjustments account or (2) the adjusted basis of the stockholder`s stock is taxed to the shareholder as a dividend up to the amount of the earnings and profits of the corporation. In this event, the decrease to each shareholder`s stock basis resulting from the distribution would be only $10,000, so that the shareholder`s ending basis would be $10,000.However, Section 1231 excludes from capital gain treatment any inventory or property held primarily for sale in the ordinary course of the corporation`s trade or business.In addition, Sections 12 require that any depreciation recapture inherent in the gain be reclassified as ordinary income.Basis adjustments to shareholders` stock are determined under Section 1367(a). If X distributes undivided interests in appreciated property worth $50,000 (with a basis of $10,000) pro rata to its four 25 percent shareholders. The four shareholders each receive a basis in the distributed property of $12,500.The gain recognized by the S corporation passes through to the shareholders and increases the bases of their corporate stock. Assuming no other gain or loss recognition by X for the year, its accumulated adjustments account is increased from $10,000 to $50,000 and decreased by the $50,000 dis­tribution to net out at $0 at year-end.In addition to taking advantage of the lower rates for indi­viduals, the pass-through entity eliminates double taxation associated with the payment of dividends from C corporations.Although both S corporations and partnerships are now tax-favored entities, there are differences between the two.Such distributions may indicate that more than one class of stock is involved, which could invalidate the corporation`s S election.Although regulations have not been proposed with respect to the single class of stock requirement, a pattern of discriminatory dispro­portionate distributions indicates that the corporation has more than one class of stock and each class has different rights with respect to the corporation`s profits and assets.

]] at year-end.In addition to taking advantage of the lower rates for indi­viduals, the pass-through entity eliminates double taxation associated with the payment of dividends from C corporations.Although both S corporations and partnerships are now tax-favored entities, there are differences between the two.Such distributions may indicate that more than one class of stock is involved, which could invalidate the corporation`s S election.Although regulations have not been proposed with respect to the single class of stock requirement, a pattern of discriminatory dispro­portionate distributions indicates that the corporation has more than one class of stock and each class has different rights with respect to the corporation`s profits and assets.

Comments Liquidating and nonliquidating distribution