ACC 584B

Under certain circumstances, the tax law applies attribution rules to assign to one taxpayer the ownership interest of another taxpayer. If, for example, the stock of Tree Corporation is held 60 percent by Mary and 40 percent by Sam, Mary may be deemed to own 100 percent of Tree if Sam is her son. In that case, the stock owned by Sam is attributed to Mary. Stated differently, Mary has a 60 percent direct and a 40 percent indirect interest in Tree. It can also be said that Mary is the constructive owner of Sam's interest.

Corporate liquidation Occurs when a corporation distributes its net assets to its shareholders and ceases its legal existence. Generally, a shareholder recognizes capital gain or loss upon the liquidation of the entity, regardless of the corporation's balance in its earnings and profits account. However, the distributing corporation recognizes gain and loss on assets that it distributes to shareholders in kind.

• A decrease in the shareholder's voting control. Used to determine whether a redemption qualifies for sale or exchange treatment.
• Not essentially equivalent redemption See redemption (not equivalent to a dividend).

A stock redemption where noncorporate shareholders are permitted sale or exchange treatment. In certain cases, an active business must have existed for at least five years. Only a portion of the outstanding stock in the entity is retired.

A process where a shareholder used the issuance and sale, or later redemption, of a preferred stock dividend to obtain long-term capital gains, without any loss of voting control over the corporation. In effect, the shareholder received corporate profits without suffering the consequences of dividend income treatment. This procedure led Congress to enact § 306, which, if applicable, converts the prior long-term capital gain on the sale or redemption of the stock to ordinary income. See also bailout.

Sale or exchange treatment is available relative to this type of redemption, to the extent of the proceeds up to the total amount paid by the estate or heir for death taxes and administration expenses. The stock value must exceed 35 percent of the value of the decedent's adjusted gross estate. In meeting this test, one can combine shareholdings in corporations where the decedent held at least 20 percent of the outstanding shares.

When a corporation acquires at least 80 percent of a subsidiary in a 12-month period, it can elect to treat the acquisition of such stock as an asset purchase. The acquiring corporation's basis in the subsidiary's assets then is the cost of the stock. The subsidiary is deemed to have sold its assets for an amount equal to the grossed-up basis in its stock.

A corporation buys back its own stock from a specified shareholder. Typically, the corporation recognizes any realized gain on the noncash assets that it uses to effect a redemption, and the shareholder obtains a capital gain or loss upon receipt of the purchase price.

Net undistributed tax-basis earnings of a corporation aggregated from March 1, 1913, to the end of the prior tax year. Used to determine the amount of dividend income associated with a distribution to shareholders. See also current earnings and profits and earnings and profits. § 316 and Reg. § 1.3162.

A taxable benefit derived by a shareholder from his or her corporation that is not actually called a dividend. Examples include unreasonable compensation, excessive rent payments, bargain purchases of corporate property, and shareholder use of corporate property. Constructive dividends generally are found in closely held corporations. See also bargain sale or purchase, closely held corporation, and unreasonable compensation.

Net tax-basis earnings of a corporation aggregated during the current tax year. A corporate distribution is deemed to be first from the entity's current earnings and profits and then from accumulated earnings and profits. Shareholders recognize dividend income to the extent of the earnings and profits of the corporation. A dividend results to the extent of current earnings and profits, even if there is a larger negative balance in accumulated earnings and profits. § 316 and Reg. § 1.3162.

Measures the economic capacity of a corporation to make a distribution to shareholders that is not a return of capital. Such a distribution results in dividend income to the shareholders to the extent of the corporation's current and accumulated earnings and profits.

A dividend consisting of in-kind (non-cash) assets of the payor, measured by the fair market value of the property on the date of distribution. The portion of the distribution representing E & P is a dividend; any excess is treated as a return of capital. Distribution of in-kind property causes the distributing corporation to recognize any underlying realized gain, but not loss. Property factor. The proportion of a multistate corporation's total property that is traceable to a specific state. Used in determining the taxable income that is to be apportioned to that state. See also apportion.

Distributions made by domestic (and certain non-U.S.) corporations to noncorporate shareholders that are subject to tax at the same rates as those applicable to net long-term capital gains (15% and 5%). The dividends must be paid out of earnings and profits, and the shareholders must meet certain holding period requirements as to the stock. Qualified dividend treatment applies to distributions made after 2002 and before 2011. §§ 1(h) (1) and (11).

A dividend consisting of stock of the payor. Not taxable if a pro rata distribution of stock or stock rights on common stock. However, some stock dividends are taxable. § 305.

Assets that convey to the holder the power to purchase corporate stock at a specified price, often for a limited period of time. Stock rights received may be taxed as a distribution of earnings and profits. After the right is exercised, the basis of the acquired share includes the investor's purchase price or gross income, if any, to obtain the right. Disposition of the right also is a taxable event, with basis often assigned from the shares held prior to the issuance of the right.

A deduction is allowed for reasonable salaries or other compensation for personal services actually rendered. To the extent compensation is excessive (unreasonable), no deduction is allowed. Unreasonable compensation usually is found in closely held corporations, where the motivation is to pay out profits in some form that is deductible to the corporation. Deductible compensation therefore becomes an attractive substitute for nondeductible dividends when the shareholders also are employed by the corporation.