C Corporation Distribution Characterization

For an ordinary nonliquidating C corporation distribution, begin with available current and accumulated earnings and profits. The distribution is generally a dividend to that extent. Any remaining nondividend amount reduces the shareholder’s stock basis, but not below zero. Amounts still remaining after basis recovery generally produce gain, typically capital gain when the stock is a capital asset.

A corporation’s cash balance and retained earnings are not substitutes for tax earnings and profits. Likewise, the shareholder’s cost in stock does not shelter the dividend layer. If a shareholder has $100,000 stock basis and receives a $5,000 distribution fully supported by E&P, it can still be a $5,000 dividend. Begin with E&P, not whichever balance is largest.

Positive current-year E&P is generally determined for the year and allocated among the year’s distributions when necessary. If current E&P is insufficient, accumulated E&P can support additional dividend treatment based on its availability and distribution timing. Multiple payments therefore require an allocation and chronology rather than applying the full E&P amount independently to each check.

A current-year deficit and accumulated positive E&P raise different allocation issues from positive current E&P with an accumulated deficit. Do not simply net every opening and closing balance without applying the relevant rules. In a basic exam question that supplies “E&P available for this distribution,” that phrase avoids the preliminary allocation problem. State that assumption before using the straightforward three-layer formula.

For a noncash distribution, the shareholder’s distribution amount generally begins with fair market value, reduced by applicable liabilities under the distribution rules. The shareholder generally takes fair-market-value basis in the property. At the corporate level, distributing appreciated property can trigger gain as though the property were sold for fair market value. A nonliquidating distribution of depreciated property generally does not give the corporation a corresponding loss deduction.

The corporate gain can affect E&P, so the shareholder dividend analysis may need an updated E&P computation. Keep corporate asset basis, property value and shareholder stock basis distinct. Liquidations, redemptions and other special distributions can follow different rules and are not solved by blindly applying this lesson’s ordinary nonliquidating model. Identify a redemption or liquidation cue before using the cash-distribution sequence.