The previous two models examined the tax implications of corporate formation. Specifically, you learned about the non-recognition provisions of code sections 1032 and 351 which apply to corporations and shareholders respectively. You also learned about various topics relating to corporate operations, such as capital structure and different types of investor losses. This module examines another aspect of corporate operations, distribution of after tax profits. As corporations operate, they can share their economic successes with shareholders by making distributions. I say can, because distributions are not necessarily required and different firms have different incentives and disincentives. For instance, a publicly traded corporation is likely to face pressure to make distributions as profitability increases. However, growing public firms often prefer to retain profits to fund further growth and expansion. Similarly, closely held firms tend to avoid certain distributions, such as dividends if they trigger double taxation. Nonetheless, distributions are common, especially in connection with major changes to capital structure and they come in different forms. Therefore, from a tax perspective, it is necessary to classify distribution as a taxable dividend, or nontaxable return of capital, or a gain from the sale of stock. As you might expect, this is no easy task as the tax rules governing distributions have been described as complex and sometimes even illogical. In this model, you'll examine the corporate and shareholder tax treatment of non-liquidating distributions. The term non-liquidating implies that the distributions are not in an effort to wind up the affairs of the corporation. Instead these operating distributions are commonly treated as dividends for tax purposes. As you will soon learn however, not all distributions from the corporation to its shareholders are considered dividends. The tax treatment of non-liquidating distributions relies on several code sections. Specifically, Code Section 301 governs the amount and classification to both corporate and non-corporate shareholders of distributions of property made by a C corporation with respect to its stock. Under Section 301 C, distributions that are considered dividends under Code Section 316 are included in gross income with non-corporate shareholders taxed at preferential long-term tax rates, and corporate shareholders paying ordinary rates after any allowable dividends received deduction. Distributions that are not considered dividends are first treated as the recovery of shareholder basis with any excess treated as a gain from the sale or exchange of the stock. So, what exactly is a non-liquidating dividend distribution? Section 316 A defines a dividend as any distribution of property made by a corporation to its shareholders out of its earnings and profits. Earnings and profits, however, is not a performance metric, but rather a pure tax concept. Thus in the first lesson, you will examine the concept of earnings and profits and its computation. Subsequent lessons will examine the tax implications of cash, property, stock, and constructive distributions followed by a discussion of qualified dividends. As usual, each lesson is separated into concepts and applications using Sunchaser Shakery.
