Question

A “C” corporation, Brown Inc., that is not undergoing a liquidation, distributes property (basis of $10,000 and fair market value of $20,000) to Brenda, its shareholder.  Brown Inc. had $100,000 of earnings & profits prior to this transaction. What, if any, taxable income is recognized by Brown, Inc.?  Please explain impact on Brown Inc’s earnings and profits from the distribution.  What are the tax consequences to Brenda?

Answer 1

TAX CONSEQUENCE

1) In the hands of BROWN INC. :

Upon distribution of Corporation property by a non-liquidating C corporation, Capital gain shall be recognized by the corporation if the Fair market value of the property exceeds its tax basis. In the given case the FMV of the property is $20,000 whereas it's tax basis is $10,000.

Therefore the corporation shall recognize a gain of $10,000 ($20000 - $10000)

Now calculating the effect on Earnings & Profit of Brown Inc.,

E&P before the distribution of dividend (A) = $100,000

Add: Capital gain recognized on distribution (B) = $10,000

Less: Higher of the Fair value or Adjusted base of the property (C) = $20,000

E &P after distribution of dividend (A)+(B)-(C) = $90,000

2) In the hands of BRENDA:

The amount distributed to Brenda is equal to the amount of Fair market value of the property that is, $20,000 and the amount distributed to the extent of Earnings & Profits of the company is taxable in the hands of the shareholder as Dividend.

Since the FMV of property is within the limits of E&P of Brown Inc., the total amount of $20,000 is taxable in the hands of Brenda as Dividend received.