Question

1. Explain the tax effect to the corporation and to the sole shareholder.

XYZ Corporation has one shareholder. The shareholder’s tax basis in his shares is $60,000. Corporate E&P BEFORE the effects of any distribution is $10,000. The corporation distributes the following property: The cororation distributes land with FMV of $120,000 and a tax basis to the corporation of $70,000.

Answer 1

Tax Effect of the events that take place is as follows:

A) Tax consequence to the corporation is :

= Distribution of Land with FMV of $ 120,000 - Tax basis to corporation of $ 70,000

= 120,000 - 70,000

= $ 50,000

In this case the tax consequence is gain of $ 50,000 recognized on distribution to the shareholder.

B) Tax consequence to the Shareholder is :

Earnings & Profits for the corporation are $ 10,000 and Shareholder's tax basis in his shares is $ 60,000

= Distribution of land received from the corporation will be considered as dividend Income to the extent of earnings of the corporation  and the rest portion after deducting the shareholders tax basis in his shares will be taken as capital gain.

= $ 10,000 Dividend Income & $ 50,000 (110,000 - 60,000) Capital Gain

In this case the tax consequence is $ 10,000 Dividend Income & $ 50,000 Capital Gain received by the shareholder.