Question

Delta Corp has 2 equal shareholders. Able and Body. Delta and Able & Body are all cash method calendar year taxpayers. On 1/01 of the current year, Delta’s A/E&P was $5,000, and its C/E&P during the present year was $20,000. Each of the E&P figures were computed without any adjustment needed because of the distributions described below. On 7/01 of the present year, Delta distributed some machinery to Able and some equipment to Body. The machinery distributed to Able had an adjusted basis of Delta of $45,000 and a fair market value of $25,000 at the time of distribution. The equipment distributed to Body had an adjusted basis to Delta of $15,000 and a fair market value of $25,000 at the time of distribution. No other distributions were made by Delta during the present year.

1. Assume A & B are both individuals. What is the effect of the July distribution to A & B and to Delta?
2. Assume that the machinery Delta distributed to Able was subject to a mortgage of $10,000 and the equipment distributed to Body was subject to a mortgage of $10,000. How would this affect your answers to any of the questions in (a) above?
3. What is the basis to the two shareholders of the respective property received by each shareholder in question (a) & (b) above

Answer 1

A. Distributions from Current E&P is termed as a dividend. If the current E&P is insufficient, the accumulated E&P is considered. Distributions to the extent of accumulated E&P is termed as a dividend, and the remaining balance is treated as return of capital and any excess is considered as taxable gains.  

In the given scenario, total of accumulated and current year E&P comes to $25,000. Delta has distributed two properties with fair value of $25,000 each. Thus totaling to $50,000. Therefore to Able & Body, they received a dividend income of $12,500 each. ($25,000 E&P divided equally between Able & Body). And the remaining  $12,500 each is the return of capital to the extent of capital and capital gains, excess if any.

Particulars	Able	Body
Dividend	$12,500	$12,500
Return of Capital	$12,500	$12,500

For the distribution made to Able, Delta can not recognize any loss(loss of $ 20,000 = $45,000 minus $25,000)

However, for the distribution made to Body, Delta can recognize a gain of $10,000(Fair market value $ 25,000 minus adjusted basis $ 15,000)

B. If the property distributed as dividends has a liablity, then the dividend will be equal to fair market value reduced by the liability. In this case, $25,000 minus $ 10,000, resulting in $15,000 each.

Particulars	Able	Body
Dividend	$12,500	$12,500
Return of Capital	$ 2,500	$ 2,500

For the distribution made to Able, Delta can not recognize any loss. However, for the distribution made to Body, Delta can recognize a gain of $20,000(Fair market value $ 25,000 minus ( adjusted basis $ 15,000 minus mortgage $10,000))

C. The basis to the two shareholders of the respective property received by each of them is always the fair market value of the property. Hene the basis is $25,000 for Able & Body in both cases (a) & (b).