Question

Iris Corporation owns 30% of Fresia Corporation's stock. On November 15, Fresia Corporation, with current E & P of $320,000, distributes land (fair market value of $100,000; basis of $160,000) to Iris. The land is subject to a liability of $80,000, which Iris assumes.

Dividends Received Deduction

Percentage of Ownership by Corporate Shareholder	Deduction Percentage
Less than 20%	50%
20% or more (but less than 80%)	65%
80% or more*	100%

a. How is Iris Corporation taxed on the distribution?

Iris Corporation has dividend income of $_______ and a dividends received deduction of $_______. Iris Corporation has a basis of $________ in the land.

b. What is Fresia Corporation’s E & P after the distribution?
$_________.

Answer 1

a.

The dividend income of Iris Corporation is $20,000 [$100,000 (fair market value of the land) – $80,000 (liability on the land)

The dividends received deduction is $13,000 (65% of Dividend received)

Dividends subject to tax is $7,000 ($20,000-$13,000)

Iris Corporation has a basis of $100,000 in the land.

When a corporation transfers properties to an individual rather than cash, the amount transferred shall be ascertained at the date of delivery by the fair market value of the property. The part of a land transfer under existing E&P, as in the case of an asset payout, is a dividend and any excess is viewed as a return on capital. If the fair market value of the sold property is greater than E & P of the company and share in the stock investment, a capital gain is usually the result. The distributed amount shall be limited by any liability relating to the distributed property immediately before and immediately following its delivery and by any liabilities borne by the owner in accordance with the company. The fair market value of the property on the date of distribution is the basis of the distributed property for the shareholder.

b.

It is reduced by $80,000.

The purchases of valuable assets generate profit for the sales company. A company distributing profits will be treated as having sold the property for its fair market value to the shareholder. The selling business does not, however, accept damages in land sales. If the land transferred meets liabilities or if that responsibility is borne by the lender, a special rule applies. The fair market value of the property is considered as not less than the amount of liability for the determination of profit on the distribution.

The deficit can not be deducted on the ground by Fresia Company. Its E&P is lowered by $80,000[ a land-based $160,000 (more than fair value)–the land-based obligation is $80,000]. As a result, the after-sale Fresia Corporation's E&P is $240,000 (current E&P of $320,000 less the discount of $80,000).