Question

Explain the role that earnings and profits play in determining the tax treatment of distributions. Describe the tax treatment of dividends for individual shareholders. Find an example of a corporation that has a dividend program and share their approach. Be sure to choose a company that is different from your classmates.

Answer 1

The Prominent reason for calculating the Earnings and Profits is to arrive at the conclusion as to whether a distribution represents a taxable dividend or a nontaxable return of shareholder’s capital, or capital gain to the shareholders who are at the receiving end . Section 316 defines a "dividend" as any distribution of property made by the corporation out of the earnings and profits whether current or accumulated.

Section 301(c) clearly explains that any distribution that amounts to dividend must be taken into account for the calculation of the gross income of the shareholder, while amounts distributed in excess of those considered a dividend are first treated as a nontaxable return of capital to the extent of the shareholder's stock basis, with any remaining distribution treated as a gain from the sale of the stock, amounting to capital gain.