Please reply to the below discussion in 2 paragraphs. In the first, clearly state with which parts of the other student’s thread you agree or disagree. You must provide an explanation for why you agree or disagree with the other student’s thread. In the second, add some additional comments of your own that add to the discussion. the reply must be at least 250 words.
What income tax issues must a corporation consider before it makes a noncash distribution to a shareholder?
Typically, a corporation makes distributions to its shareholders in the form of cash. These distributions have no effect on the taxable income of the corporation, but they do reduce the corporation’s earnings and profits (E&P). However, a corporation may occasionally distribute property other than cash to a shareholder – this is known as a distribution-in-kind or a distribution-in-specie (What is a distribution-in-kind, nd.). In this case, BOTH taxable income and E&P may be affected. For the purposes of this discussion, we will focus on the tax impact that such a distribution can have for the corporation.
The two most important factors for a corporation considering a distribution-in-kind are: (1) the fair market value (FMV) of the asset, and (2) the adjusted tax basis of the asset. This will determine the need for the recognition of capital gains and the tax consequences of such. If the FMV of the asset exceeds the adjusted tax basis of said asset, then the corporation must recognize a gain (Spilker, 2021). According to I.R.C. §311, this type of distribution is treated as if the property had been sold to the shareholder for its fair market value. This gain is then taxed as ordinary income to the corporation. As an example, let us consider a corporation whose shareholder wants to make a $65,000 stock redemption but the corporation does not have the cash available to make the full redemption. Instead, they are considering distributing a parcel of land to the shareholder, who is agreeable to the transaction. The company owns the following parcels of land:
Adjusted Tax Basis
Which parcel of land should they select? By comparing the adjusted tax basis to the FMV, we see that parcel 1 and parcel 2 would result in a capital gain of $30,000, which in turn would be added to taxable income. However, because parcel 3’s adjusted tax basis and FMV are the same, so the corporation would not recognize any gains on the distribution of this parcel. Therefore, the corporation should distribute parcel 3, along with $10,000 in cash, to the stockholder. (Ellentuck, A., 2008).
While I.R.C. §311 does treat a distribution-in-kind the same as a sale of property to the shareholder for the recognition of capital gains, there is an important difference. “If the fair market value of the property distributed is less than the corporation’s tax basis in the property, the corporation does not recognize a deductible loss for either computing taxable income or current E&P” (Spilker, 2021, p. 18-12). In this situation, it would be better for the company to sell the asset to a third party (allowing for the realization of a deductible loss), and distribute the proceeds to the shareholder (Bittker, 1959).
Tax avoidance is the primary objective of tax planning. Every financial decision made by a company should keep this in mind. To do otherwise is unwise and could be viewed as a dereliction of duty. Proverbs 22:3, offers this wisdom: “The prudent sees danger and hides himself, but the simple go on and suffer for it” (English Standard Version Bible, 2001, Proverbs 22:3). In other words, the prudent tax planner investigates the tax implications of various scenarios and chooses that which avoids the most tax, while the simple will not do the due diligence required and they end up paying more taxes than necessary.