Ann owns all of the common stock (the only class outstanding) of Pelican Corpora

Question

Ann owns all of the common stock (the only class outstanding) of Pelican Corporation. Prior to the transactions below and as a result of a Section 351 transfer, Ann has a $10,000 basis in her Pelican stock. What result to Ann and Pelican in each of the following alternative situations?

(a) In Year One, Pelican has $5,000 of current and no accumulated earnings and profits and it distributes $17,500 to Ann.

(b) Pelican has a $15,000 accumulated deficit in its earnings and profits at the beginning of Year Two. In Year Two Pelican has $10,000 of current earnings and profits and it distributes $10,000 to Ann.

(c) Pelican has $10,000 of accumulated earnings and profits at the beginning of Year Two and $4,000 of current earnings and profits in Year Two. On July 1 of Year Two, Ann sells half of her Pelican stock to Baker Corporation for $15,000. On April 1 of Year Two, Pelican distributes $10,000 to Ann, and on October 1 of Year Two, Pelican distributes $5,000 to Ann and $5,000 to Baker.

(d) Same as (c), above, except that Pelican has a $10,000 deficit in earnings and profits in Year Two as a result of its business operations.

Explanation / Answer

(a)                  

Distribution Exceeding earning & profit $10,000 tax basis to Ann for Pelican stock.

Pelican has $5,000 of current earning & profit and no accumulated earning & profit and distributes $17,500.

Result: a) $5,000 dividend - §301(c)(1)

                b) $10,000 return of capital - §301(c)(2); zero basis for the stock.

                c) $2,500 capital gain - §301(c)(3).

Pelican's earning & profit is reduced to zero - §312(a)(1).

Problem (b)  

“Nimble Dividend” Rule Effect

$15,000 accumulated deficit in earning & profit from prior year and $10,000 of current earning & profit & corp. distributes $10,000 currently.

Result: the entire $10,000 distribution is a dividend to Ann under the "nimble dividend" rule (sourced from current earning& profit).

Pelican continues to have a $15,000 deficit in its earning & profit (i.e., no adjustments to earning & profit account).

No current earning & profit (after the distribution).

Problem (c)     Distributions & Mid-Year Stock Partial Sale

Facts: (i) $10,000 of accumulated earning & profit before year two (to be allocated chronologically) and (ii) $4,000 of current earning & profit (pro-rated).

1) April 1 distribution of $10,000.

2,000 (pro rata portion of 4,000 current earning & profit);& then 8,000 of 10,000 accumulated earning & profit received as a dividend distribution.

2) October 1 distributions of $5,000 & $5,000 to (now) two shareholders.

$2,000 current earning & profit (1,000 each shareholder).   $2,000 remaining accumulated earning& profit (10,000 less 8,000) allocated 1/2 (1,000) to each shareholder. Each has $3,000 capital return. 3) On July 1 shareholder sells 1/2 of stock for 15k (impact on/of the October transaction?)

Zero EARNING & PROFIT of corp. after these distributions.

Problem (d)           

Current Year Deficit

Pelican has a $10,000 deficit in Year Two.

1) April 1 distribution of $10,000

1/4th of 10,000 loss (2,500) is allocable to the April 1 distribution of 10,000 (no earmarking); 7,500 dividend (reducing earning & profit to zero) & 2,500 return of capital.

Stock basis is reduced from 10,000 to 7,500.

  Option One (chronological)

2) July 1 - Ann sells 1/2 of stock for 15k.

(15,000 less 3,750 (1/2 basis) = 11,250 gain)

3) October 1 distribution of $5,000 & $5,000 to two shareholders - No current earning & profit & no accumulated earning & profit.    Treatment to Ann:

Less: distribution       5,000

Basis is:                     3,750

Result:                     1,250 gain                                                

Option Two (dividends 1st)

2) October 1 distribution of $5,000 & $5,000. No current earning & profit & no acc. earning & profit.    Option(s): Basis is: 7,500           3,750 (1/2?)

Less: distrib.               5,000           5,000

Result:                         2,500           1,250     

                                     (basis)               (gain)

3) July 1 sale of 1/2 stock for 15k: 11,250 gain or 13,750 gain (15x less 1/2 of 2,500 or 1,250).

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