Entity taxation
The Corporate Transaction
Section 351 defers formation gain unless boot appears, and a distribution is a dividend only to the extent of earnings and profits.
How the exam words it
- -The stem contributes property to a corporation and asks whether section 351 defers the gain.
- -Boot or liabilities are involved in the formation and it asks for recognized gain or basis.
- -A corporation distributes cash or property and it asks how much is a taxable dividend.
- -It reconciles book to taxable income (Schedule M-1) or applies the dividends-received deduction or the charitable limit.
The playbook
- 1Under section 351, defer gain when the contributors control 80 percent immediately after; the shareholder recognizes gain only up to boot received and takes a substituted basis in the stock.
- 2Test distributions against earnings and profits: a dividend to the extent of E&P, then a nontaxable return of basis, then capital gain.
- 3Apply the dividends-received deduction by ownership tier (50 percent, 65 percent, or 100 percent), and cap corporate charitable contributions at 10 percent of taxable income.
- 4Reconcile on Schedule M-1: add back nondeductible items (federal income tax, 50 percent of meals, excess charitable) and remove tax-exempt income to bridge book and taxable income.
The trap
Treating the whole distribution as a dividend. Only the portion covered by earnings and profits is a dividend; the rest is a return of capital and then capital gain.
How the exam varies it
The same pattern, re-skinned along these axes:
Section 351 formation versus a distributionBoot and liabilities versus the earnings-and-profits orderingThe dividends-received deduction versus the charitable limit versus the M-1 reconciliation
Drill this pattern
8 questions of The Corporate Transaction from across the AUD topics. Clear it by getting 5 right with a streak of 3.