If current E&P is negative and accumulated E&P is positive, how do distributions relate to negative E&P?
Understand the Problem
This question pertains to corporate taxation, specifically the concept of Earnings and Profits (E&P). It describes a scenario where a corporation has negative current E&P but positive accumulated E&P, and asks how distributions affect the negative E&P balance. Understanding how current and accumulated E&P are used to characterize distributions as dividends is key to answering this.
Answer
Distributions reduce positive accumulated E&P after accounting for the negative current E&P. Excess distributions are a return of capital.
When current E&P is negative and accumulated E&P is positive, distributions are considered to come first from current E&P (even if negative), and then from accumulated E&P to the extent thereof. Distributions reduce the positive accumulated E&P. Any distribution exceeding both current and accumulated E&P is treated as a return of capital to the extent of the shareholder's stock basis.
Answer for screen readers
When current E&P is negative and accumulated E&P is positive, distributions are considered to come first from current E&P (even if negative), and then from accumulated E&P to the extent thereof. Distributions reduce the positive accumulated E&P. Any distribution exceeding both current and accumulated E&P is treated as a return of capital to the extent of the shareholder's stock basis.
More Information
Earnings and Profits (E&P) is a corporate tax concept that determines whether a distribution to shareholders is a dividend, return of capital, or capital gain. Current E&P reflects the corporation's profitability during the current tax year, while accumulated E&P is the sum of all prior years' E&P (both positive and negative), less prior distributions.
Tips
A common mistake is to assume that negative current E&P automatically makes all distributions non-taxable. The interaction with accumulated E&P is crucial.
Sources
- Earnings and Profits Computation Case Study - The Tax Adviser - thetaxadviser.com
- Understanding How Corporate Dividends Are Taxed to Shareholders - thetaxadviser.com
- Shareholder Distribution | The ABCs of Distributions - Leo Berwick - leoberwick.com
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