Understanding the effects of nonliquidating distributions on corporations.

• Author: Ellentuck, Albert B.

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NONLIQUIDATING CORPORATE DISTRIBUTIONS are distributions of cash and/or property by a continuing corporation to its shareholders. At the shareholder level, a nonliquidating corporate distribution can produce a variety of tax consequences, including taxable dividend treatment, capital gain or loss, or a reduction in stock basis.

At the corporate level, a nonliquidating corporate distribution can also have varying tax consequences. The distribution may have no tax effect, or it may trigger corporate-level capital gain and/or ordinary income. The corporate-level tax consequences of a nonliquidating corporate distribution depend on whether the distribution consists of cash or property (other than cash). The corporation does not recognize gain or loss when it distributes cash to shareholders or when it redeems stock in exchange for cash payments (Sec. 311(a)).

Avoiding Corporate-Level Gain

When a corporation makes a nonliquidating distribution of corporate property other than cash (including a distribution to redeem stock), the corporation recognizes gain if the property's fair market value (FMV) exceeds its adjusted tax basis in the corporation's hands (Sec. 311(b)(1)). Specifically, the corporation recognizes gain as if it had sold the appreciated property for FMV to the recipient shareholder. When multiple properties are distributed, the corporation computes gain on an asset-by-asset basis (Rev. Rul. 80-283). The portion of the corporation's gain attributable to recapture items (e.g., depreciation recapture) is ordinary income, as is gain attributable to the distribution of inventory and unrealized receivables. Gain attributable to capital assets and certain property used in a trade or business (Sec. 1231 property) is capital gain.

Practice tip: Corporations generally report nonliquidating distributions to shareholders on Form 1099-DIV, Dividends and Distributions (Sec. 6042(c); Regs. Sec. 1.6042-4). The form breaks total distributions down into taxable and nontaxable categories. Form 5452, Corporate Report of Nondividend Distributions, is used to report nondividend distributions to shareholders.

Example 1: A, B, C, and D each own 2,500 shares of J Corp., a C corporation real estate development company. A disagrees with the other shareholders and wants the corporation to redeem his stock for $60,000. A has held his stock for three years, and his stock basis is $59,000. A is not related to the other shareholders. The...