In the previous lesson,

you learned that E&P represents a C corporation's accumulated prior and current capital,

and thus the amount of economic earnings available

for distribution as dividends to shareholders.

You also learn that E&P is determined by making adjustments to taxable income.

The summary document I provided outlines many of these adjustments.

In this lesson, you will use the concept of E&P

to determine the taxation of cash distributions.

After learning the concepts,

you'll apply them to Sunchaser Shakery.

The taxation of a cash distribution by a corporation with respect to its stock,

is relatively simple once you have computed E&P.

As you might expect, the amount of

the distribution equals the amount of cash received by the shareholder.

But whether and to what extent the distribution constitutes

a dividend for federal tax purposes, depends on E&P.

Recall that according to Section 301 C1 and 316A,

a distribution of cash in this case,

is a dividend for tax purposes to the extent

of the corporation's current and accumulated E&P.

In other words, the cash distributed is a dividend to the extent

the corporation had economic wherewithal to pay a dividend.

In general, dividends are gross income to the shareholder.

Notice the distinction in these rules between current and accumulated E&P.

Accumulated E&P is the total of all prior current year E&P,

reduced by any distributions made from E&P in prior years.

The distinction is especially important when distributions exceed current E&P.

More on this concept shortly.

There are two irrefutable presumptions of corporate E&P,

which are assumptions of law that cannot be rebutted by evidence,

and must be considered to be the case despite evidence to the contrary.

First section 316A, presumes that

every distribution is made out of the E&P to the extent that E&P exists.

Second, it presumes that every distribution is

made from the most recently accumulated E&P.

With these presumptions in mind,

the distributing corporation reduces its E&P by the amount of

cash distributed as long as sufficient current and accumulated E&P exist.

In other words, negative E&P can result from that operating losses,

but a deficit in the E&P cannot be created or increased by distribution.

Therefore, where there is insufficient current E&P

available to cover cash distributions made during the tax year,

E&P is allocated to the distributions to determine dividend status.

E&P allocation is governed by complex provisions and treasury regulation 1.316-2.

However, to focus on the fundamental concepts,

we will examine a set of general rules.

While general, these rules are still complex,

therefore they may not make complete sense the first time you think about them.

But, once you apply the rules to Sunchaser Shakery,

the concept should become clear. The rules are as follows.

First, if a positive amount of both current and accumulated E&P exist,

corporate distributions are considered to be made first from current E&P,

followed by accumulated E&P.

If distributions exceed current E&P,

then current and accumulated E&P are allocated to each distribution during the year.

Current E&P is applied first to distributions on a pro rata basis,

then accumulated E&P is applied beginning with the earliest distribution.

Second, if current E&P is positive but accumulated E&P is negative,

distributions are treated as dividends to the extent of current E&P.

Finally, if current E&P is negative but accumulated E&P is positive,

the amounts are netted together at the date of distribution.

If the result is zero or negative,

the distribution is return of capital.

If positive, the distribution is treated as a dividend to the extent of positive balance.

Any loss in current E&P is viewed as occurring

rotably throughout the year unless the parties can show otherwise.

From here, amounts distributed in excess of

current and accumulated E&P are not dividends,

and instead first reduce the shareholder stock basis,

with any additional excess treated as a gain from the sale or exchange of the stock.

More on these treatments later.