Rev. Rul. 74-164

Advice has been requested concerning the taxable status of corporate distributions under the circumstances described below.

X corporation and Y corporation each using the calendar year for Federal income tax purposes made distributions of $15,000 to their respective shareholders on July 1, 1971, and made no other distributions to their shareholders during the taxable year. The distributions were taxable as provided by section 301(c) of the Internal Revenue Code of 1954.

Situation 1.

At the beginning of its taxable year 1971, X corporation had earnings and profits accumulated after February 28, 1913, of $40,000. It had an operating loss for the period January 1, 1971 through June 30, 1971, of $50,000 but had earnings and profits for the entire year 1971 of $5,000.

Situation 2.

At the beginning of its taxable year 1971, Y corporation had a deficit in earnings and profits accumulated after February 28, 1913, of $60,000. Its net profits for the period January 1, 1971 through June 30, 1971, were $75,000 but its earnings and profits for the entire taxable year 1971 were only $5,000.

Situation 3.

Assume the same facts as in Situation 1 except that X had a deficit in earnings and profits of $5,000 for the entire taxable year 1971.

Situation 4.

Assume the same facts as in Situation 1 except that X had a deficit in earnings and profits of $55,000 for the entire taxable year 1971.

Section 301(a) and 301(c) of the Code provides, in part, that: (1) the portion of a distribution of property made by a corporation to a shareholder with respect to its stock which is a dividend (as defined in section 316), shall be included in the shareholder's gross income; (2) the portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock; and (3) the portion which is not a dividend to the extent that it exceeds the adjusted basis of the stock and is not out of increase in value accrued before March 1, 1913, shall be treated as gain from the sale or exchange of property.

Section 316(a) of the Code provides that the term "dividend" means any distribution of property made by a corporation to its shareholders out of its earnings and profits accumulated after February 28, 1913, or out of its earnings and profits of the taxable year computed as of the close of the taxable year without diminution by reason of any distribution made during the year, and without regard to the amount of earnings and profits at the time the distribution was made.

Section 1.316-2(a) of the Income Tax Regulations provides, in part, that in determining the source of a distribution, consideration should be given first, to the earnings and profits of the taxable year; and second, to the earnings and profits accumulated since February 28, 1913, only in the case where, and to the extent that, the distributions made during the taxable year are not regarded as out of the earnings and profits of that year.

Applying the foregoing principles, in Situation 1, the earnings and profits of X corporation for the taxable year 1971 of $5,000 and the earnings and profits accumulated since February 28, 1913, and prior to the taxable year 1971, of $40,000 were applicable to the distribution paid by it on July 1, 1971. Thus, $5,000 of the distribution of $15,000 was paid from the earnings and profits of the taxable year 1971 and the balance of $10,000 was paid from the earnings and profits accumulated since February 28, 1913. Therefore, the entire distribution of $15,000 was a dividend within the meaning of section 316 of the Code.

In Situation 2 the earnings and profits of Y corporation for the taxable year 1971 of $5,000 were applicable to the distribution paid by Y corporation on July 1, 1971. Y corporation had no earnings and profits accumulated after February 28, 1913, available at the time of the distribution. Thus, only $5,000 of the distribution by Y corporation of $15,000 was a dividend within the meaning of section 316 of the Code. The balance of such distribution, $10,000 which was not a dividend, applied against and reduced the adjusted basis of the stock in the hands of the shareholders, and to the extent that it exceeded the adjusted basis of the stock was gain from the sale or exchange of property.

In the case of a deficit in earnings and profits for the taxable year in which distributions are made, the taxable status of distributions is dependent upon the amount of earnings and profits accumulated since February 28, 1913, and available at the dates of distribution. In determining the amount of such earnings and profits, section 1.316-2(b) of the regulations provides, in effect, that the deficit in earnings and profits of the taxable year will be prorated to the dates of distribution.

Applying the foregoing to Situations 3 and 4 the distribution paid by X corporation on July 1, 1971, in each situation was a dividend within the meaning of section 316 of the Code to the extent indicated as follows:

 Situation #3