Recapture Taxes
A corporation's tax liability is increased if it recaptures credits it has taken in prior years. The following list includes credits a corporation may need to recapture.
- Indian employment credit (see the instructions for Form 8845).
- Investment credit (see the instructions for Form 4255).
- Low-income housing credit (see the instructions for Form 8611).
- New markets credit (see the instructions for Form 8874).
- Qualified electric vehicle credit (see the instructions for Form 8834).
Alternative Minimum Tax (AMT)
The tax laws give special treatment to some types of income and allow special deductions and credits for some types of expenses. These laws enable some corporations with substantial economic income to significantly reduce their regular tax. The corporate alternative minimum tax (AMT) ensures that these corporations pay at least a minimum amount of tax on their economic income. A corporation owes AMT if its tentative minimum tax is more than its regular tax.
The tentative minimum tax of a small corporation is zero. This means that a small corporation will not owe AMT.
Small corporation exemption. A corporation is treated as a small corporation exempt from the AMT for its tax year beginning in 2002 if that year is the corporation's first tax year in existence (regardless of its gross receipts for the year) or:
- It was treated as a small corporation exempt from the AMT for all prior tax years beginning after 1997, and
- Its average annual gross receipts for the 3-tax-year period (or portion thereof during which the corporation was in existence) ending before its tax year beginning in 2002 did not exceed $7.5 million ($5 million if the corporation had only 1 prior tax year).
For more information, see the instructions for Form 4626.
Form 4626. Use Form 4626 to figure the tentative minimum tax of a corporation that is not a small corporation for AMT purposes.
Accumulated Earnings Tax
A corporation can accumulate its earnings for a possible expansion or other bona fide business reasons. However, if a corporation allows earnings to accumulate beyond the reasonable needs of the business, it may be subject to an accumulated earnings tax of 38.6%. If the accumulated earnings tax applies, interest applies to the tax from the date the corporate return was originally due, without extensions.
To determine if the corporation is subject to this tax, first treat an accumulation of $250,000 or less generally as within the reasonable needs of most businesses. Treat an accumulation of $150,000 or less as within the reasonable needs of a business whose principal function is performing services in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.
In determining if the corporation has accumulated earnings and profits beyond its reasonable needs, value the listed and readily marketable securities owned by the corporation and purchased with its earnings and profits at net liquidation value, not at cost.
Reasonable needs of the business include the following.
- Specific, definite, and feasible plans for use of the earnings accumulation in the business.
- The amount necessary to redeem the corporation's stock included in a deceased shareholder's gross estate, if the amount does not exceed the reasonably anticipated total estate and inheritance taxes and funeral and administration expenses incurred by the shareholder's estate.
The absence of a bona fide business reason for a corporation's accumulated earnings may be indicated by many different circumstances, such as a lack of regular distributions to its shareholders or withdrawals by the shareholders classified as personal loans. However, actual moves to expand the business generally qualify as a bona fide use of the accumulations.
The fact that a corporation has an unreasonable accumulation of earnings is sufficient to establish liability for the accumulated earnings tax unless the corporation can show the earnings were not accumulated to allow its individual shareholders to avoid income tax.
Distributions to Shareholders
This section discusses corporate distributions of money, stock, or other property to a shareholder with respect to the shareholder's ownership of stock. However, this section does not discuss the special rules that apply to the following distributions.
- Distributions in redemption of stock. See section 302 of the Internal Revenue Code.
- Distributions in complete liquidation of the corporation. See sections 331 through 346 of the Internal Revenue Code.
- Distributions in corporate organizations. See Exchange of Property for Stock, earlier.
- Distributions in corporate reorganizations. See section 351 through 368 of the Internal Revenue Code.
- Certain distributions to 20% corporate shareholders. See section 301(e) of the Internal Revenue Code.
Money or Property Distributions
Most distributions are in money, but they may also be in stock or other property. For this purpose, property generally does not include stock in the corporation or rights to acquire this stock. However, see Distributions of Stock or Stock Rights, later.
A corporation generally does not recognize a gain or loss on the distributions covered by the rules in this section. However, see Gain from property distributions, later.
Amount distributed. The amount of a distribution is generally the amount of any money paid to the shareholder plus the fair market value (FMV) of any property transferred to the shareholder. However, this amount is reduced (but not below zero) by the following liabilities.
- Any liability of the corporation the shareholder assumes in connection with the distribution.
- Any liability to which the property is subject immediately before, and immediately after, the distribution.
The FMV of any property distributed to a shareholder becomes the shareholder's basis in that property.
Gain from property distributions. A corporation will recognize a gain on the distribution of property to a shareholder if the FMV of the property is more than its adjusted basis. This is generally the same treatment the corporation would receive if the property were sold. However, for this purpose, the FMV of the property is the greater of the following amounts.
- The actual FMV.
- The amount of any liabilities the shareholder assumed in connection with the distribution of the property.
If the property was depreciable or amortizable, the corporation may have to treat all or part of the gain as ordinary income from depreciation recapture. For more information on depreciation recapture and the sale of business property, see Publication 544.
Distributions of Stock or Stock Rights
Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as stock options) are distributions by a corporation of rights to acquire its stock. Distributions of stock dividends and stock rights are generally tax-free to shareholders. However, stock and stock rights are treated as property under the rules discussed earlier under Money or Property Distributions if any of the following apply to their distribution.
- Any shareholder has the choice to receive cash or other property instead of stock or stock rights.
- The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation's assets or earnings and profits to other shareholders.
- The distribution is in convertible preferred stock and has the same result as in (2).
- The distribution gives preferred stock to some common stock shareholders and gives common stock to other common stock shareholders.
- The distribution is on preferred stock. (An increase in the conversion ratio of convertible preferred stock made solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing the conversion right is not a distribution on preferred stock.)
For this purpose, the term stock includes rights to acquire stock and the term shareholder includes a holder of rights or convertible securities.
Constructive stock distributions. You must treat certain transactions that increase a shareholder's proportionate interest in the earnings and profits or assets of a corporation as if they were distributions of stock or stock rights. These constructive distributions are treated as property if they have the same result as a distribution described in (2), (3), (4), or (5) of the above discussion. Constructive distributions are described later.
This treatment applies to a change in your stock's conversion ratio or redemption price, a difference between your stock's redemption price and issue price, a redemption that is not treated as a sale or exchange of your stock, and any other transaction having a similar effect on a shareholder's interest in the corporation.
Expenses of issuing a stock dividend. You cannot deduct the expenses of issuing a stock dividend. These expenses include printing, postage, cost of advice sheets, fees paid to transfer agents, and fees for listing on stock exchanges. The corporation must capitalize these costs.
Constructive Distributions
The following sections discuss transactions that may be treated as distributions.
Below-market loans. If a corporation gives a shareholder a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate, the interest not charged may be treated as a distribution to the shareholder. For more information, see Below-Market Loans under Income and Deductions, earlier.
Corporation cancels shareholder's debt. If a corporation cancels a shareholder's debt without repayment by the shareholder, the amount canceled is treated as a distribution to the shareholder.
Transfers of property to shareholders for less than FMV. A sale or exchange of property by a corporation to a shareholder may be treated as a distribution to the shareholder. For a shareholder who is not a corporation, if the FMV of the property on the date of the sale or exchange exceeds the price paid by the shareholder, the excess may be treated as a distribution to the shareholder.
Unreasonable rents. If a corporation rents property from a shareholder and the rent is unreasonably more than the shareholder would charge to a stranger for use of the same property, the excessive part of the rent may be treated as a distribution to the shareholder. For more information, see chapter 4 in Publication 535.
Unreasonable salaries. If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed by the shareholder-employee, the excessive part of the salary may be treated as a distribution to the shareholder-employee. For more information, see chapter 2 in Publication 535.
Reporting Dividends and Other Distributions
A corporate distribution to a shareholder is generally treated as a distribution of earnings and profits. Any part of a distribution from either current or accumulated earnings and profits is reported to the shareholder as a dividend. Any part of a distribution that is not from earnings and profits is applied against and reduces the adjusted basis of the stock in the hands of the shareholder. To the extent the balance is more than the adjusted basis of the stock, the shareholder has a gain (usually a capital gain) from the sale or exchange of property.
For information on shareholder reporting of corporate distributions, see Publication 550, Investment Income and Expenses.
Form 1099-DIV. File Form 1099-DIV with the IRS for each shareholder to whom you have paid dividends and other distributions on stock of $10 or more during a calendar year. You must generally send Forms 1099-DIV to the IRS with Form 1096 by February 28 (March 31 if filing electronically) of the year following the year of the distribution. For more information, see the general instructions for Forms 1099, 1098, 5498, and W-2G.
Generally, you must furnish Forms 1099-DIV to shareholders by January 31 of the year following the close of the calendar year during which the corporation made the distributions. However, you may furnish the Form 1099-DIV to shareholders after November 30 of the year of the distributions if the corporation has made its final distributions for the year. You may furnish the Form 1099-DIV to shareholders anytime after April 30 of the year of the distributions if you give the Form 1099-DIV with the final distributions for the calendar year.
Backup withholding. Dividends may be subject to backup withholding. For more information on backup withholding, see the general instructions for Forms 1099, 1098, 5498, and W-2G.
Form 5452. File Form 5452 if nondividend distributions were made to shareholders.
A calendar tax year corporation must file Form 5452 with its income tax return for the tax year in which the nondividend distributions were made. A fiscal tax year corporation must file Form 5452 with its income tax return due for the first fiscal year ending after the calendar year in which the nondividend distributions were made.
Current year earnings and profits. If a corporation's earnings and profits for the year (figured as of the close of the year without reduction for any distributions made during the year) are more than the total amount of distributions made during the year, all distributions made during the year are treated as distributions of current year earnings and profits. If the total amount of distributions is more than the earnings and profits for the year, see Accumulated earnings and profits, later.
Example. You are the only shareholder of a corporation that uses the calendar year as its tax year. In January, you use the worksheet in the Form 5452 instructions to figure your corporation's current year earnings and profits for the previous year. During the year, the corporation made four $1,000 distributions to you. At the end of the year (before subtracting distributions made during the year), the corporation had $10,000 of current year earnings and profits.
Since the corporation's current year earnings and profits ($10,000) were more than the amount of the distributions it made during the year ($4,000), all of the distributions are treated as distributions of current year earnings and profits.
The corporation must issue a Form 1099-DIV to you by the end of January to report the $4,000 distributed to you during the previous year as dividends. The corporation must use Form 1096 to report this information to the IRS by February 28 (March 31 if filing electronically). The corporation does not deduct these dividends on its income tax return.
Accumulated earnings and profits. If a corporation's current year earnings and profits (figured as of the close of the year without reduction for any distributions made during the year) are less than the total distributions made during the year, part or all of each distribution is treated as a distribution of accumulated earnings and profits. Accumulated earnings and profits are earnings and profits the corporation accumulated before the current year.
If the total amount of distributions is less than current year earnings and profits, see Current year earnings and profits, earlier.
Used with current year earnings and profits. If the corporation has current year earnings and profits, figure the use of accumulated and current earnings and profits as follows.
- Divide the current year earnings and profits by the total distributions made during the year.
- Multiply each distribution by the percentage figured in (1) to get the amount treated as a distribution of current year earnings and profits.
- Start with the first distribution and treat the part of each distribution greater than the allocated current year earnings and profits figured in (2) as a distribution of accumulated earnings and profits.
- If accumulated earnings and profits are reduced to zero, the remaining part of each distribution is applied against and reduces the adjusted basis of the stock in the hands of the shareholders. To the extent that the balance is more than the adjusted basis of the stock, it is treated as a gain from the sale or exchange of property.
Example. You are the only shareholder of a corporation that uses the calendar year as its tax year. In January, you use the worksheet in the Form 5452 instructions to figure your corporation's current year earnings and profits for the previous year. At the beginning of the year, the corporation's accumulated earnings and profits balance was $20,000. During the year, the corporation made four $4,000 distributions to you ($4,000 × 4 = $16,000). At the end of the year (before subtracting distributions made during the year), the corporation had $10,000 of current year earnings and profits.
Since the corporation's current year earnings and profits ($10,000) were less than the distributions it made during the year ($16,000), part of each distribution is treated as a distribution of accumulated earnings and profits. Treat the distributions as follows.
- Divide the current year earnings and profits ($10,000) by the total amount of distributions made during the year ($16,000). The result is .625.
- Multiply each $4,000 distribution by the .625 figured in (1) to get the amount ($2,500) of each distribution treated as a distribution of current year earnings and profits.
- The remaining $1,500 of each distribution is treated as a distribution from accumulated earnings and profits. The corporation distributed $6,000 ($1,500 × 4) of accumulated earnings and profits.
The remaining $14,000 ($20,000 - $6,000) of accumulated earnings and profits is available for use in the following year.
The corporation must issue a Form 1099-DIV to you by the end of January to report the $16,000 distributed to you during the previous year as dividends. The corporation must use Form 1096 to report this information to the IRS by February 28 (March 31 if filing electronically). The corporation does not deduct these dividends on its income tax return.
Used without current year earnings and profits. If the corporation has no current year earnings and profits, figure the use of accumulated earnings and profits as follows.
- If the current year earnings and profits balance is negative, prorate the negative balance to the date of each distribution made during the year.
- Figure the available accumulated earnings and profits balance on the date of each distribution by subtracting the prorated amount of current year earnings and profits from the accumulated balance.
- Treat each distribution as a distribution of these adjusted accumulated earnings and profits.
- If adjusted accumulated earnings and profits are reduced to zero, the remaining distributions are applied against and reduce the adjusted basis of the stock in the hands of the shareholders. To the extent that the balance is more than the adjusted basis of the stock, it is treated as a gain from the sale or exchange of property.
Example. You are the only shareholder of a corporation that uses the calendar year as its tax year. In January, you use the worksheet in the Form 5452 instructions to figure your corporation's current year earnings and profits for the previous year. At the beginning of the year, the corporation's accumulated earnings and profits balance was $20,000. During the year, the corporation made four $4,000 distributions to you on March 31, June 30, September 30, and December 31. At the end of the year (before subtracting distributions made during the year), the corporation had a negative $10,000 current year earnings and profits balance.
Since the corporation had no current year earnings and profits, all of the distributions are treated as distributions of accumulated earnings and profits. Treat the distributions as follows.
- Prorate the negative current year earnings and profits balance to the date of each distribution made during the year. The negative $10,000 can be spread evenly by prorating a negative $2,500 to each distribution.
- The following table shows how to figure the available accumulated earnings and profits balance on the date of each distribution.
| March 31 Distribution |
|
| Accumulated earnings and profits |
$20,000 |
| Prorated current year earnings and profits |
($2,500) |
| Accumulated earnings and profits available |
$17,500 |
| Amount of distribution treated as a dividend |
($4,000) |
| June 30 Distribution |
|
| Accumulated earnings and profits |
$13,500 |
| Prorated current year earnings and profits |
($2,500) |
| Accumulated earnings and profits available |
$11,000 |
| Amount of distribution treated as a dividend |
($4,000) |
| September 30 Distribution |
|
| Accumulated earnings and profits |
$7,000 |
| Prorated current year earnings and profits |
($2,500) |
| Accumulated earnings and profits available |
$4,500 |
| Amount of distribution treated as a dividend |
($4,000) |
| December 31 Distribution |
|
| Accumulated earnings and profits |
$500 |
| Prorated current year earnings and profits |
($2,500) |
| Accumulated earnings and profits available |
($2,000) |
| Amount of distribution treated as a dividend |
$0 |
| Nondividend amount (reduction of stock basis or gain from sale/exchange of property) |
$4,000 |
| Year-end accumulated earnings and profits |
($2,000) |
The corporation must issue a Form 1099-DIV to you by the end of January to report $12,000 of the $16,000 distributed to you during the previous year as dividends. The corporation must use Form 1096 to report this information to the IRS by February 28 (March 31 if filing electronically). The corporation does not deduct these dividends on its income tax return. However, the corporation must attach Form 5452 to this return to report the nondividend distribution.
For more information about earnings and profits, see the Worksheet for Figuring Current Year Earnings and Profits in the Form 5452 instructions.
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