Tax Characteristics and Dividends

Dollie Moore
South University Online

a) Silver distributes land to Heather. The land was held as an investment and has
a fair market value of $54,000 and an adjusted basis of $42,000.

A $12,000 gain is recognized on the land distribution that Heather received from Silver. This
gain increases Silver's E&P. Silver will have current E&P of $12,000 and accumulated E&P
of $76,000. These gains will be available to apply to the land distribution. The value of the
land is dividend to Heather, which leaves an accumulated E&P of $34,000 for a beginning
balance for next year ($88,000 total year end E&P - $54,000 distribution). The fair market
value of the land ($54,000) is Heather's basis.

b) Assume that Silver Corporation has no current or accumulated earnings and profits prior to
the distribution. How would your answer change?

The distribution generates a dividend of $12,000 to Heather (to the extent of the current
E&P). The remaining land value (adjusted basis) reduces Heather's stock basis to $14,000 and
is a tax free recovery of capital. Heather's land basis remains $54,000.

c) Assume that the land distributed to Heather is subject to a $46,000 mortgage (which
Heather assumes). How would your answer change?

Silver recognizes a $12,000 gain, which increases the current E&P by $12,000, which
resulted from the distribution of appreciated land.The amount deemed for distribution is
$8,000. Since there is a $12,000 current E&P and a $76,000 accumulated E&P, the $8,000
distribution is taxed as a dividend. The current E&P is decreased by the $8,000 distribution,
which leaves a $80,000 E&P for the following year beginning balance.

d) Assume that the land has a fair market value of $54,000 and an adjusted basis of $62,000
on the date of the distribution. How would your answer change?

Silver realizes a loss of $8,000, the loss is recognized on the distribution. Heather receives a
dividend of $54,000 and a $54,000 basis in the land. The accumulated E&P at the beginning
of the following year is $14,000 (greater of $62,000 adjusted basis or $54,000 FMV).
e) Instead of distributing land to Heather, assume that Silver decides to distribute equipment
used in its business. The equipment has a $14,000 market value, a $1,200 adjusted basis for
income tax purposes, and a $5,200 adjusted basis for earnings and profits purposes. When the
equipment was purchased four years ago, its original fair market value was $18,000.

Silver realizes a gain of $12,800 distribution for income tax purposes. Current E&P increased
to $8,800. Heather gets a $14,000 dividend and $14,000 basis in the furniture. E&P is reduced
$14,000, which leaves the accumulated E&P for the following year at $70,800.
Total year end E&P $88,000
Beginning balnce for next year $34,000
Accumulated E&P $76,000
Heather's basis $56,000
FMV $54,000
Adjusted basis $42,000

Gain $12,000

Dividend to Heather $12,000

Stock basis $14,000

Mortgage $46,000
Current E&P $12,000
Distribution $8,000
Beginning balance $80,000

Adjusted basis $62,000

Beginning balance $14,000

FMV $18,000
MV $14,000
Adjusted basis (E&P) $5,200
Adjusted basis (tax) $1,200

Distribution $12,800
Current E&P $8,800
Beginning balance $70,800
Part 2

a) How much better off would Kristen be if she were paid a dividend rather than salary?

If Kristen received a bonus, it would be $21,600 after tax. She would net $25,500 after tax if the
payment was a dividend. With a dividend, she would come out better by a gain of $3,900.

Under current law, dividends that meet certain requirements are subject to a 15 percent tax rate for
most individual taxpayers (a 20 percent rate applies to taxpayers in the 39.6 percent income tax bracket).
Dividends received by individuals in the 10 or 15 percent rate income tax brackets are exempt from tax
(i.e., a 0 percent rate applies) (Hoffman, 2017, p. 19-11).

b) How much better off would Egret Corporation be if it paid Kristen a salary rather than a dividend?

A $30,000 bonus gets Egret a deduction for the payment. This will reduce Egret's tax liability with a $
$19,800 net after tax cost of the bonus. However, Egret would not save any taxes if the pay a dividend,
this is because dividends payments are not tax deductible. The dividend cost $30,000. Egret would be
$10,200 better off if they pay the bonus.

c) If Egret Corporation pays Kristen a salary bonus of $40,000 instead of a $30,000 dividend, how
would your answers to above change?

If Kristen received a $40,000 bous from Egret, she would get an after tax bonus of $28,800 which is
better than getting $25,500 after tax from a $30,000 dividend. The cost Egret would incur for a $40,000
bonus would be $26,400 after tax, which is better than the nondeductible $30,000 dividend cost.

What should Kristen do?

Kristen should take the bonus since she and Egret are better off with the bonus than they are with the
dividend.

Reference

Hoffman, W. H. (2017). South-Western Federal Taxation 2017: Comprehensive,

40th Edition [VitalSource Bookshelf version]. Retrieved from:

 Bonus $30,000
Dividend $30,000
Tax rates Kristen 28%
Tax rates Egret 34%
15%
Bonus after tax $21,600
Dividend $25,500
Better off $3,900

Tax saving $10,200

After tax cost $19,800
Better off $10,200

Bonus $40,000
Dividend $30,000
After tax bonus $28,800
Egret bonus cost $26,400

d from: