Corporate earnings & profits
(E&P) are not the same as taxable income. The amount
of corporate E&P determines taxation of corporate distributions to shareholders.
Taxable distributions of a C corporation come first from current E&P
and then from any accumulated E&P existing from prior years.
Corporate distributions in excess of E&P are
nontaxable to the corporate shareholder to the extent of the shareholder’s stock
basis. Corporate
distributions in excess of the shareholder’s stock basis are
taxable as a capital gain.
A corporation must file Form 5452,
Corporate Report of Nondividend Distributions, whenever nontaxable
distributions are made to corporate shareholders.
IRC §312 lists several transactions that
affect corporate E&P, but does not give a complete definition. In general,
corporate E&P may be described as the amount available to the corporation to pay
a dividend without depleting its capital. The effect on the corporate E&P
account can be determined by considering whether the transaction increases
or decreases the corporation’s ability to pay a dividend. Corporate E&P is
initially increased by the taxable income of a corporation.
—The following transactions ADD to the
amount of current Corporate Earnings & Profits.
• Tax-exempt income.
• Insurance policy proceeds on life of corporate officer.
• Deduction of excess charitable contribution in succeeding corporate taxable
year.
• Percentage depletion.
• Accelerated depreciation in excess of straight-line,
units-of-production, or machine-hours depreciation.
• Deferred gain on installment sale.
• Long-term contract reported on completed contract method.
• Intangible drilling costs deducted currently.
• Mine exploration and development costs deducted currently.
• Dividend-received deduction.
—The following transactions REDUCE the
amount of current Corporate Earnings & Profits.
• Corporate Federal income taxes.
• Loss on sale between related parties.
• Life insurance policy premiums on corporate officer.
• Excess charitable contribution (over 10% limit).
• Amortized intangible drilling costs deducted over 60 months.
• Amortized mine exploration and development costs deducted over 120
months.
• Expenses relating to tax-exempt income.
• Excess of capital losses over capital gains.
Corporations can set up their books to show
net income based on corporate E&P rather than tax return net income. This allows
the accumulation of corporate E&P (for purposes of determining how much is
available for dividend distributions) to be recorded in the corporate retained
earnings account on the corporation balance sheet. The difference between
"book" net income (corporate E&P), and "tax return" net
income is reconciled on Schedule M-1, Form 1120.
Taxable Effect Of Tax-Exempt Income
Although a C corporation does not pay tax
on corporate earnings from tax-exempt income such as municipal bond interest, the
income will increase corporate E&P. Thus, the amount of taxable dividends
available to distribute to the corporate shareholders is increased by tax-exempt
income. Likewise, nondeductible expenses such as penalties, fines, capital
losses in excess of capital gains, etc. reduce corporate E&P; thus reducing the
amount of taxable dividends available to distribute to corporate shareholders.
