In the context of taxation, “distribution in excess of basis” refers to a situation where a shareholder receives a distribution from a corporation that exceeds their adjusted basis in the corporation’s stock. This scenario is closely entwined with concepts such as “basis,” “distribution,” “corporation,” and “shareholder.” Understanding the relationship between these entities is crucial for grasping the complexities of distribution in excess of basis and its implications for taxation.
Distributions in Excess of Basis: A Detailed Guide
Distributions in excess of basis occur when a shareholder receives more money from a company than they have invested in it. This can happen when the company has accumulated earnings and profits (E&P), and the shareholder’s basis is less than the amount of the distribution.
The tax treatment of distributions in excess of basis depends on whether the shareholder is a corporation or an individual.
Corporations
For corporations, distributions in excess of basis are generally treated as dividends. This means that the corporation will pay taxes on the distribution at the corporate tax rate, and the shareholder will pay taxes on the dividend income at their individual tax rate.
Individuals
For individuals, distributions in excess of basis are taxed as follows:
- Up to the amount of the shareholder’s basis: The distribution is treated as a return of capital and is not taxable.
- Between the amount of the shareholder’s basis and the amount of the E&P: The distribution is treated as a dividend and is taxed at the shareholder’s ordinary income tax rate.
- Above the amount of the E&P: The distribution is treated as capital gain and is taxed at the shareholder’s capital gains tax rate.
In some cases, it may be possible to avoid or reduce taxes on distributions in excess of basis by using a technique called a basis step-up. This involves increasing the shareholder’s basis in the company by contributing additional capital or by having the company issue additional stock.
Example
Here is an example of how distributions in excess of basis are taxed:
- A shareholder has a basis of $10,000 in a company.
- The company has E&P of $20,000.
- The shareholder receives a distribution of $25,000.
Tax Treatment:
- The first $10,000 of the distribution is treated as a return of capital and is not taxable.
- The next $10,000 of the distribution is treated as a dividend and is taxed at the shareholder’s ordinary income tax rate.
- The remaining $5,000 of the distribution is treated as capital gain and is taxed at the shareholder’s capital gains tax rate.
Table Summarizing Tax Treatment of Distributions in Excess of Basis
| Shareholder Type | Distribution Amount | Tax Treatment |
|---|---|---|
| Corporation | Any amount | Dividend |
| Individual | Up to basis | Return of capital |
| Individual | Between basis and E&P | Dividend |
| Individual | Above E&P | Capital gain |
Question 1:
What happens when the amount of a distribution exceeds the recipient’s adjusted basis in the entity making the distribution?
Answer:
The amount of the distribution in excess of the recipient’s adjusted basis is referred to as a “distribution in excess of basis.” This distribution results in the recipient recognizing gain to the extent of the excess amount. The gain is generally taxed at the recipient’s ordinary income tax rate.
Question 2:
What are the tax implications of a distribution in excess of basis in the hands of a corporate shareholder?
Answer:
For a corporate shareholder, a distribution in excess of basis is considered a dividend to the extent of the corporation’s current and accumulated earnings and profits. Any excess amount is treated as capital gain and taxed accordingly.
Question 3:
How does a distribution in excess of basis impact the basis of the recipient’s interest in the entity making the distribution?
Answer:
The amount of the distribution in excess of basis generally reduces the recipient’s adjusted basis in their interest in the entity making the distribution. However, there are certain exceptions to this rule, such as when the distribution is made from a corporation to a non-corporate shareholder.
There you have it, folks! Now you’ve got a clearer idea about what happens when you distribute more money than the basis in your S corporation. If you’re like most people, this probably isn’t something you have to worry about every day, but if you have an S corporation, it’s good to be aware of these rules. And if you have any more questions, don’t hesitate to reach out to a tax professional. As for me, I’m signing off for now. Thanks for reading, and I hope you’ll drop by again soon.