A dividend is a distribution out of earnings and profits (E&P). § 316(a). But what exactly are E&P? The Code doesn’t define it. Instead, E&P is an economic concept that approximates a corporation’s ability to make distributions that are more than a return of capital. Estate of Uris v. Commissioner, 605 F.2d 1258 (1979).
A corporation has two E&P accounts: current E&P and accumulated E&P. Distributions are deemed to come first from current E&P, then from accumulated E&P. Reg. § 1.316‑2(a). Rev. Rul. 74‑164, 1974‑1 C.B. 74, illustrates how this works.
In Situation 1, X Corp had accumulated E&P of 50,000 for the first half, but current E&P for the whole year of
15,000 on July 1. The IRS held that the entire
5,000 from current E&P and $10,000 from accumulated E&P.
In Situation 2, Y Corp had a deficit in accumulated E&P and current E&P of only 15,000. Only $5,000 was a dividend; the rest reduced the shareholder’s stock basis and then was capital gain.
What’s the practical impact? If a corporation has low or negative E&P, distributions may be tax‑free (up to basis) or capital gain – not ordinary dividend income. But if it has high E&P, distributions are likely fully taxable as dividends. So understanding E&P is crucial for planning distributions.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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