Accounting 6073 Fall, 2011 Lesson 2B: Dividend Received Deduction, Controlled Groups and Related Issues I. Dividend Received Deduction and Related Problems A. In general-- 1. Dividend received deduction (70, 80, 100%) available a. Section 243—domestic corps. b. Section 244—public utilities c. Section 245—foreign corporations d. All subject to limitations of section 246. 2. 243(a) has most importance--reduces corporate tax rate on dividends from other corps to 10.5% (35%*.3). B. Dividends from Domestic Corps 1. Generally, 70% deduction on any dividend from a domestic corp. 2. If shareholder owns at least 20% of stock (by vote and value), rises to 80% deduction. 3. Purpose--mitigate multiple taxation of corporate earnings. C. Qualified Dividends of affiliated groups (80% vote and value) 1. 100% deduction for certain inter-corporate dividends received from members of same affiliated group 2. This applies whether or not consolidated return is filed 3. To qualify a. parent must file election to which all members consent b. dividend must be paid from E&P accumulated during time of affiliation D. Dividends on public utility preferred stock (Section 244)--more limited deduction because get deduction on some dividends paid. E. Dividends from certain foreign corps (Section 245)-- 1. Doing business in U.S.: thru complex formula, deduction for dividends received where earnings subject to US tax. 2. Doing business abroad: deemed paid FTC allows FTC on foreign taxes paid by 10% owned FCs. Covered under FTC code sections. F. Dividends paid to foreign corps--70 or 80% deduction is not available--subject to w/h tax, unless U.S. business situs. G. Definition and amount of dividend: 1. Dividend: distribution of property from corporation to its shareholder from current or accumulated E&P (IRC 316). 2. Amount of distribution: fair market value of prop or amount of cash received 3. To qualify for DRD, dividend must be included in GI of recipient 4. Non-dividend distributions: a. distributions in excess of E&P b. redemption proceeds that qualify for sale or exchange treatment c. liquidation proceeds (sale or exchange treatment) d. amounts received by shareholder in some other capacity (e.g. employee) H. Section 246--Limitation on dividend received deduction 1. Dividends from certain corps excluded--e.g. taxable under 501 2. Must limit deductions IAW formula when in NOL position (see p 5-50) 3. Must hold stock at least 45 days--holding period tolled if taxpayer reduces risk of loss thru hedge. 4. Deduction reduced by % of leveraged stock--unless a. Taxpayer owns at least 50% of the stock, b. Taxpayer is entitled to 100% DRD, or c. T owns at least 20% of corporation and 5 or fewer own at least 50% I. Section 1059: Basis reduction for “extraordinary” dividends 1. Problem: corporation buys stock for 100, dividend of 40 paid, takes DRD, sells stock for 60. 2. To combat, IRC 1059 imposes basis reduction 3. Basis is reduced by non-taxed portion of extraordinary dividend: a. exceeds 5% (preferred) or 10% of stock's basis unless b. held more than 2 years before "announcement date" 4. This rule N/A where a. consolidated return is filed, or b. stock held for all of dividend payer's existence. 5. See e.g. p. 5-54. III. Limitation on Multiple Tax Benefits for Members of Controlled Groups A. Introduction--without these rules, could obtain multiple tax benefit of lower rates by creating multiple corps (give e.g.) B. IRC 1561--component members of controlled group must divide certain benefits, as if they were one corporation. 1. Lower rate brackets 2. 250K AE tax exemption 3. $40K AMT exemption 4. Dollar value limit of various tax credits 5. Section 179 depreciation allowance 6. Various provisions re employee benefit plans (Benefits divided equally unless members agree to alternative apportionment plan). C. Controlled Group of Corporations defined--3 categories: 1. Parent/Subsidiary controlled group--one or more chains connected w/ common parent thru 80% vote/value. 2. Brother/Sister controlled group--two or more corps where 5 or fewer shareholders (individuals, estates, trusts) a. own at least 80% vote and value of each corporation and b. own more than 50% vote and value of each corporation, taking into account the stock ownership of each person only to the extent it is identical or overlapping in each corporation. c. Example—A, an individual owns 50% of the only class of stock of X Co, and 35% of the only class of Y Co. B, an individual owns 40% of X Co and 45% of Y Co. X and Y are a brother sister controlled group because: --A and B together own at least 80% of the vote and value of X and Y (together they own 90% of X and 80% of Y) and, --A and B together own more than least 50% of X and Y considering only their identical ownership. A’s identical ownership in X and Y is 35%. B’s identical ownership in those corporations is 40%. Thus, X Co. and Y Co. are a brother-sister controlled group because A’s and B’s identical ownership of those corporations totals more than 50% (75% in this case). d. See also B & E e.g. p. 13-17. 3. Combined group--three or more corps, a. each of which is a member of a parent sub group or a brother sister group and b. one of which is a common parent corporation. 4. Attribution rules provide that certain stock may be attributed to others p. 13-19. D. A bit of history: Prior to Section 1561, Section 269 said that if control of corporation is acquired for principle purpose of tax avoidance, may disallow allowances that would be unavailable without corporate form. However, it is easier for IRS to proceed under 1561, since it doesn't involve inquiry into intent of owners. E. Consolidated Returns 1. Affiliated groups may elect to file a consolidated return 2. Group would then be taxed on its consolidated income --intercompany transactions eliminated (including dividends) 3. The law is contained in lengthy regulations 4. Matching rules reflect single entity approach--e.g. affiliates must take offsetting items (e.g. interest income and interest expense) into account at the same time.
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