You previously learned that general utilities doctrine,
which was codified in 1954, allowed a corporation to distribute property
to shareholders without recognizing any gain.
A key reason for its repeal in 1986 however, was evidence that insurance
companies were redeeming large amounts of stock by distributing appreciated
securities while avoiding gain recognition at the corporate level.
Congress retorted by requiring corporate gain recognition
on distributions of appreciated property
in a redemption as if the property were sold at fair market value.
Partial liquidations, however,
continue to qualify for non-recognition at the corporate level.
In other words, there were still some elements of the General Utilities Doctrine
lurking in the code.
As you might expect,
clever tax creators were able to exploit the remaining non-recognition rules.
For example, they would transform a direct sales property by a corporation
into tax redistribution through a series of transactions.
After these schemes came to light Congress tightened the rule.
Specifically, when it comes to redemptions, Section 311B,
removes the non-recognition provisions.
And requires the corporation distributing property in redemption of stock,
including a partial liquidation, to recognize gains.
Losses, however, are not recognized on non-liquidating distributions of property.
Therefore, if a corporation wishes to distribute build in loss property,
it is better to first sell the property at a taxable transaction that allows loss
recognition and distributes the the proceeds to shareholders.
Note that the recognition of gains and non-recognition of loss occurs
regardless of whether the redemption is a qualifying redemption for the shareholder.
The effect of redemption on corporate E&P depends on the shareholder tax effects.
If the redemption is treated as a distribution or
dividend under Section 301,
the corporation adjust its E&P just as it would for non-liquidating distributions.
That is it reduces E&P by the amount of cash and
the principle amount of any obligations.
And by the greater of the adjusted basis or
fair market value of any property distributed.
Further, the corporation recognizes any gains and
correspondingly increases current E&P on the distribution of appreciated property.
And reduces current E&P by any taxes paid on that gain.
If the redeeming shareholder receives sale or exchange treatment under section
302(b), then the effective the redemption on corporate E&P is more complex.
In short, Section 312, and 7 provides that in a qualifying redemption.
The E&P of the distributing corporation is reduced by
an amount which does not exceed the ratable share
of the corporation's accumulated E&P attributable to the stock redeemed.
For purposes of this section,
accumulated E&P includes any current E&P available at the time of the redemption.