On January 1, 1955, Individual A owned all of the stock of Corporation M with an adjusted basis of $2,000. During the year A received distributions from Corporation M totaling $30,000 — $10,000 in cash plus listed securities with a fair market value of $20,000 on the date distributed. As of December 31, 1954, Corporation M had accumulated earnings and profits of $26,000 and had no earnings and profits and no deficit for the distribution year.
Section 301(c) tiers the $30,000 distribution. The first $26,000 is an ordinary dividend because it is made out of Corporation M’s earnings and profits. The next $4,000 is applied against the adjusted basis of A’s stock; $2,000 of that reduces the $2,000 stock basis to zero as a return of capital.
The remaining $2,000 exceeds A’s stock basis. Under Section 301(c)(3)(A) it is treated as gain from the sale or exchange of property, or — to the extent it comes out of increase in value accrued before March 1, 1913 — it may be exempt from tax under Section 301(c)(3)(B). Because the return-of-capital tier absorbs A’s entire basis, if A later sells the Corporation M stock the basis for determining gain or loss will be zero.
Section 301(c) splits a distribution into a dividend, then a return of capital, then gain — measured in that fixed order against E&P and stock basis.
The first $26,000 of the $30,000 distribution is an ordinary dividend because it is made out of Corporation M’s $26,000 of earnings and profits.
The next $2,000 is a nontaxable return of capital under Section 301(c)(2), reducing A’s $2,000 stock basis to zero.
The final $2,000 exceeds A’s basis and is treated as gain from the sale or exchange of property under Section 301(c)(3)(A), leaving A a zero basis in the stock.
