Corporation W is the sole (100%) shareholder of Corporation M, holding its stock with a basis of $2,000. Corporation M has accumulated earnings and profits of $26,000.
Corporation M makes a Section 301 distribution to Corporation W consisting of $10,000 in cash and securities with an adjusted basis to Corporation M of $15,000, for a total distribution of $25,000.
Under Section 301(c), a distribution is a dividend to the extent it is made out of the distributing corporation’s earnings and profits. Because the $25,000 distribution is less than Corporation M’s $26,000 of earnings and profits, the full $25,000 is treated as a dividend to Corporation W. None of the distribution reduces Corporation W’s stock basis or produces capital gain.
A Section 301 distribution is a dividend to the extent of the distributing corporation’s earnings and profits under Section 301(c)(1).
Because the $25,000 distribution is below Corporation M’s $26,000 of E&P, all $25,000 is a taxable dividend to Corporation W.
Since the distribution does not exceed E&P, none of it is a return of capital, so Corporation W’s $2,000 stock basis is unaffected and no capital gain results.
The distributed cash and securities are counted at value ($10,000 cash plus $15,000 of securities), not at the distributing corporation’s adjusted basis in the property.
