I need assistance solving the Research Mem-
To: Spartan Corporation’s Tax Director From: Katy Chowning, CPA Date: November 4th, 2017 Facts Spartan Corporation (“Spartan”) made the following cash distributions with respect to its stock during its 2016 tax year: June 1st - $1,000 (dividend distribution)1 July 1st - $2,000 (25% share redemption)2 August 31st - $4,000 (dividend distribution) Spartan’s accumulated earnings and profits (“E&P”) on January 1st, 2016 was $2,000, and current E&P for the 2016 tax year was $12,000.3 Question What is Spartan’s accumulated E&P at January 1st, 2017? Conclusion Spartan’s accumulated E&P at January 1st, 2017 is $7,625. Analysis When a corporation makes a distribution to a shareholder with respect to its stock, the portion of the distribution characterized as a dividend is includable in the gross income of the shareholder. IRC §316(a) defines a dividend as any corporate distribution that comes from either accumulated E&P or the E&P for the current taxable year. Therefore, Spartan must calculate its current and accumulated E&P to accurately determine the income character of any distributions made with respect to its stock. IRC §312(a) states in summary that a corporation should decrease its E&P by the amount of money it distributes with respect to its stock. Per Treas. Reg. §1.316-2(a), distributions are first considered to be made from current E&P. If applicable, distributions that exceed current E&P are made from accumulated E&P. Spartan calculated current E&P of $12,000 for 2016. The June 1st and August 31st distributions total $5,000. Therefore, the full amount of these distributions was made from current E&P. 1 Spartan has determined the June and August cash distributions qualify as dividend distributions pursuant to IRC §316(a). These distributions are also referred to as “ordinary distributions” in this memorandum. 2 Spartan has determined the share redemption represents a qualifying exchange under IRC §302(a). This distribution is also referred to as a “redemption distribution” in this memorandum. 3 Please be advised that Spartan’s E&P calculations were not independently verified by the tax adviser. The conclusions reached in this memorandum should only be considered in the context of the facts represented above. The decrease to E&P for distributions made in redemption of stock4 is limited to the ratable share of accumulated E&P that is attributable to the redeemed stock.5 Stated differently, the amount of Spartan’s E&P reduction related to the July 1st redemption transaction will be the lesser of $2,000 (the amount of cash distributed) or 25% of Spartan’s accumulated E&P as of July 1st (i.e. 25% of stock was redeemed, so E&P cannot be reduced by more than 25%). A revenue ruling6 was issued by the Internal Revenue Service (“IRS”) to address instances when both ordinary distributions and redemption distributions are made during the same taxable year. The IRS concluded that ordinary distributions take priority over redemption distributions subject to IRC §302(a). In adherence with the conclusions in this revenue ruling, Spartan must first reduce its current E&P by the $5,000 in ordinary distributions made during 2016. Spartan must then determine the proper amount of E&P reduction related to the redemption distribution. Rev. Rul. 74-338, 1974-2 CB 101 provides a relevant example for how to determine the ratable share of accumulated E&P attributable to redeemed stock. There are 3 general steps to follow, as demonstrated below: Step 1: Calculate the current E&P balance available for the redemption distribution (i.e. after considering reductions in E&P for all ordinary distributions). Current E&P for 20167 = $12,000 Ordinary Distributions = (5,000) Current E&P Available = $7,000 Step 2: Calculate the decrease in E&P related to the redemption distribution. Accumulated E&P 1/1/2016 = $2,000 Current E&P (Pro-rated thru 7/1/2016) = 3,500 ($7,000 from Step 1 x 6/12) Accumulated E&P 7/1/2016 = $5,500 Pro-rata portion for redemption = $1,375 ($5,500 x 25%) Step 3: Calculate the accumulated E&P available for future distributions. Accumulated E&P 1/1/2016 = $2,000 Current E&P for 2016 = 12,000 Ordinary Distributions = (5,000) Redemption Distribution = (1,375)8 Accumulated E&P 1/1/2017 = $7,625 4 IRC §302(a) or IRC §303 must apply to the redemption for §312(n)(7) to apply – Spartan has represented that the redemption was a qualifying exchange under IRC §302(a). This was not independently verified by the tax adviser but is assumed to be correct for purposes of the conclusions reached in the memo. 5 IRC §312(n)(7) 6 Rev. Rul. 74-339, 1974-2 CB 103 7 Excludes any reductions related to distributions. 8 Lesser of pro-rata portion or the amount of cash distributed (i.e. $1,375 < $2,000) 1/7 current internal revenue code sec. 168 - accelerated cost recovery system 168(k)special allowance for certain property.— 168(k)(1)additional allowance.— in the case of any qualified property— 168(k)(1)(a) the depreciation deduction provided by section 167(a) for the taxable year in which such property is placed in service shall include an allowance equal to the applicable percentage of the adjusted basis of the qualified property, and 168(k)(1)(b) the adjusted basis of the qualified property shall be reduced by the amount of such deduction before computing the amount otherwise allowable as a depreciation deduction under this chapter for such taxable year and any subsequent taxable year. 168(k)(2)qualified property.— for purposes of this subsection— 168(k)(2)(a)in general.— the term "qualified property" means property— 168(k)(2)(a)(i) 168(k)(2)(a)(i)(i) to which this section applies which has a recovery period of 20 years or less, 168(k)(2)(a)(ii) the original use of which begins with the taxpayer or the acquisition of which by the taxpayer meets the requirements of clause (ii) of subparagraph (e), and 168(k)(2)(a)(iii) which is placed in service by the taxpayer before january 1, 2027. 168(k)(2)(e)(ii)acquisition requirements.— an acquisition of property meets the requirements of this clause if— 168(k)(2)(e)(ii)(i) such property was not used by the taxpayer at any time prior to such acquisition, and 168(k)(2)(e)(ii)(ii) the acquisition of such property meets the requirements of paragraphs (2)(a), (2)(b), (2)(c), and (3) of section 179(d). javascript:void(0) 168(k)(6)applicable percentage.— for purposes of this subsection— 168(k)(6)(a)in general.— except as otherwise provided in this paragraph, the term "applicable percentage" means— 168(k)(6)(a)(i) in the case of property placed in service after september 27, 2017, and before january 1, 2023, 100 percent, 168(k) (6)(a)(ii) in the case of property placed in service after december 31, 2022, and before january 1, 2024, 80 percent, 168(k)(6)(a)(iii) in the case of property placed in service after december 31, 2023, and before january 1, 2025, 60 percent, 168(k)(6)(a)(iv) in the case of property placed in service after december 31, 2024, and before january 1, 2026, 40 percent, and 168(k)(6)(a)(v) in the case of property placed in service after december 31, 2025, and before january 1, 2027, 20 percent. current internal revenue code sec. 179 - election to expense certain depreciable business assets 179(d)(2)purchase defined.— for purposes of paragraph (1), the term “purchase” means any acquisition of property, but only if— 179(d)(2)(a) the property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b) (but, in applying section 267(b) and (c) for purposes of this section, paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants), 179(d)(2)(b) the property is not acquired by one component member of a controlled group from another component member of the same controlled group, and 179(d)(2)(c) the basis of the property in the hands of the person acquiring it is not determined— 179(d)(2)(c)(i) in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or 179(d)(2)(c)(ii) under section 1014(a) (relating to property acquired from a decedent). 179(d)(3)cost.— for purposes of this section, the cost of property does not include so much of the basis of such property as is determined by reference to the basis of other property held at any time by the person acquiring such property. javascript:void(0) javascript:void(0) javascript:void(0) javascript:void(0) javascript:void(0) javascript:void(0) current internal revenue code sec. 197 - amortization of goodwill and certain other intangibles 197(a)general rule.— a taxpayer shall be entitled to an amortization deduction with respect to any amortizable section 197 intangible. the amount of such deduction shall be determined by amortizing the adjusted basis (for purposes of determining gain) of such intangible ratably over the 15-year period beginning with the month in which such intangible was acquired. 197(c)amortizable section 197 intangible.— for purposes of this section— 197(c)(1)in general.— except as otherwise provided in this section, the term “amortizable section 197 intangible” means any section 197 intangible— 197(c)(1)(a) which is acquired by the taxpayer after the date of the enactment of this section, and 197(c)(1)(b) which is held in connection with the conduct of a trade or business or an activity described in section 212. 197(d) section 197 intangible.— for purposes of this section— 197(d)(1)in general.— except as otherwise provided in this section, the term “ section 197 intangible” means— 197(d)(1)(a) goodwill, 197(d)(1)(c) any of the following intangible items: 197(d)(1)(c)(i) workforce in place including its composition and terms and conditions (contractual or otherwise) of its employment, 197(d)(1)(c)(iii) any patent, copyright, formula, process, design, pattern, knowhow, format, or other similar item, 197(d)(1)(c)(v) any supplier-based intangible 197(d)(3)supplier-based intangible.— the term “supplier-based intangible” means any value resulting from future acquisitions of goods or services pursuant to relationships (contractual or otherwise) in the ordinary course of business with suppliers of goods or services to be used or sold by the taxpayer. javascript:void(0) javascript:void(0) federal tax regulations §1.197-2 - amortization of goodwill and certain other intangibles (a)overview (1)in general.— section 197 allows an amortization deduction for the capitalized costs of an amortizable section 197 intangible and prohibits any other depreciation or amortization with respect to that property. paragraphs (b), (c), and (e) of this section provide rules and definitions for determining whether property is a section 197 intangible, and paragraphs (d) and (e) of $2,000)="" 1/7="" current="" internal="" revenue="" code="" sec.="" 168="" -="" accelerated="" cost="" recovery="" system="" 168(k)special="" allowance="" for="" certain="" property.—="" 168(k)(1)additional="" allowance.—="" in="" the="" case="" of="" any="" qualified="" property—="" 168(k)(1)(a)="" the="" depreciation="" deduction="" provided="" by="" section="" 167(a)="" for="" the="" taxable="" year="" in="" which="" such="" property="" is="" placed="" in="" service="" shall="" include="" an="" allowance="" equal="" to="" the="" applicable="" percentage="" of="" the="" adjusted="" basis="" of="" the="" qualified="" property,="" and="" 168(k)(1)(b)="" the="" adjusted="" basis="" of="" the="" qualified="" property="" shall="" be="" reduced="" by="" the="" amount="" of="" such="" deduction="" before="" computing="" the="" amount="" otherwise="" allowable="" as="" a="" depreciation="" deduction="" under="" this="" chapter="" for="" such="" taxable="" year="" and="" any="" subsequent="" taxable="" year.="" 168(k)(2)qualified="" property.—="" for="" purposes="" of="" this="" subsection—="" 168(k)(2)(a)in="" general.—="" the="" term="" "qualified="" property"="" means="" property—="" 168(k)(2)(a)(i)="" 168(k)(2)(a)(i)(i)="" to="" which="" this="" section="" applies="" which="" has="" a="" recovery="" period="" of="" 20="" years="" or="" less,="" 168(k)(2)(a)(ii)="" the="" original="" use="" of="" which="" begins="" with="" the="" taxpayer="" or="" the="" acquisition="" of="" which="" by="" the="" taxpayer="" meets="" the="" requirements="" of="" clause="" (ii)="" of="" subparagraph="" (e),="" and="" 168(k)(2)(a)(iii)="" which="" is="" placed="" in="" service="" by="" the="" taxpayer="" before="" january="" 1,="" 2027.="" 168(k)(2)(e)(ii)acquisition="" requirements.—="" an="" acquisition="" of="" property="" meets="" the="" requirements="" of="" this="" clause="" if—="" 168(k)(2)(e)(ii)(i)="" such="" property="" was="" not="" used="" by="" the="" taxpayer="" at="" any="" time="" prior="" to="" such="" acquisition,="" and="" 168(k)(2)(e)(ii)(ii)="" the="" acquisition="" of="" such="" property="" meets="" the="" requirements="" of="" paragraphs="" (2)(a),="" (2)(b),="" (2)(c),="" and="" (3)="" of="" section="" 179(d).="" javascript:void(0)="" 168(k)(6)applicable="" percentage.—="" for="" purposes="" of="" this="" subsection—="" 168(k)(6)(a)in="" general.—="" except="" as="" otherwise="" provided="" in="" this="" paragraph,="" the="" term="" "applicable="" percentage"="" means—="" 168(k)(6)(a)(i)="" in="" the="" case="" of="" property="" placed="" in="" service="" after="" september="" 27,="" 2017,="" and="" before="" january="" 1,="" 2023,="" 100="" percent,="" 168(k)="" (6)(a)(ii)="" in="" the="" case="" of="" property="" placed="" in="" service="" after="" december="" 31,="" 2022,="" and="" before="" january="" 1,="" 2024,="" 80="" percent,="" 168(k)(6)(a)(iii)="" in="" the="" case="" of="" property="" placed="" in="" service="" after="" december="" 31,="" 2023,="" and="" before="" january="" 1,="" 2025,="" 60="" percent,="" 168(k)(6)(a)(iv)="" in="" the="" case="" of="" property="" placed="" in="" service="" after="" december="" 31,="" 2024,="" and="" before="" january="" 1,="" 2026,="" 40="" percent,="" and="" 168(k)(6)(a)(v)="" in="" the="" case="" of="" property="" placed="" in="" service="" after="" december="" 31,="" 2025,="" and="" before="" january="" 1,="" 2027,="" 20="" percent.="" current="" internal="" revenue="" code="" sec.="" 179="" -="" election="" to="" expense="" certain="" depreciable="" business="" assets="" 179(d)(2)purchase="" defined.—="" for="" purposes="" of="" paragraph="" (1),="" the="" term="" “purchase”="" means="" any="" acquisition="" of="" property,="" but="" only="" if—="" 179(d)(2)(a)="" the="" property="" is="" not="" acquired="" from="" a="" person="" whose="" relationship="" to="" the="" person="" acquiring="" it="" would="" result="" in="" the="" disallowance="" of="" losses="" under="" section="" 267="" or="" 707(b)="" (but,="" in="" applying="" section="" 267(b)="" and="" (c)="" for="" purposes="" of="" this="" section,="" paragraph="" (4)="" of="" section="" 267(c)="" shall="" be="" treated="" as="" providing="" that="" the="" family="" of="" an="" individual="" shall="" include="" only="" his="" spouse,="" ancestors,="" and="" lineal="" descendants),="" 179(d)(2)(b)="" the="" property="" is="" not="" acquired="" by="" one="" component="" member="" of="" a="" controlled="" group="" from="" another="" component="" member="" of="" the="" same="" controlled="" group,="" and="" 179(d)(2)(c)="" the="" basis="" of="" the="" property="" in="" the="" hands="" of="" the="" person="" acquiring="" it="" is="" not="" determined—="" 179(d)(2)(c)(i)="" in="" whole="" or="" in="" part="" by="" reference="" to="" the="" adjusted="" basis="" of="" such="" property="" in="" the="" hands="" of="" the="" person="" from="" whom="" acquired,="" or="" 179(d)(2)(c)(ii)="" under="" section="" 1014(a)="" (relating="" to="" property="" acquired="" from="" a="" decedent).="" 179(d)(3)cost.—="" for="" purposes="" of="" this="" section,="" the="" cost="" of="" property="" does="" not="" include="" so="" much="" of="" the="" basis="" of="" such="" property="" as="" is="" determined="" by="" reference="" to="" the="" basis="" of="" other="" property="" held="" at="" any="" time="" by="" the="" person="" acquiring="" such="" property.="" javascript:void(0)="" javascript:void(0)="" javascript:void(0)="" javascript:void(0)="" javascript:void(0)="" javascript:void(0)="" current="" internal="" revenue="" code="" sec.="" 197="" -="" amortization="" of="" goodwill="" and="" certain="" other="" intangibles="" 197(a)general="" rule.—="" a="" taxpayer="" shall="" be="" entitled="" to="" an="" amortization="" deduction="" with="" respect="" to="" any="" amortizable="" section="" 197="" intangible.="" the="" amount="" of="" such="" deduction="" shall="" be="" determined="" by="" amortizing="" the="" adjusted="" basis="" (for="" purposes="" of="" determining="" gain)="" of="" such="" intangible="" ratably="" over="" the="" 15-year="" period="" beginning="" with="" the="" month="" in="" which="" such="" intangible="" was="" acquired.="" 197(c)amortizable="" section="" 197="" intangible.—="" for="" purposes="" of="" this="" section—="" 197(c)(1)in="" general.—="" except="" as="" otherwise="" provided="" in="" this="" section,="" the="" term="" “amortizable="" section="" 197="" intangible”="" means="" any="" section="" 197="" intangible—="" 197(c)(1)(a)="" which="" is="" acquired="" by="" the="" taxpayer="" after="" the="" date="" of="" the="" enactment="" of="" this="" section,="" and="" 197(c)(1)(b)="" which="" is="" held="" in="" connection="" with="" the="" conduct="" of="" a="" trade="" or="" business="" or="" an="" activity="" described="" in="" section="" 212.="" 197(d)="" section="" 197="" intangible.—="" for="" purposes="" of="" this="" section—="" 197(d)(1)in="" general.—="" except="" as="" otherwise="" provided="" in="" this="" section,="" the="" term="" “="" section="" 197="" intangible”="" means—="" 197(d)(1)(a)="" goodwill,="" 197(d)(1)(c)="" any="" of="" the="" following="" intangible="" items:="" 197(d)(1)(c)(i)="" workforce="" in="" place="" including="" its="" composition="" and="" terms="" and="" conditions="" (contractual="" or="" otherwise)="" of="" its="" employment,="" 197(d)(1)(c)(iii)="" any="" patent,="" copyright,="" formula,="" process,="" design,="" pattern,="" knowhow,="" format,="" or="" other="" similar="" item,="" 197(d)(1)(c)(v)="" any="" supplier-based="" intangible="" 197(d)(3)supplier-based="" intangible.—="" the="" term="" “supplier-based="" intangible”="" means="" any="" value="" resulting="" from="" future="" acquisitions="" of="" goods="" or="" services="" pursuant="" to="" relationships="" (contractual="" or="" otherwise)="" in="" the="" ordinary="" course="" of="" business="" with="" suppliers="" of="" goods="" or="" services="" to="" be="" used="" or="" sold="" by="" the="" taxpayer.="" javascript:void(0)="" javascript:void(0)="" federal="" tax="" regulations="" §1.197-2="" -="" amortization="" of="" goodwill="" and="" certain="" other="" intangibles="" (a)overview="" (1)in="" general.—="" section="" 197="" allows="" an="" amortization="" deduction="" for="" the="" capitalized="" costs="" of="" an="" amortizable="" section="" 197="" intangible="" and="" prohibits="" any="" other="" depreciation="" or="" amortization="" with="" respect="" to="" that="" property.="" paragraphs="" (b),="" (c),="" and="" (e)="" of="" this="" section="" provide="" rules="" and="" definitions="" for="" determining="" whether="" property="" is="" a="" section="" 197="" intangible,="" and="" paragraphs="" (d)="" and="" (e)="">