Distributions definition
/What are Distributions?
A distribution involves the issuance of assets from a business or trust to an owner or beneficiary. This is usually done when a business is terminated, an owner retires, or there is a requirement to distribute assets. There are a number of ways to make distributions to the investors in "C" corporations and "S" corporations, as well as other entities, such as partnerships and trusts. The tax treatment of these distributions varies, as noted below.
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Distributions to "C" Corporation Shareholders
When a shareholder in a "C" corporation receives a distribution, the amount of the payment is first offset against the shareholder's basis in the stock. If the amount of the distribution is greater than the basis, then the shareholder must recognize a capital gain for the difference. Conversely, if the distribution relates to the liquidation of a "C" corporation and the amount of the distribution is less than the shareholder's basis, then the difference is a capital loss.
If the "C" corporation instead issues a dividend, the recipient recognizes it as ordinary income, because it is considered to come from the short-term earnings of the business. If a shareholder has chosen to enroll in a dividend reinvestment plan that offers a discount on the purchase of additional shares, then the shareholder must also recognize ordinary income in the amount of this discount.
If a "C" corporation issues a stock dividend to its investors, there is no tax event caused by the distribution, since the investors are not really receiving any income. However, there is a change in the tax basis of the stock, because the investors now own more shares. Accordingly, they must allocate their existing basis in the shares among all of their shares (including the new stock dividend) based on their fair market values on the issuance date of the stock dividend.
In the relatively common case where an investor sells shares in a business after the declaration date of a dividend but before it is paid, the investor must still consider the dividend taxable income, since the dividend check is still addressed to that investor.
Distributions to "S" Corporation Shareholders
When an "S" corporation makes a distribution to shareholders, the shareholders treat the distribution as a reduction of their basis in the stock. The amount by which any distribution exceeds this basis is considered a gain.
All earnings or losses generated by an "S" corporation are to be passed through to its investors. The investors then report these earnings or losses in proportion to their ownership interests in the entity. The share of this income also alters the basis of the investors in their ownership shares in the entity.
Distributions to Trust Shareholders
When a real estate investment trust or a mutual fund experiences capital gains, it can distribute these gains to investors, who then claim long-term capital gains taxes on these gains.
Distributions to Partnership Partners
When marketable securities are distributed to the partners in a partnership, the taxable income associated with this distribution is limited to the amount by which the market value of the securities exceeds their basis in the partnership. Their basis is derived from the amount of cash and other property they have contributed to the partnership.