The US Internal Revenue Service (IRS) has released guidance on the taxability of distributions from S corporations with no accumulated earnings and profits (AE&P). The guidance also addresses the items to consider to determine the taxability of non-dividend distributions, liquidating distributions, and sale-or-exchange redemption distributions.
S corporations are small business corporations that are generally treated as flow-through entities under the US Internal Revenue Code (IRC). They are required to be organized as US domestic corporations and are not permitted to have non-resident shareholders or shareholders who are not individuals. Under IRC section 1368, all distributions made by an S corporation without AE&P, and non-dividend distributions, are non-taxable up to the shareholder's stock basis. Distributions exceeding the shareholder's stock basis are taxed as gain from the sale or exchange of property (generally capital gain).
The IRS notes in its guidance that an S corporation will only have earnings and profits (E&P) if it was formerly a C corporation, i.e. a regular business corporation under the IRC, that converted to S status, or if the S corporation acquired assets from a C corporation in certain types of transactions.
The guidance is in the form of a Practice Unit, and was released on 19 August 2020. It bears a Document Control Number of SCO-T-007 and indicates a date of last update of 29 June 2020.
Practice Units are issued by the Large Business and International (LB&I) division of the IRS for the purpose of internal staff training. The document states that it is not an official pronouncement of law, and cannot be used, cited or relied upon as such.