Proportionate nonliquidating distribution

When a business operates as a partnership, the partners each report a percentage -- which is usually the same as their percentage of ownership -- of annual earnings on their personal returns.

The IRS issued revenue rulings 99-5 and 99-6 to address issues surrounding the conversion of a single-member LLC to a multiple-member LLC and the conversion of a multiple-member LLC to a single owner entity.Shareholders recognize a taxable dividend to the extent a distribution is paid out of corporate earnings and profits (E&P).If the distribution exceeds E&P, the excess reduces the shareholder's stock basis.Corporate shareholders may prefer that the distribution be treated as a dividend, allowing the corporation to take advantage of the special dividends-received deduction under Code § 243 (which allows the dividends to only be taxed once at the corporate level).On the other hand, individual shareholders often prefer that the distribution be treated as a redemption, for three reasons: A distribution qualifies as a stock redemption only if it significantly reduces the interest of the shareholder in the corporation.

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To the extent that a distribution is made from the corporation’s earnings and profits, it is taxed to the shareholder as a dividend.[1] The portion of the distribution that is not considered a dividend is applied first to reduce the shareholder’s basis in the corporation’s stock.[2] Any remaining portion is treated as gain from the sale or exchange of property (capital gain).[3] Important Note: If a shareholder assumes a liability or takes property subject to a liability, the amount of the distribution is reduced by the amount of the liability.[4] Special rules also apply at the corporate level.[5] Special rules apply to distributions to a shareholder in exchange for the shareholder’s stock (redemptions).

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