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The amount of the constructive dividend given by *
* * [a corporation] must be controlled by the
well-known rule that dividends cannot exceed retained
earnings and profits. In Hagaman, 958 F.2d at 694, we
stated that "[b]ecause dividends can only be
distributed to the extent of a corporation's earnings
and profits under IRC � 316, a court can only find a
constructive dividend to be taxable as ordinary income
to the extent of the corporation's earnings and
profits." Another opinion recognizes that
"[o]therwise, a distribution to the stockholder is
merely a recovery from his basis in his shares to the
extent that he has such a basis; to the extent that the
payments exceed the basis, the payments amount to a
[taxable capital] gain." Estate of DeNiro v.
Commissioner, 746 F.2d 327, 332 (6th Cir. 1984). * * *
See generally Action on Decision on Truesdell v. Commissioner,
supra, CC-1988-025 (Sept. 12, 1988), wherein the Commissioner
stated:
Funds diverted to the shareholder of a wholly owned
corporation should be regarded as constructive
distributions, unless the funds were additional salary
or otherwise were received in a nonshareholder
capacity. The funds should be included in the income
of the corporation and taxed to the shareholder in
accordance with I.R.C. section 301(c). When such funds
are received in a shareholder capacity, we will no
longer argue they are ordinary income regardless of
earnings and profits.
Here, we find that Nanny’s was incorporated in 1986 and that
it realized taxable income in 1986, 1987, 1988, and 1989 of
$2,436, $18,659, $31,529, and $48,006, respectively. We also
find that its retained earnings at the end of each of the first 3
respective years (before consideration of this report) were
$2,070, $18,077, and $32,306. Although a corporation’s retained
earnings are not always the same as its earnings and profits, we
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