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Section 316(a), in turn, defines “dividend” as “any
distribution of property made by a corporation to its
shareholders--(1) out of its earning and profits accumulated
after February 28, 1913, or (2) out of its earnings and profits
of the taxable year”. In other words, a section 301 distribution
is taxed as a dividend, and therefore as ordinary income, to the
extent of the distributing corporation’s earnings and profits.
Only after such earnings and profits are exhausted may the
distribution be treated as a return of basis or capital gain.
Additionally, for purposes of applying the above test to a
section 304 redemption, section 304(b)(2) specifies that the
amount of the dividend shall be determined as if the property
were distributed first by the acquiring corporation to the extent
of its earnings and profits and then by the issuing corporation
to the extent of its earnings and profits.
As previously indicated, the cancellation of a liability is
considered the equivalent of a distribution of money in the face
amount of the obligation. See sec. 1.301-1(m), Income Tax Regs.
Yet on the record before us, petitioners, who bear the burden of
proof, have introduced no evidence to show that COST lacked
earnings and profits in at least the amount of the debt release
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