Richard E. and Mary Ann Hurst - Page 9

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          related penalty under section 6662 of $107,622.80.  The Hursts              
          were Michigan residents when they filed their petition, and trial           
          was held in Detroit.                                                        
               Figuring out whether the Hursts or the Commissioner is right           
          requires some background vocabulary.  In tax law, a corporation’s           
          purchase of its own stock is called a “redemption.”  Sec. 317(b).           
          The Code treats some redemptions as sales under section 302, but            
          others as a payment of dividends to the extent the corporation              
          has retained earnings and profits, with any excess as a return of           
          the shareholder’s basis, and any excess over basis as a capital             
          gain.  Distributions characterized as dividends, return of basis,           
          or capital gains are commonly called “section 301 distributions,”           
          after the Code section that sets the general rules in this area.            
               The rules for redemptions and distributions from S corpora-            
          tions, which are found in section 1368 and its regulations, add a           
          layer of complexity, especially when the corporation has accumu-            
          lated earnings and profits (as both HMI and RHI did).  These                
          rules require computation of an “accumulated adjustments ac-                
          count,” an account which tracks the accumulation of previously              
          taxed, but undistributed, earnings of an S corporation.  Distri-            
          butions up to the amount of the accumulated adjustments account             
          are generally tax free to the extent they do not exceed a share-            

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Last modified: May 25, 2011