Under Section 311, a corporation that distributes appreciated property to its shareholders must recognize gain at the corporate level and pay income tax on the gain as if the property was sold for fair market value. The shareholder must recognize the distribution as a dividend to the extent of the corporation’s accumulated earnings and profits (AE&P).
A recent case dealt with this issue. In 2004, a building contractor corporation deeded a home and lot to the shareholders. Neither the corporation nor the shareholders reported this transfer on their tax returns. The corporate and personal returns for 2004 were audited by the IRS. The shareholders’ tax was increased by $190,093 and were assessed an accuracy-related penalty of $27,192. The corporation was issued a notice of deficiency in the amount of $130,408 plus an accuracy-related penalty of $27,192.
In tax court, the taxpayers could not produce evidence to support their assertion that they built the home out-of-pocket. They asserted that only the vacant lot was purchased by the corporation. The court upheld the tax assessments and the notices of deficiency for the cor-poration and shareholders.