Code of Federal Regulations · Section
§ 1.1371-1 — -1 Distributions Of Money By An Eligible Terminated S Corporation
26 C.F.R. § 1.1371-1
(a) Scope and definitions—(1) Scope. This section provides rules relating to qualified distributions and distributions to which section 301 of the Internal Revenue Code (Code) applies during each taxable year of the ETSC period, including the taxable year in which the ETSC period ends. If an ETSC does not make any qualified distributions during a taxable year, then no distribution by the ETSC is governed by section 1371(f) of the Code or this section. Paragraph (a)(2) of this section contains definitions that apply for purposes of this section. Paragraph (b) of this section contains rules regarding the characterization of a qualified distribution. Paragraph (c) of this section contains rules regarding the characterization of any excess qualified distribution and non-qualified distribution during each taxable year of the ETSC period, including the taxable year in which the ETSC period ends. Paragraph (d) of this section contains examples illustrating the rules of this section. Paragraph (e) of this section contains the applicability date of this section.
(2) Definitions. The following definitions apply for purposes of this section—
(i) AAA. The term AAA means the accumulated adjustments account, within the meaning of section 1368(e)(1)(A) of the Code and § 1.1368-2(a)(1).
(ii) AAA ratio. Except as provided in this paragraph or paragraph (b)(3)(iv) of this section, the term AAA ratio means the fraction of which the numerator is historical AAA and the denominator is the sum of historical AAA and historical AE&P. Notwithstanding the preceding sentence, if the AE&P of the ETSC is less than or equal to zero as of the beginning of a taxable year, then the AAA ratio is one for such year and for all subsequent taxable years of the ETSC period.
(iii) AE&P. The term AE&P means earnings and profits described in section 316(a)(1) of the Code.
(iv) AE&P ratio. Except as provided in this paragraph or paragraph (b)(3)(iv) of this section, the term AE&P ratio means the fraction of which the numerator is historical AE&P, and the denominator is the sum of historical AAA and historical AE&P. Notwithstanding the preceding sentence, if the AE&P of the ETSC is less than or equal to zero as of the beginning of a taxable year, then the AE&P ratio is zero for such year and all subsequent taxable years of the ETSC period.
(v) CE&P. The term CE&P means earnings and profits that are described in section 316(a)(2).
(vi) ETSC. The term ETSC means an eligible terminated S corporation, within the meaning of section 481(d) of the Code and § 1.481-5.
(vii) ETSC period. In general, the term ETSC period means any taxable year, or portion thereof, of an ETSC beginning on the first day after the post-termination period within the meaning of section 1377(b)(1)(A) of the Code and ending on the date on which the ETSC's AAA balance is zero. Additionally, an ETSC does not have an ETSC period if the ETSC's AAA balance is not greater than zero at the end of its post-termination transition period. See § 1.1371-2 for rules governing the impact of a post-termination period, within the meaning of section 1377(b)(1)(B), on the ETSC period.
(viii) Excess qualified distribution. The term excess qualified distribution means the portion of a qualified distribution that is not characterized pursuant to paragraph (b)(2) or (3) of this section.
(ix) Historical AAA. The term historical AAA means the AAA of the ETSC as of the beginning of the day on which the revocation of an election under section 1362(a) of the Code is effective pursuant to section 1362(d)(1).
(x) Historical AE&P. The term historical AE&P means the AE&P of the ETSC as of the beginning of the day on which the revocation of an election under section 1362(a) is effective pursuant to section 1362(d)(1). For purposes of the preceding sentence, if the ETSC's historical AE&P is less than zero, then the historical AE&P is treated as zero.
(xi) Non-qualified distribution. The term non-qualified distribution means a distribution that is not a qualified distribution and to which section 301 applies.
(xii) Qualified distribution. The term qualified distribution means a distribution of money by an ETSC during the ETSC period to which, absent the application of section 1371(f) and this section, section 301 would apply. However, if paragraph (d)(2)(i) of this section applies to the ETSC, then a qualified distribution to a non-legacy shareholder is treated as a non-qualified distribution.
(b) Characterization of qualified distribution—(1) In general. Paragraph (b)(2) of this section provides rules regarding the determination of the amount of a qualified distribution that is sourced from AAA and the corollary effects of such a characterization. Paragraph (b)(3) of this section provides rules regarding the determination of the amount of a qualified distribution that is sourced from AE&P and the corollary effects of such a characterization. Paragraph (b)(4) of this section provides rules regarding the characterization of an excess qualified distribution as a separate qualified distribution. The rules in paragraphs (b)(2) through (4) of this section are applied before the application of paragraph (c) of this section.
(2) Distribution of AAA—(i) Amount. The portion of a qualified distribution that is sourced from an ETSC's AAA is equal to the lesser of:
(A) The product of the qualified distribution and the AAA ratio; and
(B) The ETSC's AAA immediately before the qualified distribution.
(ii) Reduction or elimination of ETSC's AAA. The ETSC's AAA is reduced by the amount of the distribution described in paragraph (b)(2)(i) of this section. If, with respect to a qualified distribution, the amount described in paragraph (b)(2)(i)(A) of this section equals or exceeds the amount described in paragraph (b)(2)(i)(B) of this section, then the rules in this paragraph (b) do not apply to any subsequent distributions by the ETSC. Instead, the subsequent distributions are treated in the manner provided in paragraph (c) of this section.
(iii) Effect on the shareholder. The amount described in paragraph (b)(2)(i) of this section is applied against and reduces the shareholder's adjusted basis of the shares of stock with respect to which the distribution is made under the principles of section 301(c)(2). If the application of the amount described in paragraph (b)(2)(i) of this section would result in a reduction of basis that exceeds the shareholder's adjusted basis of any share of stock with respect to which the distribution is made, such excess is treated as gain from the sale or exchange of property. The reduction of the shareholder's basis described in this paragraph with respect to a qualified distribution occurs prior to the application of paragraph (c) of this section to the excess qualified distribution, if any, with respect to such qualified distribution.
(3) Distribution of AE&P—(i) Amount. This paragraph (b)(3) applies if an ETSC's AE&P ratio is greater than zero. If this paragraph (b)(3) applies, the portion of a qualified distribution that is sourced from the ETSC's AE&P is equal to the lesser of:
(A) The product of the qualified distribution and the AE&P ratio; and
(B) The ETSC's AE&P immediately before the qualified distribution. For purposes of the preceding sentence, if the ETSC's AE&P immediately before the qualified distribution is less than zero, then the ETSC's AE&P is treated as zero.
(ii) Effect on ETSC's AE&P. The ETSC's AE&P is reduced, as described in section 312(a)(1), by the amount of the distribution described in paragraph (b)(3)(i) of this section. The AE&P reduction described in this paragraph occurs prior to the application of paragraph (c) of this section, even if a distribution to which paragraph (c) of this section applies (regarding excess qualified distributions and non-qualified distributions) occurs earlier in time than the qualified distribution to which this paragraph applies.
(iii) Effect on the shareholder. The amount of the qualified distribution that is sourced from the ETSC's AE&P described in paragraph (b)(3)(i) of this section is included in the gross income of the shareholder as a dividend under section 301(c)(1).
(iv) Adjustment to the AAA ratio and the AE&P ratio. After the application of paragraph (b)(3)(ii) of this section, if the ETSC's AE&P is zero and the ETSC's AAA is greater than zero, then the ETSC's AAA ratio is one and the ETSC's AE&P ratio is zero for all subsequent qualified distributions during:
(A) That taxable year; and
(B) All subsequent taxable years of the ETSC period.
(4) Excess qualified distribution treated as a separate qualified distribution—(i) In general. After the application of paragraph (b)(2)(ii) of this section with respect to a qualified distribution, if the ETSC has any remaining AAA, then any amount of excess qualified distribution, with respect to such qualified distribution, is treated as a separate qualified distribution and is analyzed pursuant to paragraph (b) of this section.
(ii) No change in characterization of previously characterized portion of qualified distribution. Paragraph (b)(4)(i) will not change the characterization of any portion of a qualified distribution that was previously characterized pursuant to paragraphs (b)(2) and (3) of this section and will reflect the application of paragraphs (b)(2) and (3) of this section to the portion of the qualified distribution previously characterized.
(c) Characterization of excess qualified distribution and non-qualified distributions. After the application of paragraph (b), the excess qualified distributions, if any, and non-qualified distributions, if any, are treated in the manner provided in sections 301(c) and 316.
(d) Examples. Paragraphs (d)(1) through (5) of this section (Examples 1 through 5) illustrate the rules of this section. For purposes of paragraphs (d)(1) through (5) of this section (Examples 1 through 5), X is a calendar year S corporation with a single share of stock outstanding. A, an individual, purchased its share of X stock prior to December 22, 2017, and, except as otherwise indicated, never contributed any amounts to X's capital. A remained the sole shareholder of X when X made a valid revocation on March 15, 2018, pursuant to section 1362(d)(1) and §§ 1.1362-2 and 1.1362-6, of its S election and when that revocation became effective on January 1, 2018. X qualified as an ETSC pursuant to § 1.481-5(b) and its ETSC period began on January 1, 2019. Additionally, X did not make any distributions during its post-termination transition period, within the meaning of section 1377(b)(1)(A). Furthermore, A remains the sole shareholder of X at the time of the distribution(s) described.
(1) Example 1: Historical AE&P is zero—(i) Facts. At the beginning of January 1, 2018, X had AAA of $100 and AE&P of $0. During 2018, X had $300 of CE&P and made no distributions. At the beginning of January 1, 2019, X has AAA of $100 and AE&P of $300, and A's adjusted basis in its share of X stock is $460. During 2019, the only distribution that X makes is a $60 distribution of money to A on December 27. X's CE&P during 2019 is $150, without diminution by reason of any distributions made during the taxable year.
(ii) Analysis—(A) Calculation of AAA ratio and AE&P ratio. Pursuant to paragraphs (a)(2)(ix) and (x) of this section, respectively, X's historical AAA and X's historical AE&P are determined as of the beginning of January 1, 2018, the beginning of the day on which the revocation of X's election under section 1362(a) is effective pursuant to section 1362(d)(1). Accordingly, X's historical AAA is $100 and X's historical AE&P is $0. Therefore, X's AAA ratio is 1 ($100/($100 + $0)), and X's AE&P ratio is zero ($0/($100 + $0)).
(B) Characterization of distribution. Pursuant to paragraph (a)(2)(xii) of this section, the $60 distribution on December 27, 2019, is a qualified distribution because it is a distribution of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section.
(C) Analysis of qualified distribution—(1) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the qualified distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($60 × 1, or $60), and X's AAA immediately before the qualified distribution ($100). Therefore, $60 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $60 to $40. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $60 to $400.
(2) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: The product of the qualified distribution and the AE&P ratio ($60 × 0, or $0), and X's AE&P immediately before the qualified distribution ($300). Therefore, $0 is sourced from AE&P.
(2) Example 2: Qualified distributions with both historical AAA and historical AE&P—(i) Facts. At the beginning of January 1, 2018, X had AAA of $200 and AE&P of $100. During 2018, X had $0 of CE&P and made no distributions. At the beginning of January 1, 2019, X has AAA of $200 and AE&P of $100, and A's adjusted basis in its share of X stock is $500. During 2019, X makes a $90 distribution of money on February 9 and a $150 distribution of money on June 5. X's CE&P during 2019 is $500, without diminution by reason of any distributions made during the taxable year.
(ii) Analysis—(A) Calculation of AAA ratio and AE&P ratio. Pursuant to paragraphs (a)(2)(ix) and (x) of this section, respectively, X's historical AAA and X's historical AE&P are determined as of the beginning of January 1, 2018, the beginning of the day on which the revocation of X's election under section 1362(a) is effective pursuant to section 1362(d)(1). Accordingly, X's historical AAA is $200 and X's historical AE&P is $100. Therefore, X's AAA ratio is 0.67 ($200/($200 + $100)), and X's AE&P ratio is 0.33 ($100/($200 + $100)).
(B) Characterization of distributions. Pursuant to paragraph (a)(2)(xii) of this section, the $90 distribution on February 9, 2019, and the $150 distribution on June 5, 2019, are both qualified distributions because they are distributions of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section.
(C) Analysis of qualified distributions—(1) February 9, 2019 distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the qualified distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($90 × 0.67, or $60), and X's AAA immediately before the qualified distribution ($200). Therefore, $60 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $60 to $140. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $60 to $440.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: the product of the qualified distribution and the AE&P ratio ($90 × 0.33, or $30), and X's AE&P immediately before the qualified distribution ($100). Therefore, $30 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $30 to $70. Pursuant to paragraph (b)(3)(iii) of this section, the $30 distribution is characterized as a dividend.
(2) June 5, 2019 distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the qualified distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($150 × 0.67, or $100), and X's AAA immediately before the qualified distribution ($140). Therefore, $100 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $100 to $40. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $100 to $340.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: The product of the qualified distribution and the AE&P ratio ($150 × 0.33, or $50), and X's AE&P immediately before the qualified distribution ($70). Therefore, $50 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $50 to $20. Pursuant to paragraph (b)(3)(iii) of this section, the $50 distribution is characterized as a dividend.
(3) Example 3: Limitation on amount characterized as AAA—(i) Facts. At the beginning of January 1, 2018, X had AAA of $100 and AE&P of $300. During 2018, X had $280 of CE&P and made no distributions. At the beginning of January 1, 2019, X has AAA of $100 and AE&P of $580, and A's adjusted basis in its share of X stock is $450. During 2019, the only distribution that X makes is a $500 distribution of money to A on October 5. X's CE&P during 2019 is $150, without diminution by reason of any distributions made during the taxable year.
(ii) Analysis—(A) Calculation of AAA ratio and AE&P ratio. Pursuant to paragraphs (a)(2)(ix) and (x) of this section, respectively, X's historical AAA and X's historical AE&P are determined as of the beginning of January 1, 2018, the beginning of the day on which the revocation of X's election under section 1362(a) is effective pursuant to section 1362(d)(1). Accordingly, X's historical AAA is $100 and X's historical AE&P is $300. Therefore, X's AAA ratio is 0.25 ($100/($100 + $300)), and X's AE&P ratio is 0.75 ($300/($100 + $300)).
(B) Characterization of distribution. Pursuant to paragraph (a)(2)(xii) of this section, the $500 distribution on October 5, 2019, is a qualified distribution because it is a distribution of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section.
(C) Analysis of qualified distribution—(1) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the qualified distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($500 × 0.25, or $125), and X's AAA immediately before the qualified distribution ($100). Therefore, $100 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $100 to $0. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $100 to $350.
(2) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: the product of the qualified distribution and the AE&P ratio ($500 × 0.75, or $375), and X's AE&P immediately before the qualified distribution ($580). Therefore, $375 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $375 to $205. Pursuant to paragraph (b)(3)(iii) of this section, the $375 distribution is characterized as a dividend.
(D) Effect of qualified distribution on ETSC period. Pursuant to paragraph (a)(2)(vii) of this section, X's ETSC period ends because X's AAA balance is zero following the October 5, 2019 distribution.
(E) Analysis of excess qualified distribution—(1) Amount of excess qualified distribution. Pursuant to paragraph (a)(2)(viii) of this section, the amount of the excess qualified distribution is $25, the portion of the qualified distribution ($500) not characterized pursuant to paragraph (b)(2) or (3) of this section ($100 AAA distribution + $375 AE&P distribution).
(2) Characterization of excess qualified distribution. Paragraph (b)(4) of this section does not apply to the excess qualified distribution because X's AAA balance is zero after the application of paragraph (b)(2)(ii) of this section (see paragraph (d)(3)(ii)(C)(1) of this section). Pursuant to paragraph (c) of this section, section 301(c) applies to the excess qualified distribution. Pursuant to sections 301(c)(1) and 316, the $25 excess qualified distribution is sourced from CE&P.
(iii) Subsequent contribution. The facts are the same as paragraph (d)(3)(i) of this section, except that at the time of the October 5, 2019 distribution, A's adjusted basis in its X stock is $90. Further, on December 27, 2019, A contributes $100 to X in a transaction described in section 351(a). The analysis in paragraph (d)(3)(ii) of this section remains the same, except that, unlike the second to last sentence of paragraph (d)(3)(ii)(C)(1) of this section, A's basis in its X stock is reduced by $90 to $0 and pursuant to paragraph (b)(2)(iii) of this section, $10 is treated as gain from the sale or exchange of property. Additionally, as a result of the December 27, 2019 contribution of $100, A's basis in its X stock is increased by $100, so that at the end of 2019, A's basis in its X stock is $100.
(4) Example 4: Limitation on the amount characterized as AE&P—(i) Facts. At the beginning of January 1, 2018, X had AAA of $100 and AE&P of $100. During 2018, X had CE&P of $(75) and made no distributions. At the beginning of January 1, 2019, X has AAA of $100 and AE&P of $25, and A's adjusted basis in its share of X stock is $500. During 2019, the only distributions that X makes are a $100 distribution of money to A on July 9 and a $40 distribution of money to A on September 27. X's CE&P during 2019 is $20, without diminution by reason of any distributions made during the taxable year.
(ii) Analysis—(A) Calculation of AAA ratio and AE&P ratio. Pursuant to paragraphs (a)(2)(ix) and (x) of this section, respectively, X's historical AAA and X's historical AE&P are determined as of the beginning of January 1, 2018, the beginning of the day on which the revocation of X's election under section 1362(a) is effective pursuant to section 1362(d)(1). Accordingly, X's historical AAA is $100 and X's historical AE&P is $100. Therefore, X's AAA ratio is 0.5 ($100/($100 + $100)), and X's AE&P ratio is 0.5 ($100/($100 + $100)).
(B) Analysis of July 9, 2019 distribution—(1) Characterization of distribution. Pursuant to paragraph (a)(2)(xii) of this section, the $100 distribution on July 9, 2019, is a qualified distribution because it is a distribution of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section.
(2) Analysis of qualified distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($100 × 0.5, or $50), and X's AAA immediately before the qualified distribution ($100). Therefore, $50 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $50 to $50. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $50 to $450.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: The product of the qualified distribution and the AE&P ratio ($100 × 0.5, or $50), and X's AE&P immediately before the qualified distribution ($25). Therefore, $25 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $25 to $0. Pursuant to paragraph (b)(3)(iii) of this section, $25 of the distribution is characterized as a dividend.
(3) Recalculation of AAA and AE&P ratios. Pursuant to paragraph (b)(3)(iv) of this section, because the July 9, 2019 distribution caused X's AE&P to be reduced to zero, the AAA ratio is one and the AE&P ratio is zero for all subsequent qualified distributions during the 2019 taxable year and subsequent taxable years of the ETSC period.
(4) Excess qualified distribution—(i) Amount of excess qualified distribution. Pursuant to paragraph (a)(2)(viii) of this section, the amount of the excess qualified distribution is $25, the amount of the qualified distribution ($100) not characterized pursuant to paragraph (b)(2) or (3) of this section ($50 AAA distribution + $25 AE&P distribution).
(ii) Characterization of excess qualified distribution as a separate qualified distribution. Pursuant to paragraph (b)(4) of this section, because X has AAA remaining after characterizing the qualified distribution (see paragraph (d)(4)(ii)(B)(2)(i) of this section), the $25 excess qualified distribution is treated as a separate qualified distribution and is analyzed pursuant to paragraph (b) of this section.
(iii) Analysis of excess qualified distribution that is treated as a separate qualified distribution. Pursuant to paragraph (b)(2)(i) of this section, the portion of the distribution that is sourced from AAA is equal to the lesser of: The product of the excess qualified distribution and the AAA ratio ($25 × 1, or $25), and X's AAA immediately before the excess qualified distribution ($50). Therefore, $25 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $25 to $25. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $25 to $425. Pursuant to paragraph (b)(3)(i) of this section, because X's AE&P ratio is zero, paragraph (b)(3) of this section does not apply.
(C) Analysis of September 27, 2019 distribution—(1) Characterization of the distribution. Pursuant to paragraph (a)(2)(xii) of this section, the $40 distribution on September 27, 2019, is a qualified distribution because it is a distribution of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section.
(2) Analysis of qualified distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($40 × 1, or $40), and X's AAA immediately before the qualified distribution ($25) (see paragraph (d)(4)(ii)(B)(4)(iii) of this section). Therefore, $25 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $25 to $0. Pursuant to paragraph (b)(2)(iii) of this section, A's basis in its X stock is reduced by $25 to $400.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, because X's AE&P ratio is zero, paragraph (b)(3) of this section does not apply.
(3) Excess qualified distribution—(i) Amount of excess qualified distribution. Pursuant to paragraph (a)(2)(viii) of this section, the amount of the excess qualified distribution is $15, the portion of the qualified distribution ($40) not characterized pursuant to paragraph (b)(2) or (3) of this section ($25 AAA distribution + $0 AE&P distribution).
(ii) Excess qualified distribution not characterized as a separate qualified distribution. Pursuant to paragraph (b)(4) of this section, because X has AAA of $0 after characterizing the qualified distribution (see paragraph (d)(4)(ii)(C)(2)(i) of this section), the $15 excess qualified distribution is not treated as a separate qualified distribution.
(iii) Analysis of excess qualified distribution that is not treated as a separate qualified distribution. Pursuant to paragraph (c) of this section, section 301(c) applies to the excess qualified distribution. Pursuant to sections 301(c)(1) and 316, the $15 excess qualified distribution is sourced from CE&P.
(5) Example 5: Distributions include non-qualified distributions—(i) Facts. At the beginning of January 1, 2018, X had AAA of $100 and AE&P of $100. During 2018, X had $0 of CE&P and made no distributions. At the beginning of January 1, 2019, X has AAA of $100 and AE&P of $100, and A's adjusted basis in its X stock is $200. During 2019, X makes a $100 distribution of money on June 14; a $300 distribution of property on November 9; and a $200 distribution of money on December 18. X's CE&P during 2019 is $160, without diminution by reason of any distributions made during the taxable year.
(ii) Analysis—(A) Calculation of AAA ratio and AE&P ratio. Pursuant to paragraphs (a)(2)(ix) and (x) of this section, respectively, X's historical AAA is $100 and X's historical AE&P is $100. Therefore, X's AAA ratio is 0.5 ($100/($100 + $100)), and X's AE&P ratio is 0.5 ($100/($100 + $100)).
(B) Characterization of distributions. Pursuant to paragraph (a)(2)(xii) of this section, the $100 distribution on June 14, 2019, and the $200 distribution on December 18, 2019, are both qualified distributions because they are distributions of money by an ETSC during the ETSC period to which section 301 would apply absent the application of section 1371(f) and this section. Pursuant to paragraph (a)(2)(xi) of this section, the $300 distribution of property on November 9, 2019, is a non-qualified distribution. Pursuant to paragraph (b)(1) of this section, the rules of paragraph (b)(2) through (b)(4) of this section apply to the qualified distributions before the rules of paragraph (c) of this section apply to the non-qualified distribution and any excess qualified distributions.
(C) Analysis of qualified distributions—(1) June 14, 2019 distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($100 × 0.5, or $50), and X's AAA immediately before the qualified distribution ($100). Therefore, $50 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $50 to $50. Pursuant to paragraph (b)(2)(iii) of this section, on June 14, 2019, A's basis in its X stock is reduced by $50 to $150.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: The product of the qualified distribution and the AE&P ratio ($100 × 0.5, or $50), and X's AE&P immediately before the qualified distribution ($100). Therefore, $50 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $50 to $50. Pursuant to paragraph (b)(3)(iii) of this section, the $50 distribution is characterized as a dividend.
(iii) Amount of excess qualified distribution. The amount of the excess qualified distribution is $0, the amount of the qualified distribution ($100) not characterized pursuant to paragraph (b)(2) or (3) of this section ($50 AAA distribution + $50 AE&P distribution).
(2) December 18, 2019 distribution—(i) Distribution of AAA. Pursuant to paragraph (b)(2)(i) of this section, the portion of the distribution that is sourced from AAA is equal to the lesser of: The product of the qualified distribution and the AAA ratio ($200 × 0.5, or $100), and X's AAA immediately before the qualified distribution ($50). Therefore, $50 is sourced from AAA. Pursuant to paragraph (b)(2)(ii) of this section, after the distribution, X's AAA is reduced by $50 to $0. Pursuant to paragraph (b)(2)(iii) of this section, A must determine its basis as of December 18, 2019, in order to determine the consequences of receiving the $50 AAA distribution. Because the non-qualified distribution on November 9, 2019, which precedes the December 18, 2019 qualified distribution, could have the effect of reducing A's basis, any effect on A's basis from that non-qualified distribution must be analyzed prior to determining the effect of the December 18, 2019 distribution of AAA on A's basis. See paragraphs (d)(5)(ii)(D)(3) and (4) of this section. Pursuant to paragraph (a)(2)(vii) of this section, X's ETSC period ends because X's AAA balance is zero following the December 18, 2019 distribution.
(ii) Distribution of AE&P. Pursuant to paragraph (b)(3)(i) of this section, the portion of the distribution that is sourced from AE&P is equal to the lesser of: The product of the qualified distribution and the AE&P ratio ($200 × 0.5, or $100), and X's AE&P immediately before the qualified distribution ($50). Therefore, $50 is sourced from AE&P. Pursuant to paragraph (b)(3)(ii) of this section, after the distribution, X's AE&P is reduced by $50 to $0. Pursuant to paragraph (b)(3)(iii) of this section, the $50 distribution is characterized as a dividend.
(iii) Amount of excess qualified distribution. The amount of the excess qualified distribution is $100, the amount of the qualified distribution ($200) not characterized pursuant to paragraph (b)(2) or (3) of this section ($50 AAA distribution + $50 AE&P distribution).
(D) Analysis of non-qualified and excess qualified distributions—(1) In general. The $300 non-qualified distribution on November 9, 2019, and the $100 excess qualified distribution on December 18, 2019, are treated in the manner provided in section 301(c).
(2) Allocation of CE&P. Pursuant to section 316 and § 1.316-2, X's CE&P is allocated proportionately among the excess qualified and the non-qualified distributions. Therefore, the portion of X's CE&P that is allocated to the November 9, 2019 distribution and the December 18, 2019 distribution is $120 ($160 CE&P × ($300 distribution/$400 total excess qualified and non-qualified distributions during 2019) and $40 ($160 CE&P × ($100 distribution/$400 total excess qualified and non-qualified distributions during 2019), respectively.
(3) November 9, 2019 distribution. Pursuant to paragraph (d)(5)(ii)(D)(2) of this section, $120 of the $300 distribution is characterized as a distribution of CE&P. Pursuant to paragraph (d)(5)(ii)(C)(2)(ii) of this section, the amount of X's AE&P available to allocate the November 9, 2019 distribution is $0. Therefore, the remaining $180 is characterized pursuant to section 301(c)(2) and (3). Pursuant to paragraph (d)(5)(ii)(C)(1)(i) of this section, A's basis in its X stock prior to the November 9, 2019 distribution is $150. Therefore, $150 is applied against basis pursuant to section 301(c)(2) (reducing A's basis to $0) and $30 is treated as gain from the sale or exchange of property pursuant to section 301(c)(3).
(4) December 18, 2019 distribution—(i) Consequences of AAA distribution. As of December 18, 2019, A's basis in its X stock is $0. See paragraph (d)(5)(ii)(D)(3) of this section. Pursuant to paragraph (d)(5)(ii)(C)(2)(i) of this section, $50 of the distribution is characterized as a distribution of AAA. Because the amount of the distribution of AAA ($50) exceeds A's basis in its X stock ($0), pursuant to paragraph (b)(2)(iii) of this section, on December 18, 2019, $50 is treated as gain from the sale or exchange of property.
(ii) Characterization of excess qualified distribution. Pursuant to paragraph (d)(5)(ii)(C)(2)(iii) of this section, $100 of the December 18, 2019 distribution is an excess qualified distribution. Paragraph (b)(4) of this section does not apply to the excess qualified distribution because X's AAA balance is zero after the application of paragraph (b)(2)(ii) of this section (see paragraph (d)(5)(ii)(C)(2)(i) of this section. Pursuant to paragraph (c) of this section, section 301(c) applies to the excess qualified distribution. Pursuant to paragraph (d)(5)(ii)(D)(2) of this section, $40 of the $100 excess qualified distribution is characterized as a distribution of CE&P. Pursuant to paragraph (d)(5)(ii)(D)(3) of this section, X's AE&P as the time of the December 18, 2019 distribution is $0. Therefore, the remaining $60 is characterized pursuant to section 301(c)(2) and (3). Pursuant to paragraph (d)(5)(ii)(D)(4)(i) of this section, A's basis in its X stock prior to characterization of the excess qualified distribution is $0. Therefore, $60 is treated as gain from the sale or exchange of property pursuant to section 301(c)(3).
(e) Applicability date. This section applies to taxable years beginning after October 20, 2020. However, a corporation may choose to apply the rules in §§ 1.481-5, 1.1371-1, and 1.1371-2 in their entirety to taxable years beginning on or before October 20, 2020. If a corporation makes the choice described in the previous sentence, all shareholders of the corporation must report consistently, and the corporation must continue to apply the rules in §§ 1.481-5, 1.1371-1, and 1.1371-2 in their entirety for the corporation's subsequent taxable years.
Authorizing Statute
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Rules and regulations26 U.S.C. § 7805
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Advanced manufacturing production credit26 U.S.C. § 45X
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Alcohol, etc., used as fuel26 U.S.C. § 40
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Gross income defined26 U.S.C. § 61
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Transfers of excess pension assets to retiree health accounts26 U.S.C. § 420
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Partial exclusion for gain from certain small business stock26 U.S.C. § 1202
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Tax treatment of stripped bonds26 U.S.C. § 1286
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Current taxation of income from qualified electing funds26 U.S.C. § 1293
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Imposition of tax on certain foreign procurement26 U.S.C. § 5000C
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Returns regarding payments of interest26 U.S.C. § 6049
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Signing of returns and other documents26 U.S.C. § 6061
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General requirement of return, statement, or list26 U.S.C. § 6011
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Income from discharge of indebtedness26 U.S.C. § 108
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Indian general welfare benefits26 U.S.C. § 139E
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Bonds must be registered to be tax exempt; other requirements26 U.S.C. § 149
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Trade or business expenses26 U.S.C. § 162
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Accelerated cost recovery system26 U.S.C. § 168
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Amortizable bond premium26 U.S.C. § 171
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Golden parachute payments26 U.S.C. § 280G
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Distributions of stock and stock rights26 U.S.C. § 305
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Transfer to corporation controlled by transferor26 U.S.C. § 351
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Special rules for long-term contracts26 U.S.C. § 460
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Determination of basis of partner’s interest26 U.S.C. § 705
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Taxes of foreign countries and of possessions of United States26 U.S.C. § 901
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Controlled foreign corporations; United States persons26 U.S.C. § 957
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New energy efficient home credit26 U.S.C. § 45L
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2-percent floor on miscellaneous itemized deductions26 U.S.C. § 67
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Certain death benefits26 U.S.C. § 101
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Qualified business income26 U.S.C. § 199A
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Installment method26 U.S.C. § 453
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Certain payments for the use of property or services26 U.S.C. § 467
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Partners, not partnership, subject to tax26 U.S.C. § 701
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Extent of recognition of gain or loss on distribution26 U.S.C. § 731
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Capitalization of certain policy acquisition expenses26 U.S.C. § 848
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Special rules for determining source26 U.S.C. § 863
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Income of foreign governments and of international organizations26 U.S.C. § 892
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Definitions and special rules26 U.S.C. § 6241
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Computation and payment of tax26 U.S.C. § 1503
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Adjusted gross income defined26 U.S.C. § 62
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Treatment of loans with below-market interest rates26 U.S.C. § 7872
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Basis to distributees26 U.S.C. § 358
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Minimum participation standards26 U.S.C. § 410
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Other definitions and special rules26 U.S.C. § 860G
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Adjustments required by changes in method of accounting26 U.S.C. § 481
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Definitions26 U.S.C. § 7701
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Insurance income26 U.S.C. § 953
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Returns relating to actions affecting basis of specified securities26 U.S.C. § 6045B
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Information relating to certain trusts and annuity plans26 U.S.C. § 6047
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Enhanced oil recovery credit26 U.S.C. § 43
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Energy efficient commercial buildings deduction26 U.S.C. § 179D
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Redemption through use of related corporations26 U.S.C. § 304
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Certain stock purchases treated as asset acquisitions26 U.S.C. § 338
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Special limitations on certain excess credits, etc.26 U.S.C. § 383
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Optional treatment of elective deferrals as Roth contributions26 U.S.C. § 402A
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General rule for taxable year of inclusion26 U.S.C. § 451
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Qualified ABLE programs26 U.S.C. § 529A
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Charitable remainder trusts26 U.S.C. § 664
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Nonrecognition of gain or loss on contribution26 U.S.C. § 721
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Investment of earnings in United States property26 U.S.C. § 956
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Definitions and special rule26 U.S.C. § 1377
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Relief from joint and several liability on joint return26 U.S.C. § 6015
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Return of S corporation26 U.S.C. § 6037
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Notice of certain transfers to foreign persons26 U.S.C. § 6038B
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Information at source26 U.S.C. § 6041
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Imposition of accuracy-related penalty on underpayments26 U.S.C. § 6662
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Tax imposed26 U.S.C. § 1
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Railroad track maintenance credit26 U.S.C. § 45G
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Zero-emission nuclear power production credit26 U.S.C. § 45U
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Rehabilitation credit26 U.S.C. § 47
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Clean electricity investment credit26 U.S.C. § 48E
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Special rules26 U.S.C. § 52
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Election to expense certain depreciable business assets26 U.S.C. § 179
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Individual retirement accounts26 U.S.C. § 408
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Special rules for nondealers26 U.S.C. § 453A
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Deductions limited to amount at risk26 U.S.C. § 465
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Exemption from tax on corporations, certain trusts, etc.26 U.S.C. § 501
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Definition of regulated investment company26 U.S.C. § 851
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Source rules for personal property sales26 U.S.C. § 865
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Tax on nonresident alien individuals26 U.S.C. § 871
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Foreign base company income26 U.S.C. § 954
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S corporation defined26 U.S.C. § 1361
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Definitions26 U.S.C. § 1402
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Distributions of property26 U.S.C. § 301
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Life insurance contract defined26 U.S.C. § 7702
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Previously-owned clean vehicles26 U.S.C. § 25E
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Electricity produced from certain renewable resources, etc.26 U.S.C. § 45
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Clean fuel production credit26 U.S.C. § 45Z
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Taxation of employee annuities26 U.S.C. § 403
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Last-in, first-out inventories26 U.S.C. § 472
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Allocation of income and deductions among taxpayers26 U.S.C. § 482
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Definitions applicable to subparts A, B, C, and D26 U.S.C. § 643
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Taxable years of partner and partnership26 U.S.C. § 706
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Disposition of investment in United States real property26 U.S.C. § 897
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Administrative adjustment request by partnership26 U.S.C. § 6227
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Citizens or residents of the United States living abroad26 U.S.C. § 911
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Residence and source rules involving possessions26 U.S.C. § 937
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Rules relating to expatriated entities and their foreign parents26 U.S.C. § 7874
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Regulations26 U.S.C. § 1502
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Capitalization and inclusion in inventory costs of certain expenses26 U.S.C. § 263A
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Foreign corporations26 U.S.C. § 367
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Roth IRAs26 U.S.C. § 408A
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Minimum vesting standards26 U.S.C. § 411
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Partner’s distributive share26 U.S.C. § 704
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Unrealized receivables and inventory items26 U.S.C. § 751
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Taxation of residual interests26 U.S.C. § 860C
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Exclusions from gross income26 U.S.C. § 883
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Income affected by treaty26 U.S.C. § 894
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Other definitions and special rules26 U.S.C. § 989
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Special rules26 U.S.C. § 1474
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Returns of brokers26 U.S.C. § 6045
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Information returns of tax return preparers26 U.S.C. § 6060
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Authority to make credits or refunds26 U.S.C. § 6402
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Failure by individual to pay estimated income tax26 U.S.C. § 6654
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Interest on certain home mortgages26 U.S.C. § 25
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Credit for qualified commercial clean vehicles26 U.S.C. § 45W
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Interest on State and local bonds26 U.S.C. § 103
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Qualified lessee construction allowances for short-term leases26 U.S.C. § 110
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Losses26 U.S.C. § 165
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Charitable, etc., contributions and gifts26 U.S.C. § 170
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Incentive stock options26 U.S.C. § 422
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Deemed paid credit for subpart F inclusions26 U.S.C. § 960
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Election of mark to market for marketable stock26 U.S.C. § 1296
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Returns relating to certain life insurance contract transactions26 U.S.C. § 6050Y
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Clean vehicle credit26 U.S.C. § 30D
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Credit for carbon oxide sequestration26 U.S.C. § 45Q
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Amount of credit26 U.S.C. § 46
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Advanced manufacturing investment credit26 U.S.C. § 48D
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Arbitrage26 U.S.C. § 148
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Amortization of goodwill and certain other intangibles26 U.S.C. § 197
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Interest on education loans26 U.S.C. § 221
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Disallowance of certain entertainment, etc., expenses26 U.S.C. § 274
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Qualifications for tax credit employee stock ownership plans26 U.S.C. § 409
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Unrelated debt-financed income26 U.S.C. § 514
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Rules for allocation of basis26 U.S.C. § 755
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Rules for certain reserves26 U.S.C. § 807
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Special rules in case of foreign oil and gas income26 U.S.C. § 907
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Basis of property acquired from a decedent26 U.S.C. § 1014
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Special rules26 U.S.C. § 1298
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Definitions26 U.S.C. § 3401
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Extension of time for filing returns26 U.S.C. § 6081
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Renumbered § 45C]26 U.S.C. § 28
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Credit for production of clean hydrogen26 U.S.C. § 45V
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Energy credit26 U.S.C. § 48
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Limitation on credit26 U.S.C. § 904
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Qualified pension, profit-sharing, and stock bonus plans26 U.S.C. § 401
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Dependent care assistance programs26 U.S.C. § 129
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Special rules for nuclear decommissioning costs26 U.S.C. § 468A
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Mark to market accounting method for dealers in securities26 U.S.C. § 475
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Basis of distributed property other than money26 U.S.C. § 732
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Straddles26 U.S.C. § 1092
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Qualified electing fund26 U.S.C. § 1295
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Averaging of farm income26 U.S.C. § 1301
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Withholdable payments to foreign financial institutions26 U.S.C. § 1471
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Definitions26 U.S.C. § 1504
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Basis information to persons acquiring property from decedent26 U.S.C. § 6035
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Information with respect to certain foreign-owned corporations26 U.S.C. § 6038A
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Returns relating to cash received in trade or business, etc.26 U.S.C. § 6050I
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Credit for increasing research activities26 U.S.C. § 41
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Definitions and special rules26 U.S.C. § 150
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Passive activity losses and credits limited26 U.S.C. § 469
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Certain expenses for which credits are allowable26 U.S.C. § 280C
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Assumption of liability26 U.S.C. § 357
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Complete liquidations of subsidiaries26 U.S.C. § 332
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Distribution of stock and securities of a controlled corporation26 U.S.C. § 355
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Period for computation of taxable income26 U.S.C. § 441
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General rule for taxable year of deduction26 U.S.C. § 461
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Special rules for modified guaranteed contracts26 U.S.C. § 817A
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Treatment of variable contracts26 U.S.C. § 817
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Certain reinsurance agreements26 U.S.C. § 845
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Failure to file notice of redetermination of foreign tax26 U.S.C. § 6689
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Branch transactions26 U.S.C. § 987
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Qualified zone property defined26 U.S.C. § 1397D
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Withholdable payments to other foreign entities26 U.S.C. § 1472
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Liquidating, etc., transactions26 U.S.C. § 6043
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Verification of returns26 U.S.C. § 6065
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Mode or time of collection26 U.S.C. § 6302
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Transfer of certain credits26 U.S.C. § 6418
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American Opportunity and Lifetime Learning credits26 U.S.C. § 25A
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Refundable credit for coverage under a qualified health plan26 U.S.C. § 36B
-
Clean electricity production credit26 U.S.C. § 45Y
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Other special rules26 U.S.C. § 50
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Treatment of community income26 U.S.C. § 66
-
Basis to corporations26 U.S.C. § 362
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Election of taxable year other than required taxable year26 U.S.C. § 444
-
Transactions between partner and partnership26 U.S.C. § 707
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Special allocation rules for certain asset acquisitions26 U.S.C. § 1060
-
Discounted unpaid losses defined26 U.S.C. § 846
-
Definitions and special rules26 U.S.C. § 864
-
Capital asset defined26 U.S.C. § 1221
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Interest on tax deferral26 U.S.C. § 1291
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Passive foreign investment company26 U.S.C. § 1297
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Withholding of tax on nonresident aliens26 U.S.C. § 1441
-
Returns as to interests in foreign partnerships26 U.S.C. § 6046A
-
State and local income tax refunds26 U.S.C. § 6050E
-
Returns relating to exchanges of certain partnership interests26 U.S.C. § 6050K
-
Returns relating to higher education tuition and related expenses26 U.S.C. § 6050S
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Reporting of health insurance coverage26 U.S.C. § 6055
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Low-income housing credit26 U.S.C. § 42
-
New markets tax credit26 U.S.C. § 45D
-
Definitions and special rules26 U.S.C. § 414
-
Qualified asset account; limitation on additions to account26 U.S.C. § 419A
-
General rule for methods of accounting26 U.S.C. § 446
-
Interest on certain deferred payments26 U.S.C. § 483
-
Reserves for losses on loans of banks26 U.S.C. § 585
-
Certain revocable trusts treated as part of estate26 U.S.C. § 645
-
Insurance company taxable income26 U.S.C. § 832
-
Income from sources within the United States26 U.S.C. § 861
-
Treatment of certain foreign currency transactions26 U.S.C. § 988
-
Functional currency26 U.S.C. § 985
-
Other definitions and special rules26 U.S.C. § 1275
-
Election to extend time for payment of tax on undistributed earnings26 U.S.C. § 1294
-
Requirement to maintain minimum essential coverage26 U.S.C. § 5000A
-
Returns by exempt organizations26 U.S.C. § 6033
-
Information with respect to foreign financial assets26 U.S.C. § 6038D
-
Returns relating to the cancellation of indebtedness by certain entities26 U.S.C. § 6050P
-
Identifying numbers26 U.S.C. § 6109
-
Elective payment of applicable credits26 U.S.C. § 6417
-
Certain fringe benefits26 U.S.C. § 132
-
Dependent defined26 U.S.C. § 152
-
Interest26 U.S.C. § 163
-
Bad debts26 U.S.C. § 166
-
Special rules for credits and deductions26 U.S.C. § 642
-
General rule for inventories26 U.S.C. § 471
-
Political organizations26 U.S.C. § 527
-
Special rules applicable to sections 661 and 66226 U.S.C. § 663
-
Allowance of deductions and credits26 U.S.C. § 874
-
Branch profits tax26 U.S.C. § 884
-
Tax imposed on certain built-in gains26 U.S.C. § 1374
-
Foreign tax-exempt organizations26 U.S.C. § 1443
-
Valuation tables26 U.S.C. § 7520
-
Losses on small business stock26 U.S.C. § 1244
-
Distributions26 U.S.C. § 1368
-
Definitions26 U.S.C. § 1473
-
Information with respect to certain fines, penalties, and other amounts26 U.S.C. § 6050X
-
Failure by corporation to pay estimated income tax26 U.S.C. § 6655