Dividends, Distributions & Shareholder Taxation

Understanding the mechanics of moving cash from a C Corporation to its shareholders. Navigate the complexity of Earnings & Profits (E&P), Stock Basis, and Tax Rates to optimize after-tax wealth.

1. The Distribution Waterfall

Not all cash received from a corporation is a "dividend" for tax purposes. The IRS follows a strict hierarchy (Section 301) to determine how a distribution is taxed. It starts with E&P, eats into stock basis, and finally results in capital gains. Use the simulator below to visualize this flow.

Scenario Inputs

$
$

Accumulated + Current E&P

$

Original investment + adjustments

Distribution Composition $100,000
Dividend
ROC
Gain
1. Taxable Dividend
$40,000
Sourced from E&P. Taxed at Dividend Rates (0/15/20%).
2. Return of Capital
$30,000
Non-taxable. Reduces stock basis to zero.
3. Capital Gain
$30,000
Taxed as Capital Gain (0/15/20%). Basis is exhausted.

2. Earnings & Profits (E&P)

E&P is the "tax concept" of corporate earnings, distinct from Book Net Income or Retained Earnings. It determines a corporation's ability to pay dividends. Tracking E&P is critical because it dictates the boundary between a taxable dividend and a tax-free return of capital.

The "Two Bucket" Rule

Distributions are sourced from E&P in a specific order. Click a scenario to see how it works.

Standard Scenario: Both Positive

Current E&P is allocated first. If distributions exceed Current E&P, they draw from Accumulated E&P. Both are fully available to support taxable dividends.

visual_model.js
Bucket 1: Current E&P Positive
Source First
▼
Bucket 2: Accumulated E&P Positive
Source Second

3. The "Qualified" Advantage

Double taxation is the primary disadvantage of a C Corp. However, "Qualified Dividends" mitigate this by utilizing long-term capital gains rates (0%, 15%, or 20%) rather than ordinary income rates (up to 37%).

Requirement 1: Domestic Corp Requirement 2: >60 Day Holding Period

Compare Tax Impact

$10k $100,000 $500k

Ordinary: 22-35% | Qualified: 15%

💡 Did you know?

High earners may also face the 3.8% Net Investment Income Tax (NIIT) on top of dividend rates.

After-Tax Cash Retained

Non-Qualified (Ordinary)

Tax: $32,000

Qualified Dividend

Tax: $15,000

4. Strategic Considerations

⏳

Dividend Timing

Unlike S Corps, C Corps can retain earnings. Distributions can be timed for years when shareholders have lower taxable income or when tax rates are favorable.

  • ✓ Defer distribution to control shareholder AGI.
  • ✓ Manage E&P to trigger Return of Capital (ROC) in low earnings years.
🔄

Redemptions (Sec. 302) vs Dividends

When a corp buys back stock, it might be treated as a sale (Capital Gain + Basis Recovery) or a Dividend (Income). Section 302 provides safe harbors for sale treatment.

  • ✓ Substantially Disproportionate: Must reduce ownership percentage significantly.
  • ✓ Complete Termination: Shareholder exits entirely.