J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

4.5 Taxable Dividends of Earnings and Profits

You pay tax on dividends only when the corporation distributing the dividends has earnings and profits. Publicly held corporations will tell you whether their distributions are taxable. If you hold stock in a close corporation, you may have to determine the tax status of its distribution. You need to know earnings and profits at two different periods:

1. Current earnings and profits as of the end of the current taxable year. A dividend is considered to have been made from earnings most recently accumulated.

2. Accumulated earnings and profits as of the beginning of the current year. However, when current earnings and profits are large enough to meet the dividend, you do not have to make this computation. It is only when the dividends exceed current earnings (or there are no current earnings) that you match accumulated earnings against the dividend.

The tax term “accumulated earnings and profits” is similar in meaning to the accounting term “retained earnings.” Both stand for the net profits of the company after deducting distributions to stockholders. However, “tax” earnings may differ from “retained earnings” for the following reason: Reserve accounts, the additions to which are not deductible for income tax purposes, are ordinarily included as tax earnings.

EXAMPLES

1. During 2012, Corporation A paid dividends of $25,000. At the beginning of 2012 it had accumulated earnings of $50,000. It lost $25,000 during 2012. You are ...