[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.312-6]

[Page 48-49]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.312-6  Earnings and profits.

    (a) In determining the amount of earnings and profits (whether of 
the taxable year, or accumulated since February 28, 1913, or accumulated 
before March 1, 1913) due consideration must be given to the facts, and, 
while mere bookkeeping entries increasing or decreasing surplus will not 
be conclusive, the amount of the earnings and profits in any case will 
be dependent upon the method of accounting properly employed in 
computing taxable income (or net income, as the case may be). For 
instance, a corporation keeping its books and filing its income tax 
returns under subchapter E, chapter 1 of the Code, on the cash receipts 
and disbursements basis may not use the accrual basis in determining 
earnings and profits; a corporation computing income on the installment 
basis as provided in section 453 shall, with respect to the installment 
transactions, compute earnings and profits on such basis; and an 
insurance company subject to taxation under section 831 shall exclude 
from earnings and profits that portion of any premium which is unearned 
under the provisions of section 832(b)(4) and which is segregated 
accordingly in the unearned premium reserve.
    (b) Among the items entering into the computation of corporate 
earnings and profits for a particular period are all income exempted by 
statute, income not taxable by the Federal Government under the 
Constitution, as well as all items includible in gross income under 
section 61 or corresponding provisions of prior revenue acts. Gains

[[Page 49]]

and losses within the purview of section 1002 or corresponding 
provisions of prior revenue acts are brought into the earnings and 
profits at the time and to the extent such gains and losses are 
recognized under that section. Interest on State bonds and certain other 
obligations, although not taxable when received by a corporation, is 
taxable to the same extent as other dividends when distributed to 
shareholders in the form of dividends.
    (c)(1) In the case of a corporation in which depletion or 
depreciation is a factor in the determination of income, the only 
depletion or depreciation deductions to be considered in the computation 
of the total earnings and profits are those based on cost or other basis 
without regard to March 1, 1913, value. In computing the earnings and 
profits for any period beginning after February 28, 1913, the only 
depletion or depreciation deductions to be considered are those based on 
(i) cost or other basis, if the depletable or depreciable asset was 
acquired subsequent to February 28, 1913, or (ii) adjusted cost or March 
1, 1913, value, whichever is higher, if acquired before March 1, 1913. 
Thus, discovery or percentage depletion under all revenue acts for mines 
and oil and gas wells is not to be taken into consideration in computing 
the earnings and profits of a corporation. Similarly, where the basis of 
property in the hands of a corporation is a substituted basis, such 
basis, and not the fair market value of the property at the time of the 
acquisition by the corporation, is the basis for computing depletion and 
depreciation for the purpose of determining earnings and profits of the 
corporation.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example Oil producing property which A had acquired in 1949 at a 
cost of $28,000 was transferred to Corporation Y in December 1951, in 
exchange for all of its capital stock. The fair market value of the 
stock and of the property as of the date of the transfer was $247,000. 
Corporation Y, after four years' operation, effected in 1955 a cash 
distribution to A in the amount of $165,000. In determining the extent 
to which the earnings and profits of Corporation Y available for 
dividend distributions have been increased as the result of production 
and sale of oil, the depletion to be taken into account is to be 
computed upon the basis of $28,000 established in the nontaxable 
exchange in 1951 regardless of the fair market value of the property or 
of the stock issued in exchange therefor.

    (d) A loss sustained for a year before the taxable year does not 
affect the earnings and profits of the taxable year. However, in 
determining the earnings and profits accumulated since February 28, 
1913, the excess of a loss sustained for a year subsequent to February 
28, 1913, over the undistributed earnings and profits accumulated since 
February 28, 1913, and before the year for which the loss was sustained, 
reduces surplus as of March 1, 1913, to the extent of such excess. If 
the surplus as of March 1, 1913, was sufficient to absorb such excess, 
distributions to shareholders after the year of the loss are out of 
earnings and profits accumulated since the year of the loss to the 
extent of such earnings.
    (e) With respect to the effect on the earnings and profits 
accumulated since February 28, 1913, of distributions made on or after 
January 1, 1916, and before August 6, 1917, out of earnings or profits 
accumulated before March 1, 1913, which distributions were specifically 
declared to be out of earnings and profits accumulated before March 1, 
1913, see section 31(b) of the Revenue Act of 1916, as added by section 
1211 of the Revenue Act of 1917 (40 Stat. 336).