[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: 26CFR1.312-8]

[Page 52-53]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.312-8  Effect on earnings and profits of receipt of tax-free 
distributions requiring adjustment or allocation of basis of stock.

    (a) In order to determine the effect on earnings and profits, where 
a corporation receives (after February 28, 1913) from a second 
corporation a distribution which (under the law applicable to the year 
in which the distribution was made) was not a taxable dividend to the 
shareholders of the second corporation, section 312(f) prescribes 
certain rules. It provides that the amount of such distribution shall 
not increase the earnings and profits of the first or receiving 
corporation in the following cases: (1) No such increase shall be made 
in respect of the part of such distribution which (under the law 
applicable to the year in which the distribution was made) is directly 
applied in reduction of the basis of the stock in respect of which the 
distribution was made and (2) no such increase shall be made if (under 
the law applicable to the year in which the distribution was made) the 
distribution causes the basis of the stock in respect of which the 
distribution was made to be allocated between such stock and the 
property received (or such basis would but for section 307(b) be so 
allocated). Where, therefore, the law (applicable to the year in which 
the distribution was made, as, for example, a distribution in 1934 from 
earnings and profits accumulated before March 1, 1913) requires that the 
amount of such distribution shall be applied against and reduce the 
basis of the stock with respect to which the distribution was made, 
there is no increase in the earnings and profits by reason of the 
receipt of such distribution. Similarly, where there is received by a 
corporation a distribution from another corporation in the form of a 
stock dividend and the law applicable to the year in which such 
distribution was made requires the allocation, as between the old stock 
and the stock received as a dividend, of the basis of the old stock (or 
such basis would but for section 307(b) be so allocated), then there is 
no increase in the earnings and profits by reason of the receipt of such 
stock dividend even though such stock dividend constitutes income within 
the

[[Page 53]]

meaning of the sixteenth amendment to the Constitution.
    (b) The principles set forth in paragraph (a) of this section may be 
illustrated by the following examples:

    Example (1). Corporation X in 1955 distributed to Corporation Y, one 
of its shareholders, $10,000 which was out of earnings or profits 
accumulated before March 1, 1913, and did not exceed the adjusted basis 
of the stock in respect of which the distribution was made. This amount 
of $10,000 was, therefore, a tax-free distribution and under the 
provisions of section 301(c)(2) must be applied against and reduce the 
adjusted basis of the stock in respect of which the distribution was 
made. The earnings and profits of Corporation Y are not increased by 
reason of the receipt of this distribution.
    Example (2). Corporation Z in 1955 had outstanding common and 
preferred stock of which Corporation Y held 100 shares of the common and 
no preferred. The stock had a cost basis to Corporation Y of $100 per 
share, or a total cost of $10,000. In December of that year it received 
a dividend of 100 shares of the preferred stock of Corporation Z. Such 
distribution is a stock dividend which, under section 305, was not 
taxable and was accordingly not included in the gross income of 
Corporation Y. The original cost of $10,000 is allocated to the 200 
shares of Corporation Z none of which has been sold or otherwise 
disposed of by Corporation Y. See section 307 and Sec. 1.307-1. The 
earnings and profits of Corporation Y are not increased by reason of the 
receipt of such stock dividend.