§996 Rules for Allocation in the Case of Distributions and Losses

Summary

Sets the order for what kind of income a DISC (or former DISC) uses when it pays money to shareholders, how losses are charged, and how stock basis and tax treatment change. Actual cash paid to a shareholder is treated, in most cases, as coming first from income already taxed to the shareholder, then from accumulated DISC income, and last from other earnings and profits. Special payments made to meet qualification rules (section 992(c)) and certain deemed distributions (section 995(b)(1)(G)) are treated first as from accumulated DISC income, then other earnings and profits, and only last from previously taxed income. Money that is from previously taxed income is not included in the shareholder’s gross income except for the gains mentioned in subsection (e)(2). If the DISC has a deficit for a year, the shortfall is charged first to other earnings and profits, then to accumulated DISC income, and finally to previously taxed income, but not against accumulated DISC income already treated as deemed distributed because of an election revocation or disqualification. Actual distributions in a year come after any deemed distributions that year; distributions under section 992(c) count as made before other actual distributions. If gain on a share was treated under section 995(c) as dividend or ordinary income, the law adjusts accumulated DISC income when stock is redeemed or when distributions relate to that share. Deemed distributions under section 995(b) increase stock basis. Actual distributions from previously taxed income reduce stock basis and, to the extent they exceed basis, are treated as gain from sale; a special rule applies for stock in a decedent’s estate with a section 2032 election. Definitions: DISC income (income earned while a corporation is a DISC), accumulated DISC income (prior years’ DISC income), previously taxed income (amounts already taxed to shareholders), and other earnings and profits (earnings not in the other two categories). For nonresident alien individuals and foreign entities, gains under section 995(c) and distributions from accumulated DISC income (including deemed distributions) are treated as effectively connected with a U.S. trade or business through a U.S. permanent establishment and as U.S.-source income.