C.F.R. » Title 26 » CHAPTER I—INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY › SUBCHAPTER A—INCOME TAX › PART 1—INCOME TAXES

26 C.F.R. § 1.312-6

Earnings and profits

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(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 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).

Notes of Decisions
Cited in 22 cases, 1966–2012 · leading case: Woods Inv. Co. v. Comm'r, 85 T.C. 274 (Tax Ct. 1985).
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Woods Inv. Co. v. Comm'r, 85 T.C. 274 (Tax Ct. 1985). · cites it 6× “Thus, in the case of a corporation deducting percentage depletion as in the case of a subsidiary using accelerated depreciation, taxable income is reduced by an amount greater than the amount by which earnings and profits are reduced.”
Juha v. Comm'r, 103 T.C.M. 1338 (Tax Ct. 2012). · cites it 10× “312-6(a), Income Tax Regs. , provides that a corporation must compute earnings and profits using the same method of accounting employed in computing taxable income, earnings and profits are not equivalent to taxable income.”
Snap-Drape v. Comm'r, 105 T.C. 16 (Tax Ct. 1995). · cites it 4× “The Internal Revenue Code does not specifically define the phrase "earnings and profits". See Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par.”
Yelencsics v. Comm'r, 74 T.C. 1513 (Tax Ct. 1980). · cites it 2× “↩ Accordingly, the recomputed earnings and profits for 1967, 1968, and 1969 were $ 48,997.”
Luckman v. Comm'r, 50 T.C. 619 (Tax Ct. 1968). · cites it 6× “421-6(f), Income Tax Regs. Such actual expenses, when recognized for income tax purposes, are generally considered to reduce corporate earnings and profits available for dividends.”
Wilson v. Comm'r, 46 T.C. 334 (Tax Ct. 1966). · cites it 4× “Finally, the regulations provide that "all items *139 includible in gross income under section 61" enter into the computation of earnings and profits.”
Webb v. Comm'r, 67 T.C. 1008 (Tax Ct. 1977). · cites it 4× “The relevant Treasury regulations have long provided that a corporation in computing its earnings and profits for a taxable year must follow the same accounting method it uses for computing its taxable income.”
Prescott v. Comm'r, 66 T.C. 128 (Tax Ct. 1976). · cites it 4× “However, such interest is included in the computation of the corporation's earnings and profits.”
Anderson v. Comm'r, 67 T.C. 522 (Tax Ct. 1976). · cites it 2× “hile the Luckman case involved only one corporation which was both the employer and the issuer of the stock, we believe the rationale of the opinion of the Seventh Circuit in that case supports our thinking that the corporation that would be entitled to a deduction for the…”
Dileo v. Comm'r, 96 T.C. 858 (Tax Ct. 1991). · cites it 4× “A corporation's earnings and profits are generally calculated by making certain adjustments to the corporation's taxable income.”
Union Equity Coop. Exch. v. Comm'r, 58 T.C. 397 (Tax Ct. 1972). · cites it 2× “1216 , 1223 (1971) , and cases cited; see also sec. 1.312-6(a), Income Tax Regs. In the present case, since a dividend on capital stock is an item common to both petitioner's taxable income and its net earnings available for distribution as a patronage dividend, consistency also…”
Perano v. Comm'r, 130 T.C. 93 (Tax Ct. 2008). · cites it 2× “On brief, petitioners concede that American General is not an insurance company: "Respondent is correct in pointing out that[,] as a real estate company, American General is not an Insurance Company.”
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