IRS seeks to expand extraordinary dividend rules.

Under Internal Revenue Code section 356(a)(1), when a shareholder receives both stock and boot in a reorganization, the shareholder's gain is recognized in an amount not more than the boot's value. Under section 356(a)(2) and revenue ruling 93-61, this gain is characterized as a dividend (to the extent the company has accumulated earnings and profits) if the exchange is considered a dividend.

Corporate shareholders historically have preferred dividend treatment because of the availability of the corporate dividends-received deduction (DRD). It also was thought that reorganization boot dividends were generally immune from the extraordinary dividend rules. (Those rules require a stock-basis reduction if the dividend exceeds certain statutory thresholds.) Now, however, in proposed regulations section 1.1059(e)-1, the Internal Revenue Service characterizes a reorganization exchange as a redemption. This is significant because any dividend resulting from a redemption that is not pro rata to all shareholders is automatically an extraordinary dividend.

Observation: Corporations will have less (or no) incentive to earn reorganization boot dividends because-- as extraordinary dividends--the income will give rise to stock basis reductions measured by the DRDs when the dividends are received.

--Robert Willens, CPA, managing director at Lehman Brothers, New York City.

FYI 

* Taxpayers must attach a statement to a return in order to elect to defer research or experimental expenses on a project-by-project basis. In private letter ruling 9623003, the Internal Revenue Service said a corporation adopted the current expense method by attaching a statement to its return and elected the deferred expense method for only one project. Because the INS was informed of the taxpayer's choice, the deferred method was allowed for the one project.

* A city condemned a taxpayer's property and, subsequently, paid cash for the property. The taxpayer already owns and manages a shopping center on land that is leased. The taxpayer proposes to use the condemnation proceeds to purchase the leased land and make additional improvements to the shopping center. In private letter ruling 9620010, the INS said that the purchase would qualify as replacement property under section 1033(g).

--Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.