26 CFR § 1.995-1 - Taxation of DISC income to shareholders.
(a) In general.
(1) Under § 1.991-1(a), a corporation which is a DISC for a taxable year is not subject to any tax imposed by subtitle A of the Code (sections 1 through 1564) for the taxable year, except for the tax imposed by chapter 5 thereof (sections 1491 through 1494) on certain transfers to avoid tax.
(2) Under section 995(a), the shareholders of a DISC, or a former DISC, are subject to taxation on the earnings and profits of the DISC in accordance with the provisions of chapter 1 of the Code generally applicable to shareholders, but subject to the modifications provided in sections 995, 996, and 997.
(3) Under § 1.996-3, three divisions of earnings and profits of a DISC, or former DISC, are defined: “accumulated DISC income”, “previously taxed income”, and “other earnings and profits”. Under § 1.995-2, certain amounts of the DISC's earnings and profits are deemed to be distributed as dividends to shareholders of the DISC at the close of the DISC's taxable year in which such earnings were derived. Such deemed distributions do not cause a reduction in the DISC's earnings and profits, but are taken into account in § 1.996-3(c) as an increase in previously taxed income. To the extent the DISC's earnings and profits are paid out in a subsequent distribution which is, under § 1.996-1, treated as made out of such “previously taxed income,” they will not be taxable to the shareholders a second time.
(4) In general, “accumulated DISC income” is the earnings and profits of the DISC which have not been deemed distributed and which may be deferred from taxation so long as they are not actually distributed with respect to its stock. However, deferral of taxation on “accumulated DISC income” may be terminated, in whole or in part, in the event of: (i) Certain foreign investment attributable to producer's loans (see § 1.995-2(a)(5) and § 1.995-5); (ii) revocation of the election to be treated as a DISC or other disqualification (see § 1.995-3); and (iii) certain dispositions of DISC stock in which gain is realized (see § 1.995-4).
(5) Since a DISC is not taxed on its taxable income, section 246(d) and § 1.246-4 provide that the deduction otherwise allowed under section 243 shall not be allowed with respect to a dividend from a DISC, or former DISC, paid or treated as paid out of accumulated DISC income or previously taxed income or with respect to a deemed distribution in a qualified year under § 1.995-2(a).
(3) Amounts which, pursuant to § 1.995-3, he is deemed to receive as a distribution taxable as a dividend in the event the corporation revokes its election to be treated as a DISC or otherwise is disqualified as a DISC, and
(c) Treatment of actual distributions.
(1) Except as provided in subparagraph (3) of this paragraph, amounts actually distributed to a shareholder of a DISC, or former DISC, with respect to his stock are includible in his gross income in accordance with section 301.
(2) Since a deemed distribution does not reduce the earnings and profits of a DISC, it does not affect the determination as to whether a subsequent actual distribution is a “dividend” under section 316(a). Since, however, the amount of a deemed distribution increases “previously taxed income”, it does affect the determination as to whether a subsequent actual distribution is excluded (as described in subparagraph (3) of this paragraph) from gross income.
(3) Under § 1.996-1(c), the amount of any actual distribution (including a deficiency distribution made pursuant to § 1.992-3), with respect to stock in a DISC, or former DISC, which is treated under § 1.996-1 as made out of previously taxed income, is excluded by the distributee from gross income, but only to the extent that such amount does not exceed the adjusted basis of the distributee's stock. Under § 1.996-5(b), that portion of any actual distribution which is treated as made out of previously taxed income shall be applied against and reduce the adjusted basis of the stock and, to the extent that it exceeds the adjusted basis of the stock, it shall be treated as gain from the sale or exchange of property.
(4) A deficiency distribution pursuant to § 1.992-3 may be made after the close of the DISC's taxable year with respect to which it is made. The determinations as to whether such deficiency distribution is a dividend under section 301 and as to which division of earnings and profits is the source thereof depend upon the status of the DISC's earnings and profits account and divisions thereof at the time the distribution is actually made. See § 1.996-1(d) for the priority of such deficiency distribution over other actual distributions made during the same taxable year.
(d) Personal holding company income.
(1) Any amount includible in a shareholder's gross income as a dividend with respect to the stock of a DISC, or former DISC, pursuant to paragraph (b) of this section shall be treated as a dividend for all purposes of the Code, except that for purposes of determining whether such shareholder is a personal holding company within the meaning of section 542 any amount deemed distributed for qualified years under § 1.995-2 or upon disqualification under § 1.995-3, any amount of gain on certain dispositions of DISC stock to which § 1.995-4 applies, and any amount treated under § 1.996-1 as distributed out of accumulated DISC income or previously taxed income shall not be treated as a dividend or any other kind of income described in section 543(a).
(2) Notwithstanding subparagraph (1) of this paragraph, the shareholder may treat as an item of income described under section 543 (for example, rents) any amount to which the exception in such subparagraph (1) applies, if it establishes to the satisfaction of the district director that such amount is attributable to earnings and profits derived from such item of income.