26 U.S.C. § 1059 — Corporate shareholder’s basis in stock reduced by nontaxed portion of extraordinary dividends

(a) General rule. If a corporation^* receives an extraordinary dividend on stock^* it held for no more than 2 years before the dividend announcement date, (1) the corporation must reduce its basis in the stock, but not below zero, by the dividend’s nontaxed portion; and (2) any nontaxed portion above the basis is gain from selling or exchanging the stock in the year the dividend is received. (b) Nontaxed portion. (1) The nontaxed portion is the dividend minus its taxable portion, if that amount is positive. (2) The taxable portion is the part included in gross income minus any deduction allowed for the dividend under section 243, 245, or 245A. (c) Extraordinary dividend. (1) It is a dividend on stock equal to or greater than the threshold percentage of the taxpayer’s adjusted basis in the stock. (2) The threshold is 5 percent for stock preferred as to dividends and 10 percent for other stock. (3)(A) Dividends received by the taxpayer^* or a person described in (C) on the same stock with ex-dividend dates in the same 85 consecutive days are treated as one dividend. (B) Dividends received by them on the same stock with ex-dividend dates in the same 365 consecutive days are treated as extraordinary dividends if their total is more than 20 percent of the taxpayer’s adjusted basis, ignoring this section. (C) A person is covered if that person’s basis in the stock is determined partly or wholly by reference to the taxpayer’s basis, or the taxpayer’s basis is determined that way by reference to that person’s basis. (4) If the taxpayer proves the stock’s fair market value on the day before its ex-dividend date to the Secretary^*, the taxpayer may elect to use that value instead of adjusted basis for paragraphs (1) and (3). (d) Special rules. (1) A basis reduction occurs at the start of the extraordinary dividend’s ex-dividend date. (2) A noncash dividend is measured by the property’s fair market value on the distribution date, reduced as section 301(b)(2) provides. (3) Holding period rules similar to section 246(c)(3) and (4) apply, and days more than 2 years after the stock becomes ex-dividend are ignored. (4) “Ex-dividend date” means the date the stock becomes ex-dividend. This section does not define “ex-dividend” itself. (5) “Dividend announcement date” means the earliest date the corporation declares, announces, or agrees to the dividend’s amount or payment. (6)(A) Subsection (a) does not apply if the taxpayer held the stock for the corporation’s entire existence and, except as regulations provide, none of the corporation’s earnings and profits came from property transfers by, or earnings and profits of, a corporation that is not qualified. (B) A “qualified corporation” is a corporation, including a predecessor, in which the taxpayer directly or indirectly held at least the same ownership percentage throughout that corporation’s existence as in the dividend-paying corporation, and which has no earnings and profits earned by, or attributable to gain on property accruing while, the property-holding corporation was not described in this clause. (C) This paragraph does not apply to an extraordinary dividend to the extent that doing so would conflict with this section’s purposes. (e) Certain distributions. (1)(A) Unless regulations provide otherwise, a dividend from a stock redemption is treated under subsection (a), without regard to the holding period, if the redemption is part of a partial liquidation under section 302(e), is not pro rata among shareholders^*, or would not have been treated wholly or partly as a dividend without options counted under section 318(a)(4) or without section 304(a). For the last type, only the basis of the redeemed stock is counted. (B) A section 356 exchange treated as a dividend is treated as a stock redemption for (A). (2)(A) Unless regulations provide otherwise, an extraordinary dividend does not include a qualifying dividend under section 243. (B) That exclusion does not cover a portion attributable to earnings and profits earned while the corporation was outside the affiliated group, or to gain accruing on property while it was held outside that group. (3)(A) For one or more qualified preferred dividends, this section does not apply if the taxpayer holds the stock more than 5 years. If the taxpayer disposes of it sooner, the total basis reduction cannot exceed the qualified preferred dividends paid during the holding period minus the qualified preferred dividends that would have been paid using the stated rate of return, if positive. (B)(i) The actual rate of return uses only dividends during the holding period and the lesser of adjusted basis or liquidation preference. (ii) The stated rate is the annual qualified preferred dividend as a percentage of that lesser amount. (C)(i) A qualified preferred dividend is a fixed dividend payable at least annually that is not in arrears when acquired. It does not include a dividend on stock whose actual return exceeds 15 percent. (ii) For this holding period, subsection (d)(3) uses 5 years instead of 2 years. (f) Disqualified preferred stock. (1) A dividend on disqualified preferred stock is an extraordinary dividend under subsection (a)(1) and (2), regardless of holding period. (2) This means dividend-preferred stock whose rate declines or can reasonably be expected to decline when issued, whose issue price exceeds its liquidation rights or stated redemption price, or that is structured to avoid this section and let corporate shareholders reduce tax through dividend deductions combined with a loss on disposition. (g) Regulations. The Secretary must issue appropriate regulations, including rules for stock dividends, splits, reorganizations, pass-through entities, and consolidated groups, and rules extending subsection (f) to non-preferred stock structured to avoid this section’s purposes.