Deemed Distribution

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on July 12, 2023

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What Is a Deemed Distribution?

Deemed distribution refers to a situation in which a taxpayer is considered to have received a distribution from a corporation, retirement plan, or other entity, even though no actual cash or property has been transferred.

The distribution is treated as income for tax purposes and may be subject to various taxes, including income tax and capital gains tax.

Understanding deemed distribution is essential for taxpayers and financial professionals as it impacts taxation and financial management.

Deemed distributions can trigger tax liabilities, affect investment returns, and influence corporate decision-making. Properly managing deemed distributions can help taxpayers minimize tax liabilities and optimize their financial strategies.

Deemed Distribution: Legal and Regulatory Framework

Overview of Relevant Laws and Regulations

The legal and regulatory framework for deemed distributions is primarily based on two sources:

Internal Revenue Code (IRC)

The IRC governs federal taxation in the United States and contains provisions that address deemed distributions in various contexts, including corporate transactions, retirement plans, and international taxation.

Treasury Regulations

Treasury Regulations, issued by the U.S. Department of the Treasury, provide guidance and interpretation of the IRC provisions related to deemed distributions.

These regulations help taxpayers and financial professionals understand the tax treatment of deemed distributions and comply with the relevant tax laws.

IRS Guidance and Rulings on Deemed Distribution

The Internal Revenue Service (IRS) issues guidance, including revenue rulings, revenue procedures, and private letter rulings, to help taxpayers understand and comply with the tax laws related to deemed distributions.

International Considerations and Tax Treaties Related to Deemed Distribution

In the context of international taxation, deemed distributions may be addressed in tax treaties between countries. Tax treaties help prevent double taxation and clarify the tax treatment of deemed distributions involving taxpayers in different jurisdictions.

Types of Deemed Distributions

Deemed distributions can occur in various contexts, including at the shareholder level, the corporate level, and within retirement plans.

Deemed Distribution at Shareholder Level

Phantom Income

Phantom income refers to income recognized for tax purposes but not received by the taxpayer. This can occur, for example, when a shareholder is allocated income from a partnership or S corporation but does not receive a cash distribution.

Stock Redemptions and Buybacks

In certain cases, stock redemptions and buybacks can be treated as deemed distributions to shareholders, even if the shareholder does not receive cash or other property.

Deemed Distribution at Corporate Level

Earnings and Profits

Deemed distributions can occur at the corporate level when a corporation's earnings and profits are treated as distributed to shareholders for tax purposes, even if no actual distribution occurs.

Taxable Stock Dividends

In some instances, stock dividends may be considered taxable and deemed distributions to shareholders.

Deemed Distribution in Retirement Plans

Deemed distributions can also occur within retirement plans in several situations:

Required Minimum Distributions

When a retirement plan participant fails to take a required minimum distribution (RMD), the amount not distributed may be treated as a deemed distribution and subject to tax.

Excess Contributions

Excess contributions to retirement plans can be considered deemed distributions and subject to tax if they are not corrected in a timely manner.

Loan Defaults

If a retirement plan participant defaults on a plan loan, the outstanding loan balance may be treated as a deemed distribution and subject to tax.

Types-of-Deemed-Distributions

Tax Implications and Reporting Requirements for Deemed Distributions

Deemed distributions have various tax implications and reporting requirements for taxpayers.

Taxation of Deemed Distributions

Income Tax Consequences

Deemed distributions are generally treated as income and subject to income tax at the taxpayer's ordinary income tax rate. In some cases, deemed distributions may also be subject to additional taxes or penalties, such as the 10% early withdrawal penalty for certain retirement plan distributions.

Capital Gains Tax Consequences

In certain situations, deemed distributions can result in capital gains or losses for the taxpayer. These gains or losses are subject to capital gains tax rates, which may be more favorable than ordinary income tax rates.

Reporting Requirements for Deemed Distributions

Taxpayers must report deemed distributions on their tax returns and may need to file additional forms or schedules, depending on the specific situation.

Form 1099-DIV

Payers of deemed distributions, such as corporations or retirement plans, generally must issue Form 1099-DIV to the recipient, reporting the amount of the deemed distribution.

Form 1040

Individual taxpayers must report deemed distributions as income on their Form 1040, U.S. Individual Income Tax Return.

Form 1120

Corporations that make deemed distributions to shareholders must report the distributions on Form 1120, U.S. Corporation Income Tax Return.

Tax Planning Strategies and Considerations Related to Deemed Distributions

Taxpayers and financial professionals can use various tax planning strategies to minimize the tax impact of deemed distributions, such as:

  • Timing of Distributions: Manage the timing of deemed distributions to defer or accelerate income recognition, depending on the taxpayer's tax situation.

  • Tax-Efficient Investments: Invest in tax-efficient assets or structures that minimize deemed distributions or their tax impact.

  • Tax-Loss Harvesting: Use investment losses to offset capital gains resulting from deemed distributions, reducing the overall tax liability.

Conclusion

Deemed distributions are essential in taxation and financial management, with implications for individual and corporate taxpayers.

Understanding the legal and regulatory framework, tax implications, and reporting requirements related to deemed distributions can help taxpayers and financial professionals navigate this complex area and develop effective tax planning strategies.

By staying informed of future developments and trends in deemed distributions, such as potential changes to tax laws and regulations, technological advancements, and globalization, taxpayers and financial professionals can adapt their strategies and ensure compliance with the evolving tax landscape.

Deemed distributions are significant in taxation and financial management. By understanding the intricacies of this concept and its implications, taxpayers and financial professionals can make informed decisions and optimize their tax strategies.

Deemed Distribution FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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