March 1, 1913, or out of increase in value of property accrued prior to March 1, 1913 (whether or not realized by sale or other disposition, and, if realized, whether prior to or on or after March 1, 1913), is not a dividend within the meaning of Title I. A corporation can not distribute earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, exempt from tax, unless and until all earnings or profits accumulated since February 28, 1913, have been distributed. Whenever one corporation receives from another corporation distributions out of earnings or profits accumulated by such other corporation prior to March 1, 1913, or out of increase in value of its property accrued prior to March 1, 1913, and the "receiving" corporation, after having first distributed all of its earnings and profits accumulated since February 28, 1913, distributes to its shareholders the amount so received by it from such other corporation, the distribution by the "receiving" corporation to its shareholders is not a dividend within the meaning of Title I and is exempt from tax.

In determining whether a dividend is out of earnings or profits accumulated since February 28, 1913, or prior to March 1, 1913, due consideration must be given to the facts, and mere bookkeeping entries increasing or decreasing surplus will not be conclusive.

A tax-free distribution made by a corporation out of earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, shall be applied against the basis of the stock for the purpose of determining gain or loss from its subsequent sale. The fact that such distribution is in excess of the cost or other basis (provided in section 113 and articles 591-604) of the stock on which declared does not render it subject to tax. The provisions of this paragraph are also applicable to a distribution by a "receiving" corporation made under the conditions set forth in the first paragraph of this article, and to the distributees in determining gain or loss from the subsequent sale or other disposition of stock in the "receiving" corporation.

Example: A purchased certain shares of stock subsequent to February 28, 1913, for $10,000. He received in 1928 a distribution of $2,000 paid out of earnings and profits of the corporation accumulated prior to March 1, 1913. This distribution is not subject to tax if the earnings and profits of the corporation accumulated after February 28, 1913, have been distributed. If A subsequently sells the stock for $6,000, a deductible loss of $2,000 is sustained. If he sells the stock for $9,000, he realizes a taxable gain of $1,000.

Art. 624. Distributions other than those out of increase in value of property accrued prior to March 1, 1913, or out of earnings or profits.— Any distribution (not in partial or complete liquidation) made by a corporation to its shareholders otherwise than out of increase in value of property accrued prior to March 1, 1913, or earnings or profits, shall be taxable to the recipient only if and to the extent that such distribution exceeds the basis of his stock as provided in section 113 and articles 591-604. Any such distribution, however, shall be applied against and reduce the cost or other basis of the stock upon which declared, for the purpose of determining the gain or loss from the subsequent disposition of the stock.

Example: A purchased certain stock in 1918 for $10,000. If he receives in 1928 a distribution thereon of $2,000 paid by the corporation otherwise than out of its earnings or profits or the increase in value of property accrued prior to March 1, 1913, this distribution does not constitute taxable income to A. If A subsequently sells the stock, the difference between the amount realized therefor and $8,000 is taxable gain or deductible loss, as the case may be. If, however, A receives a distribution of $12,000 in 1928, paid by the corporation otherwise than out of its earnings or profits or the increase in value of property accrued prior to March 1, 1913, A realizes taxable income to the extent of $2,000, which at his option may be taxed as a capital gain. (See section 101 and article 501.)

ART. 625. Distributions in liquidation.—Amounts distributed in complete liquidation of a corporation are to be treated as in full. payment in exchange for the stock, and amounts distributed in partial liquidation are to be treated as in part or full payment in exchange for the stock so canceled or redeemed. The phrase "amounts distributed in partial liquidation " means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock. A complete cancellation or redemption of a part of the corporate stock may be accomplished, for example, by the complete retirement of all the shares of a particular preference or series, or by taking up all the old shares of a particular preference or series and issuing new shares to replace a portion thereof, or by the complete retirement of any part of the stock, whether or not pro rata among the shareholders.

The gain or loss to a shareholder from a distribution in liquidation is to be determined, as provided in section 111 and article 561, by comparing the amount of the distribution with the cost or other basis of the stock provided in section 113 and articles 591-604;

Art. 625

§ 115

but the gain or loss will be recognized only to the extent provided in section 112 and articles 571-580. Any gain to the shareholder may, at his option, be taxed as a capital net gain in the manner and subject to the conditions prescribed in section 101 and articles 501-503. In the case of amounts distributed in partial liquidation, other than a distribution in pursuance of a plan of reorganization as described in section 112 (h), the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of section 115 (b) for the purpose of determining the taxability of subsequent distributions by the corporation.

Example (1): A owns 10 shares of stock in the M Corporation for which he paid $1,250 in 1923. He receives in 1928 a dividend of $1,500 in complete liquidation. A is subject both to the normal tax and to the surtax upon his profit of $250 or at his option, in lieu of such taxes, to the tax upon capital net gain.

Example (2): A owns 10 shares of preferred stock and 10 shares of common stock in the M Corporation which he purchased in 1918 for $1,100 and $1,000, respectively. In 1928 the M Corporation has on hand $225,000 of capital, earnings and profits of $25,000 accumulated prior to March 1, 1913, and earnings and profits of $125,000 accumulated after February 28, 1913. The preferred stock is retired at $125 per share, $125,000 being used by the corporation for this purpose. A receives $1,250 in exchange for his 10 shares of preferred stock and is therefore subject to the normal tax and the surtax on $150, or at his option, in lieu of such taxes, to the tax upon capital net gain. The M Corporation then distributes a cash dividend of $25,000 on the common stock, which is subject only to the surtax. Without any further accumulation of earnings and profits, the M Corporation thereafter liquidates completely. A receives $2,250 in exchange for his 10 shares of common stock and is therefore subject to the normal tax and the surtax on $1,250, or at his option, in lieu of such taxes, to the tax upon capital net gain.

ART. 626. Distributions from depletion or depreciation reserves.-A reserve set up out of gross income by a corporation and maintained for the purpose of making good any loss of capital assets on account of depletion or depreciation is not a part of surplus out of which ordinary dividends may be paid. A distribution made from a depletion or a depreciation reserve based upon the cost of the property will not be considered as having been paid out of earnings or profits, but the amount thereof shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent disposi

tion of the stock. If such a distribution is in excess of the basis, the excess shall be taxed as a gain from the sale or other disposition of property. A distribution made from a depletion reserve based on the discovery value of a mine shall be similarly treated (by virtue of section 115 (d)), but a distribution from any other depletion reserve based upon discovery value, to the extent that such reserve represents the excess of the discovery value over cost or March 1, 1913, value, is, when received by the shareholders, taxable as an ordinary dividend. In the case of oil and gas wells the amount by which a corporation's depletion allowance for any taxable year based upon the income from the property (see section 114 (b) (3) and articles 241 and 611) exceeds a depletion allowance computed without reference to section 114 (b) (3), constitutes a part of the corporation's "earnings or profits accumulated after February 28, 1913," within the meaning of section 115, and, upon distribution to shareholders, is taxable to them as a dividend. A distribution made from that portion of a depletion reserve based upon a valuation as of March 1, 1913, which is in excess of the depletion reserve based upon cost, will not be considered as having been paid out of earnings or profits, but the amount of the distribution shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent disposition of the stock. No distribution, however, can be made from such a reserve until all the earnings or profits of the corporation have first been distributed.

ART. 627. Dividends paid in property.-Dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders. (See, however, section 112 (h) and article 576.) Where a corporation declares a dividend payable in stock of another corporation, setting aside the stock to be so distributed and notifying the shareholders of its action, the income arising to the recipients of such stock is its market value at the time the dividend becomes payable. (See article 333.) Scrip dividends are subject to tax in the year in which the warrants are issued.

ART. 628. Stock dividends.-The issuance of its own stock by a corporation as a dividend to its shareholders does not result in taxable income to such shareholders, but gain may be derived or loss sustained by the shareholders from the sale of such stock. The amount of gain derived or loss sustained from the sale of such stock, or from the sale of the stock in respect of which it is issued, shall be determined as provided in articles 561 and 600.

ART. 629. Distribution in redemption or cancellation of stock taxable as a dividend. If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

The question whether a distribution in connection with a cancellation or redemption of stock is essentially equivalent to the distribution of a taxable dividend depends upon the circumstances of each case. A cancellation or redemption by a corporation of a portion of its stock pro rata among all the shareholders will generally be considered as effecting a distribution essentially equivalent to a dividend distribution to the extent of the earnings and profits accumu lated after February 28, 1913. On the other hand, a cancellation or redemption by a corporation of all of the stock of a particular shareholder, so that the shareholder ceases to be interested in the affairs of the corporation, does not effect a distribution of a taxable dividend. A bona fide distribution in complete cancellation or redemption of all of the stock of a corporation, or one of a series of bona fide distributions in complete cancellation or redemption of all of the stock of a corporation, is not essentially equivalent to the distribution of a taxable dividend. Where a distribution is made pursuant to a corporate resolution reciting that the distribution is made in liquidation of the corporation, and the corporation is completely liquidated and dissolved within one year after the distribution, the distribution will not be considered essentially equivalent to the distribution of a taxable dividend; in all other cases the facts and circumstances should be reported to the Commissioner for his determination whether or not the distribution, or any part thereof, is essentially equivalent to the distribution of a taxable dividend.

SEC. 116. EXCLUSIONS FROM GROSS INCOME.

In addition to the items specified in section 22 (b), the following items shall not be included in gross income and shall be exempt from taxation under this title:

(a) Earned income from sources without United States.-In the case of an individual citizen of the United States, a bona fide nonresident of the United States for more than six months during the taxable year, amounts received from sources without the United States if such amounts constitute earned income as defined in section 31; but such