E&P is loosely based of federal income taxation, but it is truly based off the outside stock basis in a corporation (not tested on CPA Exam) with the big difference being the treatment of taxable loss. Certain non-deductible permanent differences become reductions to E&P, E&P depreciation is calculated using ADS lives and straight-line, etc.
I spent probably 40-50 hours researching E&P for a corporate client so let me give you my practical advice for 2) and 3).
1) Gain on prior year installment sale recognized in the current year –> Answer: Decrease E&P
I do not know this specific issue off the top of my head. Likely the reason is there are special rules for the timing of installment sales. Like E&P depreciation, certain “temporary difference” items are re-calculated under E&P basis.
2) State tax refunds from the prior year received in the current year –> Answer: No effect –
The inclusion of state tax refunds in E&P follows the treatment on the Federal 1120. The starting point of E&P is federal taxable income which includes state tax expense estimates and prior year state tax true-ups, so a good accountant is already accounting for this.
3) Increase in the cash surrender value of life insurance policies owned by the company –> Answer: Increase E&P.
Life insurance premiums which are non-deductible permanent differences are deducted in the calculation of E&P (to reduce basis for favorable capital gain treatment). On the other hand, tax exempt income which is permanently not included on the Federal 1120 is added back to E&P. My guess is this relates to tax exempt income. If you did not add back tax exempt income to your E&P basis, you would be punished for having tax exempt income to the extent you didn't have extra E&P for favorable capital gain treatment.
My suggestion is to focus on basic E&P adjustments, and the fact that distribution is a dividend only to the extent of corporate E&P, then it is a reduction in the shareholder's basis in the stock, and if the remaining distribution (after the E&P reduction) exceeds the basis, the rest is treated as a capital gain distribution on the sale of security.
REG 80 2/7/11
FAR 91 10/8/11
AUD 97 11/22/11
BEC 96 2/4/12
CPA 3/15/13
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