The gain is calculated based on the company's fair market value (FMV) when it distributes non-liquidating assets to its shareholders. Here's how it works:

• The corporation receives a profit if the FMV of the distributed property is higher than its adjusted tax basis. The gain is regarded as if the property was sold at FMV.
• Shareholders receive the recognized gain which leads to an increase in their share capital.
• A loss cannot be recognized by the corporation if the FMV of the distributed property is lower than its adjusted tax basis.
• At the time of distribution, the FMV of the distributed property is the shareholder's basis in it.

Here is an illustration for your explanation:

• An 'S-Corporation' distributed to "S" more than his share in the corporation.

• There were no accumulated earnings or profits for the 'S' corporation.

  What is the correct way for 'S' to handle the distribution beyond its basis?

Solution:

• It is imperative to classify it as a capital gain.
• The stock's basis is reduced when an 'S' corporation with no accumulated earnings and profits makes distributions.
• Any distribution exceeding the adjusted basis of the stock is considered a profit from the sale or exchange of the property.
• Capital gain is a result of the S-Corporation stock being considered a capital asset.

Another instance is if an S-Corporation transfers a non-liquated asset to its stockholer.

When an S-corporation sells equipment with an FMV of $20,000 and an adjusted basis of $0, it recognizes a $20,000 gain that is passed on to its shareholders. The property will be valued at $20,000 by the shareholder who receives the equipment.