What is the first impact of distributions that are considered a return of capital?

Distributions classified as a return of capital have a direct effect on the basis of the shareholder's stock in the corporation. When a corporation makes a return of capital distribution, it reduces the shareholder's basis in the stock they hold. This is important because it reflects the fact that a portion of their investment in the company has been returned to them rather than considered a taxable dividend.

This reduction in stock basis will only be taxable once the basis reaches zero, and any distribution beyond that could lead to capital gains. Thus, understanding that these distributions initially reduce the stock's basis is crucial for tax planning and reporting purposes.

The other options suggest immediate tax consequences or an increase in tax liability, which does not align with the treatment of return of capital distributions as they are not immediately taxable and only impact tax liabilities when the basis is exhausted. Ignoring the distribution for tax purposes is also not correct, as the return of capital still needs to be reported, albeit it is treated differently compared to standard dividends.