Corporation is a calendar-year taxpayer. All of the stock is owned by Fred. His basis for the stock is $35,000. On 3/1 (non-leap year), Corporation distributes $120,000 to Evan. Determine the tax consequences of the cash distribution to Fred in each of the following independent situations.
Current E&P Accumulated E&P
30,000 100,000
50,000 (50,000)
(73,000) 40,000
(20,000) (50,000)
To determine the tax consequences of the cash distribution to Fred, we need to calculate the amount of dividend income and potential capital gain he may recognize. Here's how you can do it for each of the given situations:
Situation 1:
Current E&P: $30,000
Accumulated E&P: $100,000
In this situation, Fred's basis for the stock is $35,000, which is less than the accumulated E&P of $100,000. If the distribution is less than or equal to Fred's basis, it would be considered a return of capital and not taxable. However, since the distribution amount is $120,000, which exceeds Fred's basis, it would be treated as a dividend.
The dividend income to Fred would be the distribution amount minus his basis:
Dividend income = $120,000 - $35,000 = $85,000
Situation 2:
Current E&P: $50,000
Accumulated E&P: ($50,000)
In this situation, Fred's basis for the stock is $35,000, which is greater than the accumulated E&P of ($50,000). Since the accumulated E&P is negative, it means that the Corporation has a deficit.
When the accumulated E&P is negative, the distribution is treated as a return of capital up to the stockholder's basis. Therefore, the entire distribution of $120,000 would be considered a return of capital and not taxable to Fred.
Situation 3:
Current E&P: ($73,000)
Accumulated E&P: $40,000
Similar to situation 2, the accumulated E&P is less than Fred's basis of $35,000. Therefore, the entire distribution of $120,000 would be treated as a return of capital and not taxable to Fred.
Situation 4:
Current E&P: ($20,000)
Accumulated E&P: ($50,000)
In this situation, both the current E&P and accumulated E&P are negative. The distribution is treated as a return of capital up to the stockholder's basis. Since the distribution amount is $120,000, which is greater than Fred's basis of $35,000, the taxable amount would be the excess over his basis.
Taxable amount = Distribution amount - Basis = $120,000 - $35,000 = $85,000
The tax consequences for the cash distribution to Fred in each situation are as follows:
Situation 1: $85,000 dividend income.
Situation 2: No taxable income (return of capital).
Situation 3: No taxable income (return of capital).
Situation 4: $85,000 taxable income (excess distribution over basis).