Question

Problem 5-25 (LO. 1, 2) Cardinal Corporation, a calendar year taxpayer, receives dividend income of $250,000 from a corporation in which it holds a 10% interest. Cardinal also receives interest income of $35,000 from municipal bonds. (The municipality used the proceeds from the bond issue to construct a library.) Cardinal borrowed funds to purchase the municipal bonds and pays $20,000 of interest on the loan. Excluding these three items, Cardinal's taxable income is $500,000. Cardinal has $150,000 of accumulated E & P at the end of the prior year, and it paid Federal income taxes of $131,250 during the year. Click here for the Dividend Received Deduction Table. a. After these three items are taken into account, Cardinal Corporation's taxable income is $ b. Cardinal Corporation's accumulated E & P at the start of next year is $

Answer 1

Dividends received deduction is tax break applied to corporations who receives dividend from the companies in which it holds stake. The deduction eliminates triple taxation consequences on dividend receipt.

There are three tiers of possible deductions:

	Allowed deduction of dividend
If company holds less than 20% of another company	50%
If company holds more than 20% - 80%of another company	65%
If company holds more than 80%	100%

Applicable deduction would be 50% as Cardinal holds only 10% interest.

Requirement 1

Computation of taxable
Income excluding dividends		500,000
Dividend received	250,000
Less: Dividend received deduction of 50%	(125,000)	125000
Taxable income		$ 625,000

Cardinal Corporation taxable income shall be $ 625,000

Requirement 2

E & P beginning balance	150,000
Add:
Taxable income	625,000
Dividend received deduction	125,000
Interest income	35000
Less:
Interest paid	(20,000)
Federal taxes paid	(131,250)
E & P balance	$ 783,750

Cardinal corporation accumulated E & P balance at the start of next year is $ 783,750

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