Question

1. Mantis, the sole shareholder of Xenomorph Corporation, sold her stock to Drax on July Mantis’ stock basis at the beginning of the year was $150,000. Xenomorph made a $70,000 cash distribution to Mantis immediately before the sale, while Drax received a $140,000 cash distribution from Xenomorph on November 1. As of the beginning of the current year, Xenomorph had $35,000 in accumulated E & P, while current E & P (before distributions) was $75,000. (20 points)

1. How much of the current and accumulated E&P will be allocated to each distribution?

2. How will Mantis’ distribution be treated?

3. How will Drax’s distribution be treated?

Answer 1

PART – a)

Current E&P of Xenomorph = $75,000

Pro-rata ratio = Cash distribution to Mantis/Cash distribution to Drax

                      = $70,000/$140,000

                      = 1:2

Allocation of current E&P:

Mantis = $75,000*1/3

            = $25,000

Drax = $75,000*2/3

         = $50,000

Allocation of accumulated E&P:

The allocation of accumulated E&P is made in the chronological order. Thus, firstly allocation will be made to Mantis i.e. $25,000 and the remaining amount will be allocated to Drax i.e. $10,000 computed by subtracting $35,000 from $25,000.

PART – b)

Distribution to Mantis = $25,000 + $25,000

                                     = $50,000

$50,000 will be treated as dividend and $20,000 will be treated as reduction in the stock basis.

PART – c)

Distribution to Drax = $50,000 + $10,000

                                  = $60,000

$60,000 will be treated as dividend and $80,000 will be treated as reduction in the stock basis.