Question

At the end of the year, before distributions, Bombay (an S corporation) has an accumulated adjustments account balance of $16,000 and accumulated E&P of $21,250 from a previous year as a C corporation. During the year, Nicolette (a 40 percent shareholder) received a $21,250 distribution (the remaining shareholders received $31,875 in distributions). (Assume her stock basis is $42,500 after considering her share of Bombay’s income for the year but before considering the effects of the distribution.)

• What is the amount and character of gain Nicolette must recognize from the distribution?
• What is her basis in her Bombay stock at the end of the year?

Answer 1

What is the amount and character of gain Nicolette must recognize from the distribution?

Dividend	8,500
Return on Capital	12,750

What is her basis in her Bombay stock at the end of the year?

Basis

29,750

Calculation

	Description	Amount	Calculation
(a)	Total Distribution	21,250
(b)	Bombay Accumulated Adjusted Account beginning balance	16,000
(c)	Distribution from Accumulated Adjusted Account	16,000	Lesser of (a) or (b)
(d)	Prop in excess of Accumulated Adjusted Account	21,250
(e)	Nicolettes Share Basis	6,400	(c) x 40% nontaxable
(f)	Nicolettes Beginning Stock	42,500
(g)	Nicolettes Reduced Basis	36,100	(f) – (e)
(h)	Bombay E&P	21,250
(i)	Dividend distribution E&P	21,250
(j)	Nicolette’s share dividend	8,500	(h) x 40%
(k)	Nicolettes Share Basis	6,350	(h) – (e) – (j)
(l)	Nicolettes ending Basis	29,750	(g) – (k)

Return on Capital = 21,250 - 8,500 = 12,750

Note:

(Nicole is not taxed on the first $6,400 of the distribution as Nicole's proportionate share is $6,400.

Nicole's proportionate share is $8,500. So, the next $8,500 of the distribution is a dividend to Nicole and that would not reduce the stock basis.