Question

At the beginning of the year, Myrna Corporation (a calendar year taxpayer) has E & P of $32,000. The corporation generates no additional E & P during the year. On December 31, the corporation distributes $50,000 to its sole shareholder, Abby, whose stock basis is $10,000. How is the distribution treated for tax purposes?

If an amount is zero, enter "0". As a result the distribution Abby has the following:

Dividend income: ?

Return of capital: ?

Capital gain: ?

Stock basis after the distribution: ?

Can you please explain you answer thank you!

Answer 1

To the extent that a distribution is made from corporate earnings and profits (E & P), the shareholder is deemed to receive a dividend. Distributions not treated as dividends (because of insufficient E & P) are nontaxable to the extent of the shareholder’s stock basis, which is reduced accordingly. The excess of the distribution over the shareholder’s basis is treated as a gain from sale or exchange of the stock (generally, a capital gain).

In this situation, Abby recognizes dividend income of $32,000 (the amount of E & P). Of the remaining $18,000 ($50,000 − $32,000) distributed, $10,000 reduces her stock basis to zero, and she recognizes a capital gain of $8,000.