Question

Elk Company reports negative current E&P of $270,000 and positive accumulated E&P of $440,000. Elk distributed $340,000 to its sole shareholder, Barney Rubble, on December 31, 20X3. Barney's tax basis in his Elk stock is $127,500. What is the tax treatment of the distribution to Barney and what is his tax basis in Elk stock after the distribution?

Answer 1

In Accounting,E & P refers to the earnings and profits.It implies company's net profits after the payment of dividend to the stock holders.

When the current E&P is negative, the tax status of the dividend is determined by calculating Accumalated E&P on the date of distribution.

On Dec 20X3,

Accumulated E&P(beginning of the year)	$440,000
Current yr E&P	($270,000)
Accumulated E&P	$170,000

Tax treatment of distribution to Barney:-

Out of $340,000 distributed to stakeholders,the E&P of $170,000 is treated as dividend

Then the tax basis of Barney amounting$127,500 is treated as tax free basis of return.

The remaining amount is treated as capital gain.

Earnings distributed to stakeholders	340,000
Less: Dividend	(170,000)
Less: Tax free basis of return	(127,500)
Capital gains	$42500

Tax basis after the distribution:-

Tax basis of Barney in Elk stock is decreased by the amount of dividend earned i,e the excess of Accumulated E&P of 170,000

Tax basis= 127500 - 170000

=($42500) which is recognised as capital gain

Thus the tax basis of Barney in Elk stock DECREASES.