Question

This year, Sooner Company reports a deficit in current E&P of ($362,000). Its accumulated E&P at the beginning of the year was $270,000. Sooner distributed $540,000 to its sole shareholder, Boomer Wells, on June 30 of this year. Boomer’s tax basis in his Sooner stock before the distribution is $101,500. (Leave no answer blank. Enter zero if applicable. Negative amount should be indicated by a minus sign.)

a) How much of the $540,000 distribution is treated as a dividend to Boomer?

b) What is Boomer's tax basis in his Sooner stock after the distribution?

Answer 1

Answer 1: In order to calculate a portion of $540000 to be considered as dividends:

Firstly, we have to calculate the deficit in current earnings and profit as per the question:

Deficit in current Earnings and Profit = (Current EP / Total number of months) x (Number of months since June 30 to Dec 31)

= ( 362000 / 12) x 6

Deficit in current EP = $181,000

Share of distribution to be considered as dividend = Accumulated Earnings and Profit (given) - Deficit in current EP (from above)

= $270,000 - $181,000

= $89,000 - thus $89,000 out of $540,000 shall be treated as dividend for tax purposes;

Answer 2: Calculation of tax basis for Boomer Wells in stock holdings after distribution of $540,000 would be:

The present tax basis of Boomer Wells in stock holdings is = $101,500

and, Accumulated Earnings and Profit (after deducting dividend portion) is = $540,000 - $89,000

= $451,000

Now, this portion of accumulatede earnings and profit which is not treated as dividend as per the tax laws - will reduce the tax basis of Boomer Wells.

However, here the tax basis is $101,500 less than distribution (excluding dividend) and also, in excess of accumulated E&P which is = ($451,000 - $101,500) = $349,500

Therefore, in the present case, the tax basis of Boomer wells will be $0 (zero). and the remaining balance beyond the tax basis $349,500 (from above) shall be treated as capital gains for the purpose of taxation.

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