Question

Eva has been the sole shareholder of a calendar year S-Corporation since its inception. Eva’s stock basis is $50,000, her debt basis is $15,000 and she receives a cash distribution of $88,000. There are no special elections made. All calculations must be shown. Any answers containing words or paragraphs without calculations will not be counted.

What is the tax impact of the distribution if instead the S-Corporation has accumulated adjustment account of $40,000, $0 adjusted earning and profit and $0 other adjustment account before the distribution? Please be sure to explain the $88,000 distribution.

Answer 1

SOLUTION

When a regular corporation makes a profit in a year, it pays corporate income taxes on that profit. After-tax profit can then be paid out to the shareholders as dividends or reinvested in the company as retained earnings. A company that has been granted S corp status by the Internal Revenue Service doesn't have to pay corporate income taxes. Instead, the profit "flows through" the company to its shareholders. The shareholders report that profit as personal income on their tax returns.

Example

If you hold, say, 60 percent of the stock in an S corp, and the company has a profit of $50,000, you are responsible for reporting $30,000 of that as income -- and paying taxes on it.

Just like regular corporations, S corps can distribute profits to their shareholders, keep them as retained earnings or do a little of both. The difference is that the regular corporation makes this decision after it pays corporate income taxes. An S corp doesn't pay taxes. The shareholders pay all the taxes on the company's profit, no matter what the company does with that profit. If the company then distributes profits to the shareholders, the distribution isn't taxable income to the shareholders because they are already paying income taxes on the money. But if it chooses to keep profit as retained earnings, the shareholders still pay income taxes on the money.

Conclusion

In the view of above Eva is only liable to pay tax on adjusted earning and profit for current year.

Sice adjusted earning and profit for current year is NIL therefore tax payable on distribtion by EVA is NIL