Sunchaser Shakery Corporation had $50,000 of accumulated E&P on January 1.

During the current year, it had a $40,000 operating loss for the first six months,

but ended up with $15,000 in E&P.

Sunchaser made a $25,000 cash distribution to its shareholders at the end of the year.

What is the amount of accumulated E&P at the end of the year?

So our first objective here is to determine if the cash distribution was a dividend.

And so at the end of the year, we had accumulated E&P of $50,000,

and current E&P, when everything was all said and done, of $15,000.

So total E&P available for distribution at that time, was $65,000.

And we know that a cash distribution, when made,

comes from current E&P first, and then accumulated E&P.

So, we have a $25,000 cash distribution,

and so to figure out where this is coming from,

we start with current E&P first so we know that $15,000

of the $25,000 distribution will come from current E&P.

And that's because we determined that there is

$15,000 of current E&P available for distribution.

Because it's coming from E&P,

we know that this is a taxable dividend.

The remaining $10,000 of the $25,000 distribution,

so that we properly account for the entire thing,

will now come from accumulated E&P.

Because it's coming from E&P,

it is also a taxable dividend.

And so our overall goal here,

the question that we're being asked is,

what is the amount of accumulated E&P at the end of the year.

So now that we know the tax treatment of this particular distribution,

we can answer the question.

So, for when it comes to accumulated E&P,

our beginning balance before the distribution was $50,000.

And we determined above that $10,000 of

this particular distribution is coming from this accumulated E&P.

Meaning at the end of the year,

$40,000 of accumulated E&P remains available.

Nicholas holds all of the Sunchaser Shakery Corporation stock with the basis of $8,000.

Assume Sunchaser has $15,000 of current E&P and it distributes $25,200 cash to Nicholas.

What are the tax effects of the cash distribution?

So for [inaudible] filling out the tax effects of a cash distribution,

we must first focus on how much is a dividend.

Once we figured out the dividend status,

we can then move on to cost recovery or basis reduction and

everything else that remains is treated as a gain on the sale of stock.

So let's work through that.

So in this problem we have a $22,500 cash distribution.

And to figure out its tax effects,

we must first follow E&P.

So of this distribution,

there is $15,000 of E&P available for distribution.

So the first 15,000 of the $22,500 is treated as a dividend.

That is to the extent of current E&P.

From here we now go to the next step,

which is basis reduction,

or recovery of capital.

So the shareholder, Nicholas,

has an $8,000 basis in his stock,

so we're going to reduce his basis down to zero because he has

$8,000 and we still have more distribution to account for.

So his stock basis will go from 8,000,

all the way down to zero.

And then the amount that remains,

the $2,200 left, will be treated as a gain, from the sale of stock.

And of course, if he's held these shares long-term,

then he may receive long-term capital gain treatment.

If it's capital asset,

held greater than one year.

And for Sunchaser of course the E&P balance is now zero,

because it distributed all of its current E&P as a dividend.

Nicholas holds all of the Sunchaser Shakeri Corporation stock with a basis of $8,000.

Assume Sunchaser has a $15,000 deficit and accumulated E&P,

current year E&P of $20,000,

and it distributes $20,000 to Nicholas.

What are the tax effects of the cash distribution?

Well all distributions out of current E&P are dividends,

and distributions are deemed to come from current E&P, first.

So with that in mind, let's still write down everything that we know.

So we have a deficit of accumulated E&P of $15,000 and we have current E&P of $20,000.

And again, we know the distributions come out of current E&P first.

We have a distribution of $20,000.

So this initial $20,000 is going to come out of current E&P,

leaving no more of current E&P.

So this entire distribution,

because it's coming out of current E&P,

will be a taxable dividend to Nicholas.

And then even though Sunchaser has $15,000 of a deficit and accumulated E&P remaining,

all distributions to the extent of current E&P are still dividends.

And that's it.

Sunchaser Shakery Corporation

reports accumulated E&P of $200,000 at the beginning of the year,

and a deficit in current E&P of $100,000 at year end.

Sunchaser distributed $300,000 cash to its sole shareholder Nicholas in the current year.

In part A, we want to know what amount of the distribution is

treated as a dividend if it was made in December.

So let's recap what we know here.

We have accumulated E&P of $200,000,

and current E&P which is a deficit of $100,000.

So because current E&P is negative,

and accumulated E&P is positive,

then we know from the concepts discussion,

that we're allowed to net the two.

Leaving us with $100,000 of E&P available for distribution at the end of the year.

So since this number is positive,

any distributions of cash in this case,

which we have, are going to be dividends to the extent of this positive amount of E&P.

So, the distribution to Nicholas of $300,000,

will be treated as a taxable dividend,

to the extent of E&P available.

So $100,000, would be a dividend.

The remaining $200,000 would be basis reduction,

return of capital and gain from a sale of stock to the extent that we exceed the basis.

We don't have the basis information here for

this particular problem because the question is

about how much would be treated as a dividend.

So the answer for part A, is $100,000.

But we know the effects of the rest of it which would depend on basis and so forth.

And part B we want to know what are the effects of

the same distribution if instead of being made in December,

it was actually made in January.

Well this one's a little bit different because if the distribution's made in January,

current E&P was not yet existent.

And so for this we had at the time,

accumulated E&P of $200,000.

And so because we have $200,000 of E&P available for distribution,

when we examine the $300,000 distribution,

we know that the first $200,000 of it would be a taxable dividend.

Because it's to the extent of E&P on hand.

The remaining amount would affect basis and

potentially again on sale just like the prior part,

but we don't have that information here because the question is focused on dividends.

Lesson 5.2.2 Cash Distributions: Applications

Taxation of Business Entities I: Corporations

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