Question

Beaver Company reports current E&P of $100,000 in year 1 and accumulated E&P at the beginning of the year of $200,000. Beaver distributed $400,000 to its sole shareholder on January 1, year 1. The shareholder's tax basis in her stock in Beaver is $200,000. How is the distribution treated by the shareholder in year 1?

a. $200,000 dividend and $200,000 nontaxable return of basis.
b. $400,000 dividend.
c. $100,000 dividend, $200,000 nontaxable return of basis, and $100,000 capital gain.
d. $300,000 dividend and $100,000 nontaxable return of basis.

Answer 1

The distribution by the shareholder in year 1 will be treated as a $200,000 dividend and a $200,000 nontaxable return of basis (option a). When a corporation distributes earnings and profits (E&P), it is treated as a dividend to the shareholders. However, since the shareholder's tax basis in her stock is $200,000, she will also have a nontaxable return of basis of $200,000.

Step-by-step explanation:

The distribution by the shareholder in year 1 will be treated as a $200,000 dividend and a $200,000 nontaxable return of basis (option a).

When a corporation distributes earnings and profits (E&P), it is treated as a dividend to the shareholders. In this case, Beaver Company distributed $400,000 to its sole shareholder, which exceeds its current E&P of $100,000. Therefore, the entire distribution will be treated as a dividend.

However, since the shareholder's tax basis in her stock is $200,000, she will also have a nontaxable return of basis of $200,000. This means that $200,000 of the distribution will not be subject to tax as it is a return of her initial investment in the company.