Question

Lone Star Company is a calendar-year corporation, and this year Lone Star reported $112,000 in current E&P that accrued evenly throughout the year. At the beginning of the year, Lone Star's accumulated E&P was $13,440. Lone Star declared $33,600 in cash distributions on each of the following dates: April 1, July 1, October 1, and December 31. a. How much of the $134,400 in total distributions will be treated as dividends? b. Suppose that Matt owned all Lone Star's shares at the beginning of the year and sold half of the shares to Chris on June 1stJune 1st for $44,800. How much dividend income will Matt recognize this year? c. If Matt's basis in the Lone Star shares was $7,840 at the beginning of the year, how much capital gain will he recognize on the sale and distributions from Lone Star?

a. How much of the $134,400 in total distributions will be treated as dividends?

Answer 1

a. The dividends will be $8,960.
b. Matt will recognize dividend income of $3,360,000.
c. Matt will recognize a capital gain of $40,880 on the sale and a capital gain of $130,480 on the distributions from Lone Star.

Step-by-step explanation:

To determine how much of the $134,400 in total distributions will be treated as dividends, we need to calculate the current and accumulated earnings and profits (E&P) of Lone Star Company. At the beginning of the year, the accumulated E&P was $13,440. Throughout the year, Lone Star reported $112,000 in current E&P that accrued evenly. The total dividends declared on April 1, July 1, October 1, and December 31 amount to $134,400. To find out how much will be treated as dividends, we subtract the accumulated E&P and the current E&P from the total distributions. The dividends will be $134,400 - $13,440 - $112,000 = $8,960.

To answer part b, we need to consider the ownership of shares. Matt owned all of Lone Star's shares at the beginning of the year and sold half of the shares to Chris on June 1st for $44,800. The dividend income that Matt will recognize this year is equal to the dividend distribution per share multiplied by the number of shares Matt owned at the time of distribution. The dividend distribution per share is $33,600, so Matt's dividend income will be $33,600 x (total shares owned - shares sold) = $33,600 x (200 - 100) = $33,600 x 100 = $3,360,000.

To answer part c, we need to calculate the capital gain on the sale and distributions from Lone Star. Matt's basis in the Lone Star shares at the beginning of the year was $7,840. When Matt sold half of the shares to Chris on June 1st, the basis for the shares sold is half of the original basis, which is $7,840/2 = $3,920. The capital gain on the sale of shares is the selling price minus the basis, which is $44,800 - $3,920 = $40,880. The capital gain on the distributions is the total distributions minus the basis for the shares retained, which is $134,400 - $3,920 = $130,480. Therefore, Matt will recognize a capital gain of $40,880 on the sale and a capital gain of $130,480 on the distributions from Lone Star.