Question

Husker Corporation reports current E&P of negative $200,000 in year 1 and accumulated E&P at the beginning of the year of $300,000. Husker distributed $200,000 to its sole shareholder on December 31, year 1. The shareholder's tax basis in her stock in Husker is $50,000. How is the distribution treated by the shareholder in year 1?

A) $200,000 dividend.
B) $100,000 dividend and $100,000 tax-free return of basis.
C) $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain.
D) $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain.

Answer 1

The distribution by Husker Corporation to its shareholders in year 1 is treated as a combination of dividends, tax-free return of basis, and capital gain. The correct option is C) $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain.

Step-by-step explanation:

The distribution by Husker Corporation to its sole shareholder in year 1 will be treated as a combination of dividend, tax-free return of basis, and capital gain. Since the accumulated E&P at the beginning of the year is $300,000 and the current E&P is negative $200,000, the distribution can be considered as a dividend to the extent of $100,000. The remaining $100,000 is treated as a tax-free return basis because it does not exceed the shareholder's tax basis of $50,000. Lastly, the $50,000 difference between the distribution and the shareholder's tax basis is treated as a capital gain.

The correct option is C) $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain.