Question

Longhorn Company reports current E&P of $100,000 in year 1 and accumulated E&P at the beginning of the year of negative $200,000. Longhorn distributed $300,000 to its sole shareholder on January 1, year 1. The shareholder's tax basis in his Longhorn stock is $100,000. How is the distribution treated by the shareholder in year 1?

A) $300,000 dividend.
B) $100,000 dividend and $200,000 tax-free return of basis.
C) $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain.
D) $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain.

Answer 1

The distribution from Longhorn Company is treated as a $0 dividend with a $100,000 tax-free return of basis and $200,000 capital gain for the shareholder.

Step-by-step explanation:

In this scenario, Longhorn Company distributed $300,000 to its sole shareholder when the accumulated E&P at the beginning of the year was negative $200,000, and the current E&P for the year was $100,000. The treatment for the shareholder would be Option C: $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain. The initial $100,000 of the distribution is a return of the shareholder's basis in the stock, and since the remaining distribution exceeds the current E&P, the excess $200,000 is treated as a capital gain.