Question

Steven owns 100% of Wildhorse Inc stock, which he purchased 9 months ago on March 31 for $2,800. Wildhorse Inc distributes cash of $6,900 to Steven on December 31, when their earnings and profits (E&P) were $3,900. What is the tax effects to Steven from the payment of the cash distribution. Dividend Income, Reduction of basis of stock, Short-term capital gain/loss

Answer 1

1 The entire $6,900 distribution is treated as a dividend for tax purposes.

2 The reduction in basis is $3,000.

3 The short-term capital gain is $6,900.

1 The distribution of $6,900 is greater than the company's earnings and profits (E&P) of $3,900. Therefore, the entire $6,900 distribution is treated as a dividend for tax purposes.

2 The cash distribution of $6,900 will reduce Steven's basis in his Wildhorse Inc stock. The basis is essentially the amount Steven has invested in the stock. The reduction in basis is calculated as the excess of the distribution over the E&P. In this case, it is:

= $6,900 - $3,900

= $3,000.

3 If the cash distribution exceeds Steven's basis in the stock, the excess is treated as a capital gain. In this case, since the distribution ($6,900) is greater than Steven's adjusted basis ($0), there will be a short-term capital gain.

The short-term capital gain is calculated as the excess of the distribution over the adjusted basis:

= $6,900 - $0

= $6,900.