Question

On January 2, Chaz transfers cash of $193,800 to a newly formed corporation for 100% of the stock. In its initial year, the corporation has net income of $48,450. The income is credited to its earnings and profits account. The corporation distributes $14,535 to Chaz.

a. How do Chaz and the corporation treat the $14,535 distribution?
b. Assume instead that Chaz transfers to the corporation cash of $96,900 for stock and cash of $96,900 for a note of the same amount. The note is payable in equal annual installments of $9,690 and bears interest at the rate of 6%. No distributions are made during the year to Chaz. However, at the end of the year, the corporation pays an amount to meet the loan obligation(i.e., the annual $9,690 principal payment plus the interest due).
Determine the total amount of the payment and its tax treatment to Chaz and the corporation.

Answer 1

a. Chaz treats the $14,535 distribution as a return of capital. b. The total payment to meet the loan obligation depends on the principal payment and interest due. The tax treatment to Chaz and the corporation will depend on various factors.

Step-by-step explanation:

a. When Chaz receives a distribution of $14,535 from the corporation, it is treated as a return of capital. This means that Chaz is getting back part of their initial investment. The distribution is not taxable to Chaz, but it reduces Chaz's basis in the stock of the corporation.

b. In the second scenario, the total amount of the payment made by the corporation to meet the loan obligation at the end of the year is $9,690 principal payment plus the interest due. The tax treatment to Chaz and the corporation will depend on various factors, such as whether the interest paid is deductible for the corporation and the tax treatment of the principal payment.