CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a C corporation, has accumulated earnings and profits (E&P) of $100,000. It distributes $70,000 cash to its sole shareholder, whose basis in the stock is $50,000. What is the amount of taxable dividend recognized by the shareholder?
- A$70,000
- B$50,000
- C$0
- D$20,000
Show answer & explanationAnswer & explanation
Correct answer: A. $70,000
Distributions from a C corporation are considered dividends to the extent of the corporation's current and accumulated E&P. Since the corporation has $100,000 of E&P, the entire $70,000 cash distribution is considered a taxable dividend to the shareholder.
Why the other options are wrong
- B. This is the shareholder's basis, which is only relevant after E&P is exhausted.
- C. This is incorrect; distributions from E&P are taxable dividends.
- D. This would be the amount if the distribution exceeded E&P and basis, resulting in a capital gain.
C Corp Distribution Hierarchy
Distributions from a C corporation are taxed in a specific order: first as a dividend to the extent of E&P, then as a return of capital to the extent of stock basis, and finally as a capital gain.
- 1. To extent of E&P: Taxable Dividend.
- 2. To extent of stock basis: Tax-free return of capital.
- 3. Excess over stock basis: Capital Gain.
Memory trick: E&P First, Basis Next, Gain Last!