CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a C corporation, has $50,000 of current earnings and profits (E&P) and an accumulated deficit of ($20,000) at the beginning of the year. The corporation makes a cash distribution of $60,000 to its sole shareholder during the current year. What portion of the distribution is taxable as a dividend to the shareholder?
- A$60,000
- B$50,000
- C$30,000
- D$0
Show answer & explanationAnswer & explanation
Correct answer: B. $50,000
A distribution is a dividend to the extent of current E&P, then accumulated E&P. Current E&P is $50,000. This amount is distributed first as a taxable dividend. Since the accumulated E&P is a deficit, no further portion of the distribution will be considered a dividend from accumulated E&P. The remaining $10,000 ($60,000 - $50,000) will reduce the shareholder's stock basis and then be treated as capital gain once basis is exhausted.
Why the other options are wrong
- A. Incorrect. The distribution exceeds current E&P, and there is no accumulated E&P to cover the rest.
- C. Incorrect. This may result from an incorrect calculation or understanding of the E&P hierarchy.
- D. Incorrect. Current E&P makes a portion of the distribution taxable as a dividend.
C Corp Distribution Hierarchy with E&P
Corporate distributions are taxed as dividends to the extent of current E&P, then accumulated E&P. Amounts exceeding E&P reduce stock basis, then are treated as capital gains.
- Current E&P is exhausted first.
- Accumulated E&P is exhausted second.
- Distributions in excess of total E&P reduce shareholder's stock basis.
- Once basis is zero, further distributions are capital gain.
Memory trick: Current first, Accumulated second, Basis then Capital.