CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a C corporation, has $70,000 of current earnings and profits (E&P) and an accumulated deficit in E&P of ($30,000). The corporation distributes $100,000 cash to its sole shareholder. How much of the distribution is treated as a dividend?
- A$0
- B$100,000
- C$70,000
- D$40,000
Show answer & explanationAnswer & explanation
Correct answer: C. $70,000
Corporate distributions are first treated as dividends to the extent of current E&P, then accumulated E&P. Current E&P is not offset by an accumulated deficit. Therefore, the entire $70,000 of current E&P is treated as a dividend.
Why the other options are wrong
- A. This is incorrect; current E&P will always be distributed first as a dividend.
- B. This would imply the entire distribution is a dividend, which is incorrect as it exceeds the current E&P.
- D. This calculation incorrectly nets current and accumulated E&P, which is not done when current E&P is positive and accumulated E&P is negative.
C Corp Distribution Hierarchy with E&P
For C corporations, distributions to shareholders are first treated as dividends to the extent of current E&P, then accumulated E&P, then as a return of capital (reducing stock basis), and finally as capital gain.
- Current E&P is distributed first, even if there's an accumulated deficit.
- Accumulated E&P is offset by an accumulated deficit before distributions are applied.
- Distributions reduce stock basis to zero before being treated as capital gain.
Memory trick: C-Corp Cash Out: Current, Accumulate, Basis, Gain.