Earnings and Profits For this assignment, read the scenario below and then evalu

Question

Earnings and Profits

For this assignment, read the scenario below and then evaluate the impact of E&P.

ABC Corporation has current E&P of ($200,000). E&P at the beginning of the year was ($100,000). ABC Corp. makes a distribution of $350,000 to its sole shareholder on the least day of the year. The shareholder had a tax basis of $50,000. Determine the following (make sure that you show all calculations):

- How much of the distribution is treated like a dividend to the shareholder?

- After the distribution takes place, what is the shareholder's tax basis in the ABC Corp. stock after the distribution?

- What is the balance in E&P for ABC Corp. the day after the distribution?

- Discuss why E&P is measured. If E&P was not measured in the scenario presented above, what are the potential problems?

Explanation / Answer

When both current and accumulated E&P are negative, then any distributions are considered a nontaxable return of paid-in capital.

Ans: Distribution as dividend is nil as E& P balance is negative so $350000 is treated as return on capital.

Ans:The shareholder tax basis will be $50000 as $350000 received from corporation is return on capital which is not taxable.

Ans: E & P after day distribution is $200000+$100000=$(300000) it would remain same as it is negative.

Ans: E & P is measured beacause t has 2 choices as to what to do with it: it can retain the earnings so that it can be invested in the business or it can be distributed to shareholders in the form of dividends. Any distribution of cash or property to the owners of a corporation is known as a distribution. Whether that distribution is taxable depends on whether the distribution is classified as a dividend or a return of capital. A return of paid-in capital is not taxable, since it is not a profit.

The potential problem is that if E & P was not measured we would have treated $350000 as dividend but in the above scenario it is not dividend as E & P is negative and it is return on capital.

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