Can someone who is familiar with the US tax laws help me with this question? ABC

Question

Can someone who is familiar with the US tax laws help me with this question? 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? I think that because E&P is negative for both current and accumulated that none of the distribution would be treated as a dividend and therefore is not taxable in the hands of the shareholder. Can anyone tell me what the shareholder's tax basis in the ABC Corp. stock is after the distribution and what the balance in E&P for ABC Corp. is the day after distribution? I am having trouble understanding this concept when the distribution is not taxable to the shareholder. Thanks so much!

Explanation / Answer

You are right in analyzing that because E&P is negative for both current and accumulated that none of the distribution would be treated as a dividend and therefore is not taxable in the hands of the shareholder.

Distributions in excess of E&P are treated as a return of capital that reduces the Shareholder's basis in the stock (not below zero), and distributions in excess of basis are capital gains (assuming the stock is a capital asset to the Shareholder).

So, here the distributions are in excess of E&P and should be treated as a return of capital that reduces the Shareholder's basis in the stock not below zero; we have to see the basis of his tax as he is the sole shareholder, his basis would be reduced by $350000.

After the distribution,  the balance in E&P for ABC Corp. would be same -$300000 and this amount of $350000 would not be subtracted from E&P as it is not a dividend distribution.

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