Bluebird Corporation has a deficit in accumulated E&P of $180,000. For 2014, it

Question

Bluebird Corporation has a deficit in accumulated E&P of $180,000. For 2014, it has current E&P of $120,000. On December 31, 2015, Bluebird distributes $135,000 to its sole shareholder, Cameron. Cameron has a basis of $60,000 in his stock in Bluebird Corporation. As a result of the distribution,

a. Cameron has dividend income of $135,000.

b. Cameron has dividend income of $60,000 and reduces his stock basis to zero, and has a capital gain of $15,000.

c. Cameron has dividend income of $120,000 and reduces his stock basis to $45,000.

d. Cameron has no dividend income [because netting AEP and CEP yields negative amount], reduces his stock basis to zero, and has a capital gain of $75,000.

e. None of the above statements are correct.

Explanation / Answer

The correct answer is option C.

Dividend income is determined by the amount of both current and accumulated(positive) E&P. The corporation had current E&P (by the year end) of $120,000, ever through the corporation has a deficit in accumulated E&P. Therefore, only $120,000 of the distribution is a dividend.

The additional $15,000 distribution ($135,000-$120,000) is a "Return on capital" and reduces the basis from $60,000-$45,000.

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