Rocky Corporation, an S corporation, reports the following results for the curre

Question

Rocky Corporation, an S corporation, reports the following results for the current year: Ordinary Income, $70,000 Long-term Capital Gain, $20,000 Municipal Bond interest income, $10,000 Domestic corporate dividends, $6,000, Charitable Contributions, $16,000 Rocky's AAA and accumulated E&P balances at the beginning of the year are $80,000 and $50,000, respectively. Rocky makes a $100,000 cash distribution to its sole shareholder on June 1 and a second $100,000 cash distribution on December 1. The shareholder's basis for Rocky stock on January 1 was $120,000. Discuss the consequences of these transactions (Refer to Chapter 11, S Corporations, S Corporations Distributions).

Explanation / Answer

Step 1: Calculate the Increase to the Basis of Shareholder's Stock

The increase to the basis of shareholder's stock is calculated as follows:

Increase to the Basis of Shareholder's Stock = 120,000 (Basis as on 1st January) + 70,000 (Ordinary Income) + 20,000 (Long Term Capital Gain) + 10,000 (Municipal Bond Interest Income) + 6,000 (Domestic Corporate Dividends) - 16,000 (Charitable Contributions) = $210,000.

_______

Step 2: Calculate Rocky's AAA Balance before Distributions for the Current Year

Rocky's AAA balance before distributions for the current year is calculated as follows:

Balance before Distributions for the Current Year = 80,000 (Opening E&P Balance) + 70,000 (Ordinary Income) + 20,000 (Long Term Capital Gain) + 6,000 (Domestic Corporate Dividends) - 16,000 (Charitable Contributions) = $160,000

_______

Step 3: Determine the Tax Consequences

The amount of cash distribution from Rocky's AAA balance is exempt from tax as the revised value of Rocky's stock basis ($210,000) is more than the Rocky's AAA balance ($160,000). The amount of cash distribution from Rocky's AAA balance is $80,000 [(100,000/(100,000 + 100,000)]*160,000] with respect to each distribution. Therefore, $80,000 for each cash distribution will be exempt from tax.

The remaining portion of $20,000 (100,000 - 80,000) of each cash distribution will be from Rocky's Accumulated E&P balance and will be treated as taxable dividend. The balance in the E&P balance at year end will be $10,000 (50,000 - 20,000 - 20,000). The allocation of $40,000 from E&P balance towards the cash distribution will have no effect on the stock basis.

The value of $10,000 municipal Bond interest income is a non-taxable income and it forms a part of the stockholder's basis only.

Rocky's stock basis at the end of the year will be $50,000 (210,000 - 160,000).

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.