Pheasant Corporation, a calendar year taxpayer, has $400,000 of current E & P and a deficit in accumulated E & P of $180,000. If Pheasant pays a $600,000 distribution to its shareholders on July 1, how much dividend income do the shareholders report?

Question

Pheasant Corporation, a calendar year taxpayer, has $400,000 of current E & P and a deficit in accumulated E & P of $180,000. If Pheasant pays a $600,000 distribution to its shareholders on July 1, how much dividend income do the shareholders report?

BlackTom AI · Accepted Answer

We need to determine how much of the $600,000 distribution is treated as dividend income to the shareholders.
First, recall the rules: a distribution from a corporation is treated as a dividend to the extent of the corporation's earnings and profits (E&P). E&P consists of current E&P (for the year) plus accumulated E&P. If there is a deficit in accumulated E&P, that deficit reduces the amount of E&P available to be treated as dividends.
Option-by-option analysis:
- $0: This would imply there is no dividend income at all. That would only occur if the corporation had no positive E&P available to distribute as dividends. Here, the current year E&P is $400,000 and there is a deficit in accumulated E&P of $180,000, so there is still some positive E&P available.
- $20,000: This would represent a very small dividend, but given the numbers, even after accounting for the deficit, there should be more E&P available than $20,000. Specifically, the available E&P equals current E&P minus the accumulated E&P deficit: $400,000 − $180,000 = $220,000. Thus a dividend of $20,000 is too small.
- $220,000: This matches the calculation of available E&P after accounting for the deficit in accumulated E&P. The current year E&P is $400,000, but there is a deficit of $180,000 in accumulated E&P, so the portion of the distribution that can be treated as a dividend is $220,000. The remaining $380,000 would be treated as a return of capital or as other tax treatments, depending on basis, but the dividend amount is $220,000.
- $400,000: This would suggest all of the current year E&P ($400,000) is available as a dividend, ignoring the accumulated E&P deficit. However, the $180,000 deficit in accumulated E&P reduces the amount of E&P available for dividends, so $400,000 cannot be the dividend amount.
- None of the above: Since $220,000 correctly reflects the E&P available after accounting for the deficit, this option is not correct.
In summary, the correct interpretation is that the dividend income reported by shareholders equals the positive E&P available for the distribution: current E&P of $400,000 reduced by the $180,000 accumulated E&P deficit, yielding $220,000 as dividend income. The remaining $380,000 would not be considered dividends and would typically be a return of capital to the extent of the shareholder's basis, potentially creating capital gain if the basis is exhausted.

Pheasant Corporation, a calendar year taxpayer, has $400,000 of current E & P and a deficit in accumulated E & P of $180,000. If Pheasant pays a $600,000 distribution to its shareholders on July 1, how much dividend income do the shareholders report?

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