Wildcat Corporation reports a deficit in current E&P of ($200,000) in the current year and accumulated E&P at the beginning of the year of $100,000. Wildcat distributed $300,000 to its sole shareholder on December 31 of the current year. How much of the distribution is treated as a dividend in the current year?

Question

BlackTom AI · Accepted Answer

Topic at hand: determining the portion of a corporate distribution that is treated as a dividend for the current year when there is both current year E&P deficit and beginning accumulated E&P.
Option 1: "$0". This is the correct choice. Here’s why: the company starts with $100,000 of accumulated E&P. The current year shows a deficit in E&P of $200,000. When E&P is negative in the current year, the distribution reduces accumulated E&P first, and if the current year E&P is negative enough to erase all accumulated E&P, then no portion of the distribution is treated as a dividend for the current year. In this case, beginning E&P of $100,000 is entirely offset by the $200,000 current-year deficit, leaving no positive E&P to support a current-year dividend. Therefore, the distribution is not a dividend to the extent of E&P in the current year, and the entire amount would be treated as a return of capital to the extent of the shareholder’s basis, with any remainder potentially as a capital gain. So $0 is the amount treated as a dividend in the current year.
Option 2: "$100,000". This would imply that some positive E&P remains to support a dividend, but the current-year E&P deficit ($-200,000) more than offsets the beginning accumulated E&P ($100,000), resulting in no positive E&P available for a current-year dividend. Hence this choice is incorrect.
Option 3: "$200,000". This would suggest that $200,000 of the distribution is covered by E&P in the current year, but the current-year E&P is negative, not positive, so it cannot create a $200,000 dividend amount in the current year. This reflects a misapplication of the ordering of E&P or a misunderstanding that a deficit increases dividend eligibility, which is not the case.
Option 4: "$300,000". This would treat the entire distribution as a dividend, ignoring the E&P deficits entirely. In reality, dividends are limited to available E&P; when E&P is negative for the current year, and accumulated E&P is not enough to create positive current-year E&P, not all of the distribution qualifies as a dividend. Therefore this option overstates the dividend portion.
In summary, the key concept is that current-year E&P deficit reduces or eliminates the available positive E&P to support a current-year dividend, and any remaining distribution is treated as a return of capital (to the extent of basis) with any excess as gain. Thus, the correct amount treated as a dividend in the current year is $0.

SU25-BL-BUS-A329-2695 Quiz 19

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