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arushi_13
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Posted: 07 Jul 2009 at 23:06 \| IP Logged

Chicago Corp. a calendar year C corp. had accumulated earnings and profits of $100,000 as of Jan 1,2006 and had a deficit of its CEP for the entire 2006 tax year in the amount of $140k. Chicago Corp. distributed $30,000 cash to its shareholders on Dec 31,2006. What would be the balance of Chicago Corp.'s AEP as of Jan 1,2007?

Ans: (40k)

My Q is since AEP is positive the 30k distributed as cash is a dividend distribution. So it reduces AEP on a FIFO basis. Thus at yr end the AEP should be 100k-140k-30k=(70k). So why are we just netting CEP of
($140k) against AEP of $100k and since the balance is negative of ($40k) we are leaving it to that....

Please advise:)

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bryris
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Posted: 08 Jul 2009 at 00:23 \| IP Logged

Here is my take: (disclaimer: I was stumped on this too and had to look it up in my old tax stuff)

Distributions to a shareholder are only taxed as a dividends to the shareholder to the extent of corp E&P.

In the case of (and ONLY in the case of) having a negative C E&P, with a positive A E&P, we must utilize the date of the distribution and net the prorata share of the negative C E&P with the A E&P as of that date to determine the extent of TOTAL E&P available from which to pay dividends.

In this example, we use Dec 31 as the distribution date. Accordingly, there is no prorating involved. We must net the (140k) with the 100k to get a negative TOTAL E&P balance of (40k). Which is the answer.

Thus, since there is NO E&P from which to distribute dividends, the distribution will be tax free to the extent of shareholder basis (return of capital).

Added note:

There are 4 combinations of E&P situations.

1 + C + A (If +C, any dist made on any date of the year can be taken out of C as if the dist were made at the end of the year)
2 +C -A (Same as #1)
3 -C +A (Must net C as of # of days into the year dist was made with A to determine whether E+P existed on that date)
4 -C -A (No dist can be made as div, all ROC to SH)

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Nan - Louisiana
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Posted: 08 Jul 2009 at 00:29 \| IP Logged

I had $100,000 in my investment account. This year I lost $140,000, so my account is now overdrawn by $40,000. You were expecting a share of my profits, but I didn't have any to share.

Earnings and Profits come off of the income statement into the Accumulated E&P Balance Sheet Account (i.e., Retained Earnings), which now has a negative 40,000 balance.

I want to keep you around, though, so I gave you the company car instead which is worth 30,000. (Assume FMV on car = current BV, so no gain/loss calculation.)

Conversion of asset (whether car or cash like question says) is a balance statement transaction: Reduce assets by 30,000. Reduce shareholder's equity by 30,000. Since no E&P is available to distribute, shareholder's basis in stock is reduced by 30,000. As long as the recipient's basis in stock is equal to or greater than the 30,000, this basis-reduction "dividend" is not taxable income to the stockholder.

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