A C Corporation has current year Earnings & Profits (E&P) of $20,000 and accumulated E&P of ($30,000) at the beginning of the year. The corporation makes a $25,000 cash distribution to its sole shareholder. What is the tax treatment of the distribution?

Answer options:

$0 dividend, $25,000 return of capital.

$20,000 dividend, $5,000 return of capital (to extent of basis).

$0 dividend, because net E&P is negative ($20k - $30k = -$10k).

$25,000 dividend.

How to approach this question

Nimble Dividend Rule: If Current E&P is positive, distributions are dividends up to that amount, regardless of negative Accumulated E&P.

Full Answer

B.$20,000 dividend, $5,000 return of capital (to extent of basis).✓ Correct

Distributions are dividends to the extent of Current E&P ($20,000). The fact that Accumulated E&P is negative is ignored when Current E&P is positive. The remaining $5,000 is a return of capital (reducing basis) and then capital gain.

Common mistakes

Netting positive current E&P with negative accumulated E&P.

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