ExpertHard1 markMultiple Choice
CPA · Question 33 · Area III: Entity Tax Planning
An S Corporation has Accumulated Earnings and Profits (AEP) of $20,000 from C Corp years. The Accumulated Adjustments Account (AAA) balance is $10,000. The shareholder has a stock basis of $50,000. The corporation distributes $40,000 cash. What is the tax treatment for the shareholder?
An S Corporation has Accumulated Earnings and Profits (AEP) of $20,000 from C Corp years. The Accumulated Adjustments Account (AAA) balance is $10,000. The shareholder has a stock basis of $50,000. The corporation distributes $40,000 cash. What is the tax treatment for the shareholder?
Answer options:
A.
$40,000 Tax-Free Return of Capital
B.
$10,000 Tax-Free; $30,000 Dividend Income
C.
$10,000 Tax-Free; $20,000 Dividend Income; $10,000 Return of Capital
D.
$30,000 Tax-Free; $10,000 Dividend Income
How to approach this question
Distribution Ordering for S Corp with AEP: 1. AAA (Tax free, reduces basis). 2. AEP (Taxable Dividend, no basis reduction). 3. Return of Capital (Tax free, reduces basis). 4. Capital Gain.
Full Answer
C.$10,000 Tax-Free; $20,000 Dividend Income; $10,000 Return of Capital✓ Correct
IRC §1368(c). Distribution $40,000. 1. From AAA ($10,000) -> Tax-free. 2. From AEP ($20,000) -> Taxable Dividend. 3. Remainder ($10,000) -> Return of Capital (reduces remaining basis).
Common mistakes
Skipping AEP; reducing basis for AEP distribution.
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