On January 1, 2014, Kinney, Inc., an electing S corporation, holds $5,000 of AEP and $9,000 in AAA. Kinney has two shareholders, Eric and Maria, each of whom owns 500 shares of Kinney's stock. Kinney's 2014 taxable income is $6,000. Kinney distributes $6,000 to each shareholder on February 1, 2014, and distributes another $3,000 to each shareholder on September 1. How is Erin taxed on the distribution?

Question

Quizplus · Accepted Answer

Since Kinney is an electing S corporation, its taxable income flows through to the shareholders. In 2014, Kinney had taxable income of $6,000, which will also flow through to the shareholders, Eric and Maria.

The first distribution of $6,000 on February 1 will be taken out of the accumulated earnings and profits (AEP) first, up to the amount of AEP ($5,000 in this case), then the rest of the distribution ($1,000) will be considered a distribution of AAA. Therefore, each shareholder will have a $500 dividend income for that distribution.

The second distribution of $3,000 on September 1 will be considered a distribution of AAA since all of the AEP has been distributed in the first distribution. Therefore, each shareholder will have a $1,500 dividend income for that distribution.

So in total, Erin will have $2,000 ($500 + $1,500) of dividend income.