On January 1, 2011, Zundel, Inc., an electing S corporation, has $4,000 of AEP and a balance of $10,000 in AAA. Zundel has two shareholders, Erin and Maine, each of whom owns 500 shares of Zundel's stock. Zundel's 2011 taxable income is $5,000. Zundel distributes $6,000 to each shareholder on February 1, 2011, and distributes another $3,000 to each shareholder on September 1. How is Erin taxed on this distribution?

Question

Quizplus · Accepted Answer

Zundel's AEP on January 1, 2011, is $4,000, and its AAA balance is $10,000. Thus, each shareholder's AAA balance is $5,000 ($10,000 ÷ 2 shareholders). Erin receives $6,000 on February 1, and $3,000 on September 1. Zundel's taxable income for the year is $5,000, but its distributions to Erin total $9,000.

Erin is first allocated the $5,000 of AAA (which goes tax-free to her). The next $1,500 of distributions ($6,000 - $4,500) is considered dividend income, and the remaining $2,500 is considered a return of capital. Thus, Erin's reportable dividend income for 2011 is $1,500. Option C is the correct answer.