On January 1,2015,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 2015 taxable income is $6,000.Kinney distributes $6,000 to each shareholder on February 1,2015,and distributes another $3,000 to each shareholder on September 1.How is Erin taxed on the distribution?

Question

Quizplus · Accepted Answer

According to the information provided, at the beginning of the year, Kinney, Inc. had $9,000 in AAA and $5,000 of AEP. This means that the AAA balance was sufficient to cover the distributions made by the S-corporation. Under the rules of S-Corporations, distributions are deemed to come out of AAA first, and then AEP.

Therefore, Eric's first $6,000 distribution is considered to come out of AAA, which now has a balance of $3,000 ($9,000-$6,000). The distribution of $3,000 made on September 1 is also treated as a distribution of the AAA account.

Since Eric received $9,000 in distributions during the year and the S-Corporation's taxable income for the year was only $6,000, Eric will have dividend income of $1,500 ($9,000-$7,500). Therefore, choice C is correct.