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

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Quizplus · Accepted Answer

The distribution is treated as a dividend to the extent of AAA, which is $9,000. Since Eric owns 50% of the stock, he is taxed on $4,500 of the distribution as a dividend. The remaining $1,500 is a nontaxable distribution of previously taxed income.