H owns 100 shares of A Corp.(or 1% of the stock), which he purchased two years ago for $30 each.A's net earnings this year were respectable-2 million-but their board decides to distribute $4 million.Assuming A Corp.had no AE&P before this year, how is the amount shareholder H receives reported on his individual return?

Question

Quizplus · Accepted Answer

The total amount distributed by A Corp. is $4 million, and since H owns 1% of the stock, he will receive $40,000 ($4 million x 1%). However, the amount he receives may consist of different types of income. First, the amount of the distribution in excess of A Corp.'s earnings (which is $2 million in this case) is considered a return of capital. Therefore, $2 million of the $4 million distributed to H is a nontaxable return of capital. Second, the remaining $2 million distributed to H is classified as a dividend. Since H bought his shares two years ago for $30 each, his tax basis in the stock is $3,000 ($30 per share x 100 shares). Thus, the taxable portion of the $2 million dividend is $37,000 ($40,000 distribution - $2,000,000 return of capital - $1,000 tax basis). This $37,000 is subject to the lower tax rate for qualified dividends, while the $3,000 nontaxable return of capital reduces H's tax basis in the stock to $0. Therefore, H has a $17,000 ($37,000 taxable portion - $20,000 tax on qualified dividends) capital gain on the sale of his stock (assuming he sells it for its fair market value).

H Owns 100 Shares of a Corp