Aaron and Michele, equal shareholders in Cavalier Corporation, receive $25,000 each in distributions on December 31 of the current year. During the current year, Cavalier sold an appreciated asset for $60,000 (basis of $15,000). Payment for the sale of the asset will be made as follows: 50% next year and 50% in the following year with interest payable at a rate of 6 percent. Before considering the effect of the asset sale, Cavalier's current-year E & P is
$40,000 and it has no accumulated E & P. How much of Aaron's distribution will be taxed as a dividend?
A) $0
B) $20,000
C) $25,000
D) $42,500
E) None of these.

Question

Quizplus · Accepted Answer

$25,000The distribution to Aaron will be taxed as a dividend to the extent of the corporation's current Earnings and Profits (E&P). Given that Cavalier Corporation's current-year E&P is $40,000 before considering the asset sale, and the sale of the appreciated asset would increase E&P by the gain on the sale ($60,000 - $15,000 = $45,000), the total E&P for the year would be $85,000 ($40,000 + $45,000). Since the distributions ($25,000 to Aaron and $25,000 to Michele, totaling $50,000) are less than the available E&P, Aaron's entire distribution of $25,000 will be taxed as a dividend.

Aaron and Michele, Equal Shareholders in Cavalier Corporation, Receive $25,000