At the beginning of the year, Clampett, Incorporated, had $100,000 in its AAA and $60,000 of earnings and profits from prior C corporation years. During the year, Clampett, Incorporated, earned $50,000 of ordinary income and paid $200,000 in distributions to its shareholders. Assume that J.D. owns 25percent of Clampett, Incorporated, his basis in Clampett, Incorporated, at the beginning of the year is $30,000, and his share of the distribution was $50,000. How much, if any, of the distribution is taxable as a dividend?

Question

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The first step is to calculate Clampett, Incorporated's current earnings and profits. This is the sum of the prior earnings and profits ($60,000) plus the current year's ordinary income ($50,000), which equals $110,000.

Next, we need to calculate J.D.'s share of the AAA and the earnings and profits. J.D.'s share of the AAA at the beginning of the year is 25% of $100,000, or $25,000. His share of the prior year's earnings and profits is 25% of $60,000, or $15,000.

Since the distribution of $50,000 exceeds J.D.'s share of the AAA ($25,000), the first $25,000 of the distribution will be treated as a non-taxable return of capital. The remaining $25,000 of the distribution is treated as a dividend.

J.D.'s share of the dividend is 25% of $25,000, or $6,250. However, J.D.'s basis in Clampett, Incorporated, is only $30,000, so he can only take $30,000 of the distribution tax-free as a return of capital. Therefore, $20,000 ($30,000 - $10,000) of J.D.'s $50,000 share of the distribution is taxable as a dividend.

Thus, the answer is choice C, $12,500.

At the Beginning of the Year, Clampett, Incorporated, Had $100,000