Longhorn Company reports current E&P of $195,000 in 20X3 and a deficit of ($390,000)in accumulated E&P at the beginning of the year. Longhorn distributed $585,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $195,000. How is the distribution treated by the shareholder in 20X3?
A)$585,000 dividend
B)$195,000 dividend, $195,000 tax-free return of basis, and $195,000 capital gain
C)$195,000 dividend and $390,000 tax-free return of basis
D)$0 dividend, $195,000 tax-free return of basis, and $390,000 capital gain

Question

Quizplus · Accepted Answer

The distribution of $585,000 is first applied to reduce the accumulated E&P deficit of ($390,000). The remaining $195,000 is considered a dividend to the shareholder. However, since the shareholder's tax basis in the stock is also $195,000, the first $195,000 of the distribution is considered a tax-free return of basis, reducing the shareholder's tax basis to zero. The remaining $390,000 is considered a capital gain to the shareholder. Therefore, the correct answer is B.

Longhorn Company Reports Current E&P of $195,000 in 20X3 and a Deficit