Oreo Corporation has accumulated E&P of $8,000 at the beginning of the current year. During the year (a nonleap year), the corporation incurs a current E&P deficit of $18,250. The corporation distributes $11,000 on March 20th to Morris, its sole shareholder, who has a $9,000 basis for his stock. If the exact loss cannot be determined as of the date of distribution, the treatment of the distribution will be
A)$4,100 dividend and a $6,900 capital gain.
B)$11,000 return of capital.
C)$4,100 dividend and a $6,900 tax free return of capital.
D)$8,000 dividend and a $3,000 return of capital.

Question

Quizplus · Accepted Answer

Since the corporation started with an E&P of $8,000 and then incurred a deficit of $18,250, it has a negative E&P for the year. The distribution of $11,000 first applies against the positive beginning E&P, resulting in a $4,100 dividend. The remaining $6,900 reduces the shareholder's basis in the stock, but since the basis is $9,000, this portion is a tax-free return of capital, not a capital gain.

Oreo Corporation Has Accumulated E&P of $8,000 at the Beginning