On January 1, 2012, Zundel, Inc., an electing S corporation, has $4,000 of AEP and a balance of $10,000 in AAA.Zundel has two shareholders, Erin and Maine, each of whom owns 500 shares of Zundel's stock.Zundel's 2012 taxable income is $5,000.Zundel distributes $6,000 to each shareholder on February 1, 2012, and distributes another $3,000 to each shareholder on September 1.How is Erin taxed on this distribution?

Question

Quizplus · Accepted Answer

Since Zundel is an S Corporation, its profits and losses are passed through to the shareholders and taxed on their individual tax returns.

At the beginning of the year, Zundel had $4,000 of accumulated earnings and profits (AEP) and $10,000 in accumulated adjustments account (AAA).

When Zundel makes a distribution to its shareholders, it first reduces the AAA balance, then reduces the AEP balance, and any remaining distribution is treated as a taxable dividend to the shareholder.

In this case, Zundel distributed a total of $9,000 to each shareholder in 2012, which is greater than the AAA balance of $10,000. Therefore, the entire distribution is treated as a taxable dividend to the shareholders.

Since Erin owns 500 shares of Zundel stock, she received a total of $9,000 in distributions. Since the entire distribution is treated as a dividend, Erin will report $1,500 of dividend income on her individual tax return.

Therefore, the answer is C) $1,500 dividend income.