Chance Corporation has a $20,000 deficit in earnings and profits as of January 1, 2018. During 2018, the corporation has current earnings and profits of $40,000 and makes a $70,000 cash distribution to its shareholders. What part of the distribution is taxable as dividend income to Chance's shareholders?
A)$- 0 -
B)$20,000
C)$30,000
D)$40,000
E)$70,000

Question

Quizplus · Accepted Answer

The distribution is taxable as dividend income to the extent of current earnings and profits ($40,000). The deficit in earnings and profits from the beginning of the year does not reduce the current year's earnings and profits for dividend distribution purposes. Therefore, the first $40,000 of the distribution is considered dividend income. The remaining $30,000 is a return of capital or capital gain, depending on the shareholder's basis in the stock.

Chance Corporation Has a $20,000 Deficit in Earnings and Profits