Kinney, Inc., an electing S corporation, holds $5,000 of AEP and $9,000 in AAA at the beginning of the calendar tax year. Kinney has two shareholders, Eric and Maria, each of whom owns 500 shares of Kinney's stock. Kinney's taxable income is $6,000 for the year. Kinney distributes $6,000 to each shareholder on February 1, and it distributes another $3,000 to each shareholder on September 1. How is Erin taxed on the distribution?

Question

Quizplus · Accepted Answer

First, we need to determine each shareholder's share of AEP:

Eric’s share = (500/1000) x $5,000 = $2,500 
Maria’s share = (500/1000) x $5,000 = $2,500

Next, we need to determine the balance in each shareholder's AAA account after the February dividend distribution:

Eric's AAA balance after February distribution: 
Beginning balance = $4,500 
Distribution = $6,000 x (500/1000) = $3,000 
Ending balance = $4,500 - $3,000 = $1,500

Maria's AAA balance after February distribution: 
Beginning balance = $4,500 
Distribution = $6,000 x (500/1000) = $3,000 
Ending balance = $4,500 - $3,000 = $1,500

Now, we can determine the taxability of the September distribution. Each shareholder will receive:

$3,000 x (500/1000) = $1,500

Since each shareholder has a positive AAA balance after the February distribution, the September distribution is considered a dividend distribution from AAA rather than AEP.

Therefore, Eric will have $1,500 of dividend income, and so will Maria.