12 18 in order to determine the treatment of these

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12-18 In order to determine the treatment of these distributions, the balances in the var- ious retained earnings accounts must be determined. The balances are determined on the last day of the taxable year regardless of when the distributions are made. More importantly, the balances are those after positive adjustments and before ad- justments for nondeductible and deductible items. The balances are as follows: Stock Basis AAA OAA AE&P Balances before distributions � � � $210,000 $229,000 $13,000 $4,000 a. The $100,000 distribution is all from AAA and represents a nontaxable return of capital, reducing the shareholder’s basis to $110,000 and the AAA account to $129,000 as shown below. Stock Basis AAA OAA AE&P Balances before distributions � � � $210,000 $229,000 $13,000 $4,000 Distribution $100,000 � � � � � � � � AAA (100,000 ) � � � � � � � (100,000 ) (100,000 ) Ending balances� � � � � � � � � � � � � $110,000 $129,000 $13,000 $4,000 b. The $220,000 distribution represents $220,000 of AAA. Distributions of AAA are nontaxable but only to the extent of the shareholder’s basis. Therefore, of the $220,000 distributed, $210,000 is a nontaxable return of basis and the remaining $10,000 is capital gain. Note that because the distribution exhausts the shareholder’s basis, the capital loss and the charitable contribution are not deductible and must be carried over. Stock Basis AAA OAA AE&P Balances before distributions � � � $210,000 $229,000 $13,000 $4,000 Distribution $220,000 � � � � � � � � (210,000 ) (200,000 ) Ending balances� � � � � � � � � � � � � $ 0 $ 9,000 $13,000 $4,000
Solutions to Problem Materials 12-7 Unauthorized reproduction prohibited. © Pratt & Kulsrud c. The $260,000 represents $229,000 from AAA, $4,000 from Accumulated E&P, $13,000 from OAA, and $3,000 from paid-in capital. As a result, the shareholder must report a capital gain of $46,000 and a dividend of $ 4,000 as computed below. As above, the distribution exhausts the shareholder’s basis, thereby preventing the deduction of the capital loss and the charitable contri- bution both of which can be carried over to the following year. Stock Basis AAA OAA AE&P Balances before distributions � � � $210,000 $229,000 $13,000 $4,000 Distribution $260,000 � � � � � � � � AAA (229,000 ) � � � � � � � (210,000 ) (229,000 ) Balances � � � � � � � � � � � � � � � � � � $ 0 $ 0 $13,000 $4,000 AEP (4,000 ) � � � � � � � (4,000 ) Balances � � � � � � � � � � � � � � � � � � $ 0 $ 0 $13,000 $ 0 OAA (13,000 ) � � � � � � � (13,000 ) Balances � � � � � � � � � � � � � � � � � � $ 0 $ 0 $ 0 $ 0 (See Examples 1, 3, and 4 and pp. 12-5 through 12-8.) 12-19 a. The corporation must recognize a long-term capital gain of $25,000 on the distribution of the IM stock. b. J and G report their shares of ordinary income ($35,000 × 50% = $17,500) and their shares of the capital gain on the stock ($25,000 × 50% = $12,500). AAA AE&P Total Beginning balance � � � � � � � � � � � � � � � � $ 90,000 $30,000 $120,000 Net ordinary income � � � � � � � � � � � � � � 35,000 35,000 Gain on stock � � � � � � � � � � � � � � � � � � � 25,000 25,000 Subtotal� � � � � � � � � � � � � � � � � � � � � � � � $150,000 $30,000 $180,000 Distribution—G � � � � � � � � � � � � � � � � � � (75,000) (75,000) Distribution—J� � � � � � � � � � � � � � � � � � � (75,000 ) (75,000 ) $ 0 $30,000 $ 30,000 The distribution to the extent of AAA is allocated equally to J and G. Both shareholders have sufficient basis to prevent any of the distribution from being taxable as gain from sale of stock.

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