ExpertHard1 markMultiple Choice
CPA · Question 34 · Area V: Entity Taxation
An S Corporation has an Accumulated Adjustments Account (AAA) of $20,000 and Accumulated Earnings and Profits (AEP) from C Corp years of $10,000. The corporation distributes $35,000 to its sole shareholder. The shareholder's stock basis (before distribution) is $50,000. How is the distribution taxed?
An S Corporation has an Accumulated Adjustments Account (AAA) of $20,000 and Accumulated Earnings and Profits (AEP) from C Corp years of $10,000. The corporation distributes $35,000 to its sole shareholder. The shareholder's stock basis (before distribution) is $50,000. How is the distribution taxed?
Answer options:
A.
$35,000 Tax-Free Return of Capital
B.
$20,000 Tax-Free; $10,000 Dividend Income; $5,000 Tax-Free Return of Capital
C.
$20,000 Tax-Free; $15,000 Dividend Income
D.
$35,000 Dividend Income
How to approach this question
Ordering Rule for S Corps with AEP: 1. AAA (Tax Free/Basis Redux). 2. AEP (Taxable Dividend). 3. Remaining Basis (Tax Free/Basis Redux). 4. Excess (Capital Gain).
Full Answer
B.$20,000 Tax-Free; $10,000 Dividend Income; $5,000 Tax-Free Return of Capital✓ Correct
Distributions come first from AAA (tax-free to extent of basis): $20,000. Next from AEP (taxable dividend): $10,000. Remaining $5,000 is return of basis (tax-free). Total: $20k + $5k tax-free, $10k taxable.
Common mistakes
Skipping the AEP layer or treating the whole amount as return of basis.
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