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2 August, 21:02

Aaron and Michele, equal shareholders in Cavalier Corporation, receive $25,000 each in distributions on December 31 of the current year. During the current year, Cavalier sold an appreciated asset for $60,000 (basis of $15,000). Payment for the sale of the asset will be made as follows: 50% next year and 50% in the following year, with interest payable at a rate of 6 percent. Before considering the effect of the asset sale, Cavalier's current year E & P is $40,000 and it has no accumulated E & P. How much of Aaron's distribution will be taxed as a dividend?

a. $0

b. $20,000

c. $25,000

d. $42,500

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Answers (1)
  1. 2 August, 22:59
    0
    b. $20,000

    Explanation:

    Dividend is an amount of money that a company pays out its earnings and profits (E&P) and/or reserves on a regular basis, especially yearly, to its shareholders, especially ordinary shareholders and preference shareholders.

    It should be noted that reserves are accumulated E&P. Therefore, a company that does not have accumulated E&P can only pay dividend out of its current E&P. Any amount paid in excess of the current profit after tax when there is no accumulated E&P cannot be considered as dividend.

    From the question,

    Cavalier's current year E&P = $40,000

    Cavalier's accumulated E&P = 0

    Aaron's Shareholding in Cavalier = 50%

    Amount received by Aaron = $25,000

    Cavalier's total amount that can be considered as dividend = Cavalier's current year E&P + Cavalier's accumulated E&P

    Cavalier's total amount that can be considered as dividend = $40,000 + 0

    = $40,000

    Dividend received by Aaron is Cavalier's total amount that can be considered as dividend multiply by Aaron's Shareholding in Cavalier. That is:

    Dividend received by Aaron = $40,000 * 50%

    = $20,000

    Amount received by Aaron but not dividend = Amount received by Aaron - Dividend received by Aaron

    Amount received by Aaron but not dividend = $25,000 - $20,000

    = $5,000

    Therefore, Aaron's distribution that will be taxed as a dividend is $20,000 which is the actual dividend received by Aaron.

    All the best.
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