Maria owns 75% and Christopher owns 25% of Cockatoo Corporation, a calendar year taxpayer. Cockatoo makes a $600,000 distribution to Maria on April 1 and a $200,000 distribution to Christopher on May 1 . Cockatoo's current E & P is $120,000 and its accumulated E & P is $500,000 . What are the tax implications of the distributions to Maria and Christopher?
Current E & P is allocated on a pro rata basis to each distribution made during the year. Cockatoo Corporation made $800,000 of distributions during the year. Christopher's distribution represents 25% ($200,000/$800,000) of that amount. Consequently, 25% of Cockatoo's current E & P, or $30,000 ($120,000 × 25%), is allocated to Christopher's distribution. Maria's distribution represents 75% ($600,000/$800,000) of total distributions. Consequently, 75% of Cockatoo's current E & P, or $90,000 ($120,000 × 75%), is allocated to Maria's distribution.
Accumulated E & P is applied in chronological order beginning with the earliest distribution.
When Maria's distribution is made, Cockatoo has $590,000 of dividend-paying capacity ($500,000 of accumulated E & P plus $90,000 of current E & P). Therefore, $590,000 of Maria's distribution is treated as a dividend with the balance ($10,000) being a return of capital (to the extent of her stock basis) and then a capital gain. After this distribution, Cockatoo has no accumulated E & P remaining.
When Christopher's distribution is made, Cockatoo has $30,000 remaining in current E & P. Therefore, $30,000 of Christopher's distribution is treated as a dividend with the balance ($170,000) being a return of capital (to the extent of his stock basis) and then a capital gain. After the distribution to Christopher, Cockatoo has no remaining current or accumulated E & P.
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