Confused about REG MCQ

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  • #3305537

    Hi all,

    I am very confused about the below REG MCQ:

    Lark owns 10% of Baltic Corp., a calendar year-end C corporation. On June 30, year 2, Baltic made a $250,000 pro-rata cash distribution to its stockholders. Baltic had a $40,000 deficit in accumulated earnings and profits on January 1, year 2, and current earnings and profits for year 2 as follows:

    1st quarter $11,000
    2nd quarter ($10,000)
    3rd quarter $80,000
    4th quarter $60,000
    What portion of Lark’s June 30 distribution would be classified as a nontaxable return of capital, assuming that Lark’s tax basis in Baltic stock is $20,000?

    The answer is $1,000. My questions are following:

    1) What is the $240,000?? I thought it was accumulated E&P for Year 2, but no the math does not check out.
    2) How are we supposed to read this current E&P Schedule? Does it mean (a) CEP just for Quarter 2, this one quarter, is ($10,000) or (b) CEP BALANCE at Quarter 2 is ($10,000)?
    3) The answer key utilized Accumulated E&P at beginning of year of <40,000> in its final allocation of distribution into dividend/ROC. I don’t agree with this. This is beginning of year Accumulated E&P, we should have computed end of year E&P before making the allocation.

    Thanks guys… honestly surprised that I’m the only one stuck with this question. Any help is appreciated!

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