[needhelpnow]

Bridge, a C corporation, had $15,000 in accumulated earnings and profits at the beginning of the current year. During the current year, Bridge reported earnings and profits of $10,000 and paid $20,000 in cash distributions to its shareholders in both March and July. What amount of the July distribution should be classified as dividend income to Bridge’s shareholders?

a $20,000

b $15,000

c $10,000

d $5,000

Answer: D

When total distributions during the year exceed current and accumulated earnings and profits (E&P), the dividends paid must be allocated as follows: (i) current E&P are allocated on a pro rata basis to each distribution; (ii) accumulated E&P are applied in a chronological order, beginning with the first distribution. The $10,000 of current E&P is allocated equally between the March and July distributions. The $15,000 of accumulated E&P is allocated entirely to the March distribution. Thus, $20,000 of the March distribution and $5,000 of the July distribution is classified as a dividend.

Can someone please dumb down this for me and try explaining? I don’t quite understand how they came up with that answer 🙁 Thank you!

[lamfi02]

Even though in total they are distributing $40,000, the only amount of the $40,000 distribution that can be dividend income is to the extent of the accumulated earnings (15,000) and the current earnings (10,000) for a total of $25,000.

First there is a $20,00 distribution in March:

total accum and current earnings 25,000

less the March distribution (20,000)

remaining earnings = 5,000

So, even though there is a second distribution in July of 20,000, only 5,000 will be dividend income to the shareholders for that month because dividend income is only recognized to the extent of the accumulated earnings and current earnings that is left after the March distribution(5,000). I believe that the remaining 15,000 of the distribution is considered a “return of capital” to the shareholders.

I hope that helps!

[Author]

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