[kukuna2008]

Ninja MCQ:

Elm Corp. is an accrual-basis calendar-year C corporation with 100,000 shares of voting common stock issued and outstanding as of December 28, 2015. On Tuesday, December 29, 2015, Hall surrendered 2,000 shares of Elm stock to Elm in exchange for $33,000 cash. Hall had no direct or indirect interest in Elm after the stock surrender. Additional information follows:

Hall’s adjusted basis in 2,000 shares of Elm

on December 29, 2015 ($8 per share) $16,000

Elm’s accumulated earnings and profits at

January 1, 2015 25,000

Elm’s 2015 net operating loss (7,000)

What amount of income did Hall recognize from the stock surrender?

A.$33,000 dividend

B.$25,000 dividend

C.$18,000 capital gain

D.$17,000 capital gain

correct answer is D, But I thought should be B, since 25,000 will be distributed from AE&P first, tax as Dividends. then will be return of capital.

Thanks!

FAR - 83, 04/2015
AUD - 73, 86, 08/2015
REG - 75
BEC - 71, rematch in 04/2016

[Josh]

Confusing, huh? I tend to get tripped up on details like a e&p, etc.; but it appears to be a simple calculation of cash – adjusted basis for the capital gain? At least, that's what I read in a class from 6 years ago. I just got this question in a class I'm in tomorrow.

[CPA788]

Was there no NINJA explanation? If you just do a straight calc of 33k cash – 16k basis, you get 17k. That highlights the fact that this question didn't once say anything about a distribution 🙂 amirite. They gave you all the facts though to make you think it was a distribution. The stockholder just sold his shares back to the company, so it's just a plain jane FMV-basis situation. Selling shares is a capital gain.

You were almost on the right track btw if this 33k was a legit cash distribution. I do believe though that you would have had to do 25k-7k=18k of E/P and then work from there to calculate dividend amount. Someone call me out if that's not right.

BEC - 74, 77
FAR - 72, 71 (retake 7/29)
REG - 69
AUD - Q4 '16

CA Candidate

[thelatebloomer]

@kukuna2008 This is a stock redemption problem that usually tries to trick you into thinking that it's a dividend, when it's always a capital gain. If you do enough questions, you will see a bunch of these.

@CPA788 If this was a straight cash distribution with no redemption of stock, wouldn't you just take the $33,000 in cash and count the first $25,000 as dividend income to deplete the accumulated E&P, and the remaining $7,000 would be a return of capital? It is a funny hypothetical, considering there are several reasons this problem can't end up that way.

[CPA788]

@thelatebloomer – keeping this topic alive because i'm trying to master it still.

Per my Becker book: “If current E&P is negative and accumulated E&P is positive, the two amounts are netted, and distributions are dividends if the net is positive.”

Adding the rest to round it out:

>”If both current and accum are positive, there are no netting issues; distributions are dividends to the extent of the total of current and accumulated E&P.”
>”If current E&P is positive and accumulated E&P is negative, distributions are dividends to the extent of current E&P only.”

***
Visually b/c this is literally helping me re-learn at this point:

+Acc E&P
+ Current E&P
= Dividends are combination of both acc and current E&P

(Acc E&P)
+ Current E&P
= Dividends are limited to Current E&P only

+Acc E&P
(current E&P)
= Net accumulated with current. Dividends are limited to this amount.

BEC - 74, 77
FAR - 72, 71 (retake 7/29)
REG - 69
AUD - Q4 '16

CA Candidate

[thelatebloomer]

@CPA788: Oh! Thanks for hammering that out. Current would be netted with accumulated to end up with $17,000. That makes a lot more sense.

[jereumie]

They just redeemed the stock. This is not a distribution (dividend), so the calculation is 33k – 16k (basis) = 17k cap gain. This has nothing to do with E&P. You care about E&P to calculate the taxable distribution when paying out dividends. E&P is just there to confuse us, to ruin our career, if not.

Speaking of E&P, if current E&P is positive and Accum. E&P is negative, you net it and the netted amount is taxable distribution as dividend.

Adding on, + current and + accum, you also net this. If – current and – accum, nothing is taxable, because you made nothing. Everything is return of capital.

One tricky part is + current and – accum. In this case, you deduct from current first, then rest is return of capital. For example, if current is 10 and accum is -10. If you got a distribution of 15, then 10 (taking off from current) is taxable dividend, and the rest 5 is return of capital.

[Author]

Replies