Question

Albatross Corporation has a deficit in accumulated E & P of $600,000 to its sole shareholder, Eugene, who has a basis in his stock of $105,000. As a result of the distribution, Eugene has:

A. Dividend income of $450,000 and reduces his stock basis to $55,000.

B. No dividend income reduces his stock basis to zero and has a capital gain of $500,000.

C. Dividend income of $105,000 and reduces his stock basis to zero.

D. None of the choices.

E. Dividend income of $450,000 and no adjustment to stock basis.

Please show works.

Answer 1

Choice C: Dividend income of $105,000 and reduces his stock basis to zero.

Stock basis determines how much money the investor can obtain from the corporation without having to realize a capital gain or income. Calculating stock basis is important since it measures the amount the shareholder can withdraw or receive from the corporation without realizing income or gain. The shareholder’s basis should reflect the shareholder’s economic investment in the corporation. Basis adjustments should be made at the end of each taxable year, taking into account income, distributions and deductions and losses—in the right order.

Since it has mentioned in the question that Eugene had a stock basis of $105,000, Eugene can only withdraw $105,000 from the corporation. Hence, if Eugene receives a dividend income of $105,000 his stock basis will reduce to zero. Thus, option C is correct