The Serenity Corporation distributes $200,000 in cash to its shareholder during 2014. Accumulated earnings and profits are $80,000 as of January 1, 2014. Current earnings and profits for 2014 are $84,000. Jonas, the sole shareholder of Serenity Corporation, has a basis of $48,000 in his stock. What is the tax effect of the distribution for Jonas?
A) Jonas will recognize ordinary income of $164,000 and a capital gain of $36,000.
B) Jonas will recognize ordinary income of $84,000, capital gain of $80,000 and a tax-free recovery of capital of $36,000.
C) Jonas will recognize ordinary income of $164,000 and a tax-free return of capital of $36,000.
D) Jonas will recognize ordinary income of $164,000 and a capital loss of $12,000.
E) Jonas will recognize ordinary income of $200,000 and a capital loss of $12,000.

Question

Quizplus · Accepted Answer

The distribution is first applied to earnings and profits, totaling $164,000 ($80,000 accumulated + $84,000 current), which is ordinary income. The remaining $36,000 is a return of capital, reducing the basis to zero.

The Serenity Corporation Distributes $200,000 in Cash to Its Shareholder