Longhorn Company reports current E&P of $175,000 in 20X3 and accumulated E&P at the beginning of the year of negative $350,000. Longhorn distributed $525,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $175,000. How is the distribution treated by the shareholder in 20X3?

Answer: $175,000 dividend, $175,000 tax-free return of basis, and $175,000 capital gain.

Explanation:

First off let us establish the facts,

We have an Accumulated E&P at beginning of year - $350,000

Current E&P is $175,000

And they Distributed $525,000 to sole shareholder on January 1, 20X3

Shareholder tax basis is $175,000

Due to the above facts, the shareholder will treat $525,000 as follows:

Current E&P is $175,000 so Dividends will be $175,000.

The tax basis being 175,000 will then lead to $175,000 to be counted as a tax free return of basis.

The rest being, 525,000 - 175,000 - 175,000

= $175,000 will be treated as Capital Gain.

So in conclusion the distribution will be treated by the shareholder like this,

$175,000 dividend, $175,000 tax-free return of basis, and $175,000 capital gain.