At the beginning of the current year, both Gerald and Nicolas own 50% of Apple Corporation. In July, Gerald sold his stock to Sarah for $110,000. At the beginning of the year, Apple Corporation had accumulated E & P of $200,000 and its current E & P is $250,000 (prior to any distributions). Apple distributed $260,000 on March 1 ($130,000 to Gerald and $130,000 to Nicolas) and distributed another $260,000 on October 1 ($130,000 to Sarah and $130,000 to Nicolas). What are the tax implications of the $130,000 distribution to Sarah?

Distributions are taxable income and are included in the gross income computation as they are total amount in cash ($130,000) or otherwise, received by the owners or accrued to the owners or in favor of the owners and must be not of a capital nature.

Therefore the $130,000 is taxable income is as a profit share.

As present E and P is assigned on a star rata premise to circulations made during the year, one-half, or $125,000 ($250,000 ' $260,000/$520,000), is designated to the March 1 dispersion and one-half ($125,000) is dispensed to the October 1 conveyance.

The $200,000 of aggregated E and P is distributed sequentially. Subsequently, on March 1, Apple has $325,000 of profit paying limit ($125,000 of current E and P and $200,000 of aggregated E and P). Consequently, the March 1 dispersion is altogether treated as a profit and Apple has $65,000 of amassed E and P staying after the circulation.

On October 1, Apple has $190,000 of profit paying limit ($125,000 of current E and P and $65,000 of collected E and P). So of the $260,000 dissemination, $190,000 is treated as a profit and, as a half investor, a lot of this is $95,000.

In this way, of the $130,000 got by Sarah, $95,000 is a profit disseminated from E and P ($62,500 current E and P + $32,500 amassed E and P), while the remaining $35,000 is a nontaxable recuperation of capital. Thus, her stock premise is diminished to $75,000 ($110,000 - $35,000).