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Money, Inc., a calendar year S corporation in Denton, Texas, has two unrelated shareholders, each owning 50% of the stock. Both shareholder record a $400,000 stock basis as of January 1. At the beginning of the tax year, Money reports balances in AAA of $300,000 and AEP of $600,000. During the year, Money generates operating income of $100,000. At the end of the year, Money distributes securities worth $1,000,000, with an adjusted basis of $800,000. The two shareholders consent to an AAA bypass election. What is the Federal income tax effects of these transactions for the shareholders? If an amount is zero, enter "0". Each shareholder receives a $ taxable distribution and a $ tax-free distribution from AAA. The AAA is $ at the end of the year, and each shareholder's basis is $ . AEP is reduced to $ .

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Answer:

Both shareholder has $200,000 of dividend income resulting from the distribution.

Explanation:

Solution

Given that:

Now,

When the securities are issued, there will be a gain recognized  of $200,000 to Money Inc. thus, The $200,000 = $1 million - $800,000.

The AAA will increase by $200,000.

This  gain known will flow through to the two shareholders of Money Inc. as   50% is owned  by both shareholders and  the stock amount for each shareholder will be $200,000/2 = $100,000.

so, the basis of stock for each shareholder will increase by $100,000.

Now,

The distribution before AAA of securities the result will be  = 300,000+100,000+200,000 = $600,000.

Then,

A  $1 million distribution will be acted on first as coming first from AAA to the extent of $600,000.the amount balanced will be  $1 million - $600,000 = $400,000. This will be serve as coming from AEP.

so,

The AAA  is = 600,000 – 600,000 = 0.

The basis for each shareholder before distribution will be = 400,000+100,000+50,000 = 550,000.

The  portion of non taxable  of the above distribution = 300,000 from AAA.

Hence,the  basis = 550,000 – 300,000 =250,000

Therefore, each shareholder has $200,000 of dividend income resulting from the distribution.

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