Taxable distribution and current year E&P

[new_user2020]

I read that "as long as a corp has current E&P a distribution may be treated as having come from current E&P, even if the corp has a deficit balance in its accumulated E&P".

So for example: if a shareholder invested $35,000 and company ACME had $25,000 in current E&P and a $10,000 accumulated E&P deficit, then ACME made a distribution back to the shareholder of $35,000 - the first $25,000 would be considered coming out of current E&P (thus taxable) while the remaining $10,000 would be a return-of-capital (non-taxable).

Is this interpretation correct? So even though the shareholder has a cost-basis of $35,000 and receives a distribution of $35,000 - the first $25,000 would not be considered a return of capital for that original cost-basis?

[Rick19744 · Accepted solution]

Your understanding is correct.

A cash distribution to a shareholder is a taxable dividend to the extent of the corporation's current or accumulated E&P. If the current E&P equals or exceeds the amount of the distribution, it is a fully taxable dividend to the shareholder even if the corporation has negative accumulated E&P (Regs. Sec. 1.316-1(a)). In other words, if there is sufficient current E&P to cover all distributions made during the year, all distributions are taxable dividends. 

You also need to keep in mind that E&P is not the same as retained earnings.  There are many differences between the two.

Additionally, you will need to file form 1099-DIV for the dividend portion of the distribution.

Finally, to the extent you pay out a distribution that is a return of capital, you will be required to complete form 5452.

https://www.irs.gov/pub/irs-pdf/f5452.pdf

[tagteam]

Your interpretation appears to be correct (edit: see @Rick19744's response).

[new_user2020]

And the taxable dividend can be a qualified dividend depending on the holding period and some other requirements, correct?

[tagteam · Accepted solution]

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@new_user2020 wrote:

And the taxable dividend can be a qualified dividend depending on the holding period and some other requirements, correct?

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Correct. See https://www.irs.gov/publications/p550#en_US_2019_publink100010073 for the requirements.