Assumptions: The stock of ChadCo is owned equally by two shareholders: SecondCo (a corporation) and Arnold (an individual). ChadCo and SecondCo use the accrual method, Arnold uses the cash method. All use a calendar taxable year. Assume § 1059 does not apply. Use a 34 percent corporate tax rate in this problem. During the current year, ChadCo accrued income and expenses as follows: Gross Income from business: $500,000  Dividends on AT&T stock (consider section 243): 100,000  Interest on municipal bonds (section 103): 100,000  Capital gain: 100,000 Total: 800,000 Deductible section 162(a)(I) business expenses: 430,000 Noncapital expenses not deductible under section 162(e): 90,000 Capital losses (see section 1211(a)): 146,000 Total: 666,000 Net: 134,000 (800,000 - 666,000) (1) On December 24 of the preceding year, SecondCo and Arnold incorporated ChadCo and capitalized ChadCo with cash of $100,000 each. On December 31 of that preceding year, SecondCo and Arnold received distributions from ChadCo of $5,000 each; ChadCo did not earn any income for that year. In addition, SecondCo and Arnold received distributions of $5,000 each, in the current year. Which distributions should be gross income to SecondCo and Arnold, in what amounts, and why? What does E&P have to do with this? (2) Alternative: Arnold just bought the ChadCo shares on December 30 of the current year from another shareholder for FMV of $145,000, before the declaration and payment of a $5,000 distribution to Arnold on December 31 of the current year. Should the distribution be taxable income to Arnold? Why? (3) Now assume that SecondCo’s basis in its ChadCo stock is $100,000 and Arnold’s basis in his ChadCo stock is $40,000. On January 2 of the current taxable year, ChadCo distributes $100,000 in cash to SecondCo and $100,000 in cash to Arnold. As of the end of the preceding taxable year, ChadCo’s accumulated E&P was zero. What are the tax consequences of this distribution to ChadCo, SecondCo, and Arnold? [Hint: First compute ChadCo’s current-year taxable income and then compute current- year E&P before reducing the E&P for the distribution (“interim E&P”); after reducing for the distribution, compute final accumulated E&P.] (4)  Variation: Assume Arnold’s shares were owned by a different shareholder every quarter and $50,000 was distributed ratably to all shareholders quarterly? How much dividend would SecondCo and the holders of Arnold’s shares receive? (5)  Suppose under the basic facts in (3) above that ChadCo had an accumulated de  fi  cit of $100,000 in its E&P account as of December 31 of the preceding taxable year. (6)  If, on December 1 of the current year (the declaration date), ChadCo’s board of directors voted to pay the $200,000 distribution by mailing the checks on December 31 of the current taxable year (the payment date, the identi  fi  cation of which is a practice generally used only by widely held corporations) to shareholders of record on December l.

1. Assumptions: The stock of ChadCo is owned equally by two
shareholders: SecondCo (a corporation) and Arnold (an
individual). ChadCo and SecondCo use the accrual method,
Arnold uses the cash method. All use a calendar taxable year.
Assume § 1059 does not apply. Use a 34 percent corporate tax
rate in this problem. During the current year, ChadCo accrued
income and expenses as follows:
Gross Income from business: $500,000
Dividends on AT&T stock (consider section 243): 100,000
Interest on municipal bonds (section 103): 100,000
Capital gain: 100,000
Total: 800,000
Deductible section 162(a)(I) business expenses: 430,000
Noncapital expenses not deductible under section 162(e):
90,000
Capital losses (see section 1211(a)): 146,000
Total: 666,000
Net: 134,000 (800,000 - 666,000)
(1) On December 24 of the preceding year, SecondCo and
Arnold incorporated ChadCo and capitalized ChadCo with cash
of $100,000 each. On December 31 of that preceding year,
SecondCo and Arnold received distributions from ChadCo of
$5,000 each; ChadCo did not earn any income for that year. In
addition, SecondCo and Arnold received distributions of $5,000
each, in the current year.
Which distributions should be gross income to SecondCo and
Arnold, in what amounts, and why? What does E&P have to do
with this?
(2) Alternative: Arnold just bought the ChadCo shares on

2. December 30 of the current year from another shareholder for
FMV of $145,000, before the declaration and payment of a
$5,000 distribution to Arnold on December 31 of the current
year.
Should the distribution be taxable income to Arnold? Why?
(3) Now assume that SecondCo’s basis in its ChadCo stock is
$100,000 and Arnold’s basis in his ChadCo stock is $40,000.
On January 2 of the current taxable year, ChadCo distributes
$100,000 in cash to SecondCo and $100,000 in cash to Arnold.
As of the end of the preceding taxable year, ChadCo’s
accumulated E&P was zero.
What are the tax consequences of this distribution to ChadCo,
SecondCo, and Arnold? [Hint: First compute ChadCo’s current-
year taxable income and then compute current- year E&P before
reducing the E&P for the distribution (“interim E&P”); after
reducing for the distribution, compute final accumulated E&P.]
(4) Variation: Assume Arnold’s shares were owned by a
different shareholder every quarter and $50,000 was distributed
ratably to all shareholders quarterly?
How much dividend would SecondCo and the holders of
Arnold’s shares receive?
(5) Suppose under the basic facts in (3) above that ChadCo had
an accumulated de
fi
cit of $100,000 in its E&P account as of December 31 of the
preceding taxable year.
(6) If, on December 1 of the current year (the declaration date),

3. ChadCo’s board of directors voted to pay the $200,000
distribution by mailing the checks on December 31 of the
current taxable year (the payment date, the identi
fi
cation of which is a practice generally used only by widely held
corporations) to shareholders of record on December l5 of the
current taxable year (the record date), such checks actually
being received by SecondCo and Arnold in the mail on January
2 of the next year? Assume that SecondCo and Arnold are the
public and that they are the only shareholders (as in the basic
facts).
How would your answer to (3) above change?
(7) Suppose that SecondCo is an individual and that ChadCo
has always been an S corporation.
What is ChadCo’s E&P‘? How is each shareholder’s personal
income tax return affected for the current year by the tax items
of ChadCo? How will ChadCo distribution of $100,000 to each
shareholder in the current year affect shareholders?