Let's break down the problem step by step: ## **Given:** - **Beginning AAA:** $25,000 - **Beginning AE&P:** $50,000 - **OAA (Other Adjustments Account):** $5,000 - **Athena's Beginning Stock Basis:** $25,000 - **1998 Activity:** - **Ordinary Losses:** $(50,000)$ - **Capital Gains:** $20,000 - **Distribution to Athena:** $55,000 (on 12/31/98) - **Negative Timing Differences:** $(20,000)$ - **Positive Timing Differences:** $15,000 - **Permanent Differences:** $30,000 --- ## **Step 1: Compute S Corp Income for AAA and Stock Basis** ### **S Corp Income (not including AE&P)** - **Ordinary Loss:** $(50,000)$ - **Capital Gain:** $20,000$ - **Permanent Differences:** $30,000$ (typically tax-exempt income, increases AAA & basis) - **Timing Differences:** - **Negative (deduction not yet allowed):** $(20,000)$ (does not affect AAA or basis) - **Positive (deduction previously taken, now income):** $15,000$ (does not affect AAA or basis) **Total S Corp Income for AAA and Basis:** = $(50,000) + 20,000 + 30,000 = $0$ --- ## **Step 2: Compute Ending AAA Before Distribution** **Beginning AAA:** $25,000 **Plus S Corp Income:** $0 **Less Distribution:** $55,000 **Ending AAA:** $25,000 - $55,000 = $(30,000)$ (AAA can go negative due to losses, but not due to distributions. For distributions, you cannot reduce AAA below zero.) **So, only $25,000$ of the distribution comes from AAA.** --- ## **Step 3: AE&P Calculation** - **AE&P at beginning:** $50,000 - **Not affected by S Corp income or losses.** - **Distributions in excess of AAA come out of AE&P.** **Distribution: $55,000** - First $25,000 from AAA (not taxable, reduces basis) - Next $30,000 from AE&P (taxable as a dividend) --- ## **Step 4: OAA (Other Adjustments Account)** - Typically tracks tax-exempt income and related expenses. - OAA is not used to determine the order of distributions, but tax-exempt income increases basis and is tracked here. --- ## **Step 5: Stock Basis Calculation** **Beginning Basis:** $25,000 **Plus S Corp Income:** $0 **Less Distribution:** $25,000 (the portion from AAA) **Less Losses:** $(50,000)$ (ordinary loss) **Plus Capital Gain:** $20,000 **Plus Permanent Differences:** $30,000 - **Note:** Losses cannot reduce basis below zero. Basis is reduced in the following order: 1. Ordinary income/loss 2. Capital gain/loss 3. Tax-exempt income or permanent differences ### **Let's do this step by step:** - **Start with $25,000 basis** - **Increase for capital gain:** +$20,000 → $45,000 - **Increase for permanent difference:** +$30,000 → $75,000 - **Reduce for ordinary loss:** -$50,000 → $25,000 - **Reduce for distribution:** -$25,000 (tax-free portion from AAA) → $0 **NOTE:** The $30,000 dividend from AE&P does NOT reduce basis. **Athena's ending basis is $0.** --- ## **Step 6: Taxable Portion of Distribution** - **Distribution:** $55,000 - First $25,000: tax-free return of basis (from AAA) - Next $30,000: taxable dividend (from AE&P) - Any excess would be capital gain if distribution > AAA + AE&P + basis (not the case here) --- ## **Final Answers:** ### **How much of the $55,000 distribution is taxable to Athena?** - **$30,000** (taxable as a dividend from AE&P) ### **What is Athena’s ending adjusted basis?** - **$0** --- ### **Summary Table** | Distribution Portion | Source | Taxable? | Amount | |----------------------|--------|----------|--------| | $25,000 | AAA | No | $25,000 | | $30,000 | AE&P | Yes (dividend) | $30,000 | **Taxable to Athena:** **$30,000** **Ending basis:** **$0**