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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 shareholders 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.

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When the securities are distributed there will be a recognized a gain of $200,000 to Money Inc. This $200,000 = $1 million - $800,000. This will increase AAA by $200,000. This recognized gain will flow through to the two shareholders of Money Inc. As both shareholders own 50% of the stock amount for each shareholder will be $200,000/2 = $100,000.

Thus the stock basis of each shareholder will increase by $100,000. AAA before distribution of securities will be = 00,000+100,000+200,000 = $600,000. The $1 million distribution will be treated as coming first from AAA to the extent of $600,000. The balance amount is $1 million - $600,000 = $400,000. This will be treated as coming from AEP. AAA = 600,000 – 600,000 = 0. AEP = 600,000 – 400,000 = 200,000. Basis for each shareholder before distribution = 400,000+100,000+50,000 = 550,000. The non taxable portion of the above distribution = 300,000 from AAA. Thus basis = 550,000 – 300,000 =250,000 Each shareholder has $200,000 of dividend income resulting from the distribution.

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