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Assume the following year 2 income statement for Johnstone Corporation, which was a C corporation in...

Assume the following year 2 income statement for Johnstone Corporation, which was a C corporation in year 1 and elected to be taxed as an S corporation beginning in year 2. Johnstone’s earnings and profits at the end of year 1 were $10,780. Marcus is Johnstone’s sole shareholder, and he has a stock basis of $43,000 at the end of year 1.

What is Johnstone's accumulated adjustments account at the end of year 2, and what amount of dividend income does Marcus recognize on the year 2 distribution in each of the following alternative scenarios?

Johnstone Corporation
Income Statement
December 31, Year 2
Year 2
(S Corporation)
Sales revenue $ 162,000
Cost of goods sold (38,000 )
Salary to owners (63,000 )
Employee wages (53,500 )
Depreciation expense (7,000 )
Miscellaneous expenses (4,300 )
Interest income 11,520
Overall net income $ 7,720

1. Johnstone distributed $10,600 to Marcus in year 2. What is dividend income?

2. Johnstone distributed $16,600 to Marcus in year 2. What is dividend income?

3. Johnstone distributed $26,600 to Marcus in year 2. What is dividend income?

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Answer #1
1) Johnstone distributed $10,600 to Marcus in year 2. What is dividend income?
Beginning Accumulated Adjustment Account (AAA) 0
Separately stated interest 11520
Ordinary loss ( 11520-7720) -3800
Distribution from AAA -7720
Closing AAA baalnce 0
Distribution out of Accumulated earnings & profits (E& P) (10600-7720) -2880
Accumulated E& P at the end of year 2 (10780-2880) 7900
Therefore dividend recognised by Marcus is 2880
2) Johnstone distributed $16,600 to Marcus in year 2. What is dividend income?
Beginning Accumulated Adjustment Account (AAA) 0
Separately stated interest 11520
Ordinary loss ( 11520-7720) -3800
Distribution from AAA -7720
Closing AAA baalnce 0
Distribution out of Accumulated earnings & profits (E& P) (16600-7720) -8880
Accumulated E& P at the end of year 2 (10780-8880) 1900
Therefore dividend recognised by Marcus is 8880
3) Johnstone distributed $26,600 to Marcus in year 2. What is dividend income?
Beginning Accumulated Adjustment Account (AAA) 0
Separately stated interest 11520
Ordinary loss ( 11520-7720) -3800
Distribution from AAA -7720
Closing AAA baalnce 0
Distribution out of Accumulated earnings & profits (E& P) -10780
Accumulated E& P at the end of year 2 (10780-10780) 0
Therefore dividend recognised by Marcus is 10780
Out of total distribution of 26,600 , 7720 will be from AAA balance,10780 will be from Accumulated E& P
and remaining 8100 will reduce Marcus stock basis. Thus only 10,780 distributed from
Accumulated E& P will be considered as dividend income
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