Answer: $175,000 dividend, $175,000 tax-free return of basis, and $175,000 capital gain.
Explanation:
First off let us establish the facts,
We have an Accumulated E&P at beginning of year - $350,000
Current E&P is $175,000
And they Distributed $525,000 to sole shareholder on January 1, 20X3
Shareholder tax basis is $175,000
Due to the above facts, the shareholder will treat $525,000 as follows:
Current E&P is $175,000 so Dividends will be $175,000.
The tax basis being 175,000 will then lead to $175,000 to be counted as a tax free return of basis.
The rest being, 525,000 - 175,000 - 175,000
= $175,000 will be treated as Capital Gain.
So in conclusion the distribution will be treated by the shareholder like this,
$175,000 dividend, $175,000 tax-free return of basis, and $175,000 capital gain.
