0:19
Let's now apply the concepts of corporate E&P computation to Sunchaser Shakery.
Sunchaser Shakery Corporation reported taxable income of $625,000
and pay $200,000 in federal income taxes.
Not included in the computation where the non-deductible meals of $3,000,
tax-exempt income of $7,000,
and deferred gain on an installment sale of $12,000.
And our goal here is to determine current E&P.
So let's start with taxable income and then make
the necessary adjustments to arrive at current E&P.
So we're told taxable income is $625,000,
so that's going to be our starting point.
And we're going to make adjustments to
counteract some of the tax effects that are out there that
remove economic income from the calculation of taxable income.
So let's remove federal income tax expense.
As this is an expense that was actually paid by the corporation but is non-deductible.
So when we're thinking about what amount is available from
an economic standpoint for distribution to shareholders,
we need to remove this amount.
Next we have the non-deductible meals.
So these meal expenditures were actually incurred
by the corporation but again are non-deductible.
So 50 percent of meals in entertainment is deductible.
The other 50 percent was still paid,
it's just not reflected in taxable income.
So we need to remove that from taxable income to get to this economic concept of E&P.
So we have $3,000 which we need to reduce taxable income by.
And now let's add in tax-exempt income,
because this is income that was earned by the firm,
but is not reflected in taxable income.
So technically, it is available economically speaking for
distribution to shareholders, $7000.
And then finally we have deferred gain a DFT for deferred,
gain on the installment sale.
2:16
And if you recall from the concepts discussion,
the installment method is not allowed for calculating E&P.
So we need to add this $12,000 of deferred gain back.
In other words, it is economically available for distribution to shareholders.
So we start with taxable income.
We make these adjustments and we find out that current E&P for
this particular entity Sunchaser is $441,000.
And that's all there is to it. Sunchaser Shakery Corporation,
an accrual basis taxpayer had E&P of $74,000 last year.
The following information pertained to this tax year.
Taxable income on the tax return, $304,000.
Charitable contributions in excess of 10 percent limitation, $9,000.
Interest paid for tax-exempt bonds, $5,000.
Tax-exempt interest received, $8,000.
Federal income tax, $97,000 and MACRS depreciation in excess of ADS depreciation, $3,500.
And our goal is to determine E&P.
So to do this, let's start with E&P from the prior year,
so that we ultimately end up with an overall estimate of
current and accumulated E&P for this particular tax year.
So E&P from last year,
we are told a $74,000.
Now let's calculate current E&P.
So we start with,
as we always do, taxable income,
as sort of our first performance measure and then we'll make adjustments to
account for the things that are reflected and not reflected in taxable income,
but it affect the economic ability to pay dividends.
So taxable income of $304,000,
is our starting point and now we need to make those adjustments to that.
So, we'll start by looking at
all the positive adjustments and then let's work through the negative adjustments.
So the first positive adjustment we need to make is tax-exempt interest.
As before, this is interest that is available to
the firm for distribution to shareholders but is not a tax,
so it's not reflected in this taxable income number of $8,000.
And so, we'll just write a note on the side for later that this is income,
but not in taxable income.
So that when you go back and look at this, you know why.
Okay, the other positive adjustment we need to make is for excess depreciation.
4:39
And in this case, it's $3,500.
And the reason for this is that,
the ADS system is allowed for E&P purposes,
in other words to calculate E&P whereas MACRS is not.
So the amount that is from
MACRS but in excess of what the methods that we're allowed to use ADS,
we need to add that back to get to
the true representation of what the code says is the economic ability to pay dividends.
So we add back this $3,500.
Now we can work through the negative adjustments.
And the first one is the excess contributions, the charitable contributions.
5:16
So these are distributions or a contributions
to charities that were actually made by the corporation,
but they're just not deductible so they're not reflected in taxable income.
But because they were made, they're not available
inside the firm for distribution to shareholders.
So we need to reduce taxable income by that amount.
So we can write,
the charitable contribution was made but it was non-deductible.
Similarly, we have interest paid on tax-exempt bonds,
something on interest paid, tax-exempt.
So these are expenditures that were made,
and are not available for distribution,
but the expenditure is not reflected in taxable income.
So we have made,
we're paid, and again non-deductible.
And then finally, federal income tax.
So this is an expenditure that the firm incurs,
but is non-deductible, so it's not reflected in taxable income.
Thus, it's not available for distribution,
because it doesn't exist, economically speaking.
So we add all this up, starting with our E&P from last year rolling into,
what I would call the current E&P calculations.
We see that E&P at the end of the year,
for this particular tax year would be $278,500. And that's all there's to it.
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
