A corporation needs to accurately calculate its earnings and profits (E&P) for various reasons. Generally, a corporation’s E&P is the accumulated net profit or loss generated by the corporation.
From a U.S. federal tax perspective, corporate E&P is important because E&P generally determines the amount of corporate distributions that are treated as dividend income or nontaxable non-dividend distributions.
Example E&P Calculation
Company ABC Inc., a Delaware corporation, was formed on January 1, 2023 and is 100% owned by John Doe. In its first year of operations, the corporation generated $1,000,000 of revenue and had $800,000 of expenses for a net pre-tax profit of $200,000.
The corporation paid corporate income taxes of 21% on profits, which amounted to $42,000. The corporation’s after-tax E&P was $158,000 for the 2023 fiscal year.
The corporation distributes $175,000 as a dividend to John Doe. The distribution of $175,000 comprises a dividend distribution to the extent of corporate E&P and a nondividend distribution for the excess amount. The composition is as follows:
- Taxable dividend distribution: $158,000
- Nondividend distribution: $12,000
On John Doe’s Form 1040 (US Individual Income Tax Return), he reports the $158,000 as taxable dividend income, and the $12,000 is a nontaxable return of principal.