Aaron and Michele, equal shareholders in Cavalier Corporation, receive $25,000 each in distributions on December 31 of the current year. During the current year, Cavalier sold an appreciated asset for $60,000 (adjusted basis of $15,000). Payment for the sale of the asset will be made as follows: 50% next year and 50% in the following year. Cavalier is an accrual basis taxpayer, but reports the sale using the installment method. Before considering the effect of the asset sale, Cavaliers current year E & P is a negative $40,000 and it has negative accumulated E & P of $100,000 at the beginning of the year. How much of Aarons distribution will be taxed as a dividend?

a. $2,500 b. $5,000 c. $25,000 d. $42,500 e. The correct answer depends on whether Cavalier Corporation reported the gain on the sale of the asset on the accrual basis or using the installment method.