Assumptions: The stock of X is owned equally by two shareholders: Y (a corporation) and A (an individual). X and Y use the accrual method, A uses the cash method, and all use a calendar taxable year. Assume section 1059 does not apply. Use a 34 percent corporate tax rate in this problem. During the current year, X accrued income and expenses as follows:

Gross income from business $500

Dividends on AT&T stock (consider sec. 243) 100

Interest on municipal bonds (sec. 103) 100

Capital gain 100

Total $800

Deductible sec. 162(a)(1) business expenses $ 430

Noncapital expenses not deductible under sec. 162(e) 90

Capital losses (see sec. 1211(a)) 146

Total $ 666

Net $134

On December 24 of the preceding year, Y and A incorporated X and capitalized X with cash of $100 each. On December 31 of that preceding year, Y and A received distributions from X of $5 each, in the current year. Which distributions should be gross income to Y and A, in what amounts, and why?

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