Longhorn Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of negative $400,000. Longhorn distributed $600,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $200,000. How is the distribution treated by the shareholder in 20X3?

1. $200,000 dividend.
2. $200,000 dividend, $200,000 tax-free return of basis, and $200,000 capital gain.
3. $200,000 dividend and $400,000 tax-free return of basis.
4. $0 dividend, $200,000 tax-free return of basis, and $400,000 capital gain.