The amount of accumulated E&P (Earnings & Profit) is usually the amount of E&P at the end of the preceding tax year. The steps that are used to calculate accumulated E&P are:
Accumulated E&P (beginning year)
Distributions from current E&P
Distributions from accumulated E&P
Accumulated E&P (end of year) (CPANet, 2011)
This might get a little confusing so I would like to use an example; let’s say that I am the sole shareholder of a company named Sasha, Inc. and I have a $10,000 basis in my stock. Sasha has $5,000 in E&P and distributes $17,000 to Jennifer. Jennifer is taxed on a dividend of $5,000
(Sasha's E&P) and the remaining $12,000 reduces Jennifer's basis in her stock from $10,000 to zero and also results in her being taxed on $2,000 of gain which is, the excess of the $12,000 non-dividend portion of the distribution over her $10,000 basis.
When current E&P is positive and accumulated E&P has a deficit balance, accumulated E&P is not netted against current E&P. Instead, the distribution is deemed to be a taxable dividend to the extent of the positive current E&P balance. E&P is taxed as a dividend whether it’s current or accumulated. Accumulated E&P is allocated among distributions by the corporation in the order in which they are made. The installment method is not allowed with E&P and the percentage of completion must be used.
The distinction between current and accumulated E&P is very important because taxability of corporate distributions depends on how current and accumulated E&P are allocated to each distribution made during year. E&P is a very complicated and confusing topic but it is very important in our tax system.