Which of the following is subtracted from taxable income when computing current earnings and profits (E&P)?

• A. Tax-exempt interest income
• B. Life insurance proceeds on key employees
• C. Dividends received deduction
• D. Federal income taxes paid

Answer: (D)

Verified step by step guidance

1. Understand the concept of Earnings and Profits (E&P): E&P is a measure used in tax accounting to determine a corporation's ability to pay dividends to its shareholders. It is calculated by adjusting taxable income for certain items, both additions and subtractions.
2. Identify the items that are subtracted from taxable income when computing current E&P: Federal income taxes paid are subtracted because they represent an expense that reduces the corporation's ability to distribute earnings as dividends.
3. Clarify why the other items listed are not subtracted: Tax-exempt interest income and life insurance proceeds on key employees are typically added back to taxable income when computing E&P because they increase the corporation's ability to pay dividends. The dividends received deduction is also not subtracted; it is an adjustment to taxable income for tax purposes but does not directly affect E&P.
4. Recognize the importance of federal income taxes paid in the calculation: Federal income taxes paid are a direct cash outflow that reduces the corporation's available earnings, making them a subtraction in the E&P calculation.
5. Apply this understanding to similar problems: When computing E&P, always analyze whether an item increases or decreases the corporation's ability to pay dividends, and adjust taxable income accordingly.