Question

Question 27 Henry, Emmy, and Frannie, unrelated individuals, own all of the stock in New Corporation with earnings and profits of $1,200,000 as follows: Henry own 1,300 shares; Emmy owns 400 shares; and Frannie owns 300 shares. New Corporation redeems 300 of Henry’s shares with a basis of $60,000 for $450,000. With respect to the distribution in redemption of the stock:

A. Henry has a capital gain of $390,000.

B. Henry has dividend income of $450,000.

C. Henry has dividend income of $390,000.

D. Henry has a capital gain of $450,000.

Question 28

Lucinda owns 1,100 shares of Old Corporation stock at a time when Old Corporation has 2,000 shares of stock outstanding. The remaining shareholders are unrelated to Lucinda. The corporation redeems 400 shares from Lucinda. Does the transaction qualify as substantially disproportionate redemption as to Lucinda?

A. We do not have sufficient information.

B. No.

C. Yes.

D. This is not a transaction that could qualify for sale or exchange treatment.

Answer 1

Solution 27:

As per taxation provisions, The tax consequences of the stock redemption depend on whether the equity interest of a stockholder is the same or significantly less after the redemption. If a stockholder's equity interest relative to other stockholders in the corporation remains the same, then the stock redemption is treated as a dividend payment.

If the stock redemption significantly decreases the stockholder's equity stake in the corporation, then the stock redemption is treated as a capital sale, in which a stockholder will either have a capital gain or loss.

If redemption decreases the shareholders voting power to less than 50% of corporation's outstanding stock then it will be treated as stock sale.

In the given situation, New corporation redeems 300 shares of Henry, in that case, henry's voting power will be more than 50% of corporation outstanding stock, therefore this redemption will be treated as dividend income of henry.

Therefore henry has dividend income of $450,000

Option B is the right choice.