Question

Flintstone Company is owned equally by Fred Stone and his sister Wilma, each of whom hold 1,800 shares in the company. Wilma wants to reduce her ownership in the company, and it was decided that the company will redeem 460 of her shares for $29,900 per share on December 31 of this year. Wilma’s income tax basis in each share is $8,300. Flintstone has current E&P of $10,620,000 and accumulated E&P of $50,040,000.

a. What is the amount and character (capital gain or dividend) recognized by Wilma as a result of the stock redemption, assuming only the “substantially disproportionate with respect to the shareholder” test is applied?

b. Given your answer to part (a), what is Wilma’s income tax basis in the remaining 1,340 shares she owns in the company?

c. Assuming the company did not make any dividend distributions this year, by what amount does Flintstone reduce its E&P as a result of the redemption?

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Bonnie and Clyde are the only two shareholders in Getaway Corporation. Bonnie owns 65 shares with a basis of $6,500, and Clyde owns the remaining 35 shares with a basis of $11,500. At year-end, Getaway is considering different alternatives for redeeming some shares of stock. Evaluate whether each of the following stock redemption transactions will qualify for sale and exchange treatment. (Round your percentage answers to the nearest whole number.)

a. Getaway redeems 15 of Bonnie’s shares for $5,500. Getaway has $25,000 of E&P at year-end and Bonnie is unrelated to Clyde.

b. Getaway redeems 33 of Bonnie’s shares for $11,000. Getaway has $25,000 of E&P at year-end and Bonnie is unrelated to Clyde.(Do not round intermediate calculations.)

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c. Getaway redeems 8 of Clyde’s shares for $6,000. Getaway has $25,000 of E&P at year-end and Clyde is unrelated to Bonnie.

Answer 1

a. 1,375,4000

Wilma will recognizes a dividend of $1,375,4000 ($29,900 × 460 shares).

Wilma reduces the ownership in from 50% to 42.68 % (1,340/3,140).

But Wilma fails the“substantially disproportionate” test to treat the redemption as an exchange.

Although she reduces her ownership below 50%, her ownership percentage after the redemption is not less than 80% of her ownership before the redemption (80% × 50% = 40%). So she has to recognize Dividend of $1,375,4000.

b). Tax basis for Remaining Shares - 14,940,000

Wima will adds back the “unused” tax basis of the 460 shares redeemed ($3,818,000) to the basis of her remaining 1340 shares ($11,122,000)

c) Flintstone reduces its E&P by the amount of dividend income reported by Wilma i.e $13,754,000.