Question

CINCO, Inc. is a C corporation started by Jay Franklin in 2001. Jerry owns 40 of 60 shares of CINCO stock, his daughter Megan owns 10 shares and his son Sean 10 shares. CINCO is valued at $6 Million. Jay’s basis in his shares is $450,000 and our firm recently did an earnings and profits calculation that concluded the E&P is $150,000. Jay wants to increase the ownership of Megan and Sean and proposes to do so by redeeming 20 of his shares in exchange for $2 Million. This will increase the ownership of both Megan and Sean from 16.67% to 25% reduce Jay’s ownership from 66.67% to 50%. CINCO will pay for the redeemed shares by immediately giving Jay $400,000 (2020) and issuing a note for $1.6 Million that will pay $400,000 each year beginning in 2021 and continuing through 2024. The note will also pay 3% interest.

What will be the tax results for each and supporting sections? will it be considered a distribution or exchange?

Answer 1

Exchange distribution is the sale of a large block of stock or another security reported as a large, single transaction. It may appear as a singular position between one buyer and seller, even when it represents multiple buyers purchasing shares from one seller.

that is why this case is of exchange ,

Taxation of Stock Dividends. Distributions of a C corporation's own stock to its shareholders (stock dividends) are generally tax-free to the recipient shareholders (Sec. 305(a)). The term "stock" includes rights to acquire such stock.

So the transaction is tax free