Question

A. General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of...

A.

General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X9. Henry owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Henry's stock in the company. After the partial liquidation, Henry continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Henry's income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What are the tax consequences to Henry because of the transaction?
B.

Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X9, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $250,000 on December 31, 20X9. What are the tax consequences to Comet because of the stock redemption?
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Answer #1

1. Henry has a capital gain of $25,000 and has tax basis of $100 per share for his remaining number of shares. This is done because as per partial liquidation rules an individual gets exchange treatment in the whole transaction.  

2. A reduction of $50,000 in E&P because of the exchange. This is done because when a stock redemption is treated as an exchange, the corporation distributing reduces its E&P by the lesser of:

  • the amount paid in redemption or  
  • percentage of stock redeemed multiplied by the E&P on the day of redemption.
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