Question

Veronica and Tracy, unrelated individuals, own all the stock in Beige Corporation as equal shareholders. Each...

Veronica and Tracy, unrelated individuals, own all the stock in Beige Corporation as equal shareholders. Each has a basis of $20,000 in her 20 shares. Beige Corporation has accumulated E & P of $900,000. Veronica wishes to retire in the current year and wants to sell her stock for $500,000, the fair market value. Tracy would like to purchase Veronica's shares and, thus, become the sole shareholder in Beige Corporation. However, because Tracy is short of funds, Beige Corporation redeems all of Veronica's shares for $500,000. Which of the following is a correct statement regarding the tax consequences of this redemption?

a.Veronica will have a capital gain of $480,000.

b.Tracy will have dividend income of $500,000.

c.Beige Corporation will not reduce its E & P as a result of the redemption.

d.Veronica will have dividend income of $500,000.

e.None of these choices are correct.

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Answer #1

Here we assume that the appreciation in value of the equity is due to both dividend payment and share value rise. Hence when Beige Corporation redeems Veronic's shares, Veronica has a capital gain of $480,000 which would be taxed accordingly.

  • Option b is not correct.
  • Option c is not correct as the company buys back the shares and hence its E & P would go down.
  • Option d is not correct because the amount is not solely dividends.

Hence option a is correct.

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