Stock Cash Redemption - DOC by pab38554


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									                     Homework Set 3—Distributions in Redemption of Stock

Sections 302, 303, 306, 318

Case 1

The stock of Kryler Corporation is owned by the following shareholders:

         Clark                                                400 shares
         Lois                                                 600 shares
         SM, Inc.                                           1,500 shares
         Gotham Partners                                      500 shares
         Total shares outstanding                           2,000 shares

Clark and Lois are husband and wife. In addition, Clark owns 50 percent of SM, Inc. The other
50 percent is owned by a group of shareholders unrelated to either Clark or Lois. Lois, however,
does own a 20 percent (one-fifth) partnership interest in Gotham Partners. None of the other
partners are related to Lois or Clark.

1. This year, Kryler redeemed all 600 of Lois' Kryler shares. Will the redemption qualify as a
   complete termination of Lois' interest in the corporation?

2. Will the redemption qualify as a substantially disproportionate redemption?

3. How much tax will Lois owe in connection with the above transaction?

4. Assume Kryler redeemed all 500 of Gotham Partners’ Kryler stock, rather than Lois' stock.
   Would the redemption qualify as a complete termination of Gotham's interest?

5. Would the transaction in number 3 above qualify as a substantially disproportionate

Case 2

Early Corporation is owned 30 percent by Joan Early and 70 percent by Late Incorporated. Joan's
basis in her Early stock is $75,000. Late Corporation's basis in its Early stock is $175,000. Early
is engaged in two lines of business: the manufacture of alarm clocks and the manufacture of
electric coffeemakers. This year, Early sold all the assets used in its coffee machine
manufacturing process for $1.5 million, recognizing a $600,000 gain. The gain increased the
company's E&P to 1.8 million. Early invested $500,000 of the sales proceeds in improving its
clock manufacturing facilities. The remainder was distributed to its two shareholders in
redemption of 40 percent of the shares held by each. Both lines of business have been conducted
by Early Corporation since its formation in 1980.
1. Will the $300,000 distribution to Joan be treated as a dividend distribution or a qualified
   redemption transaction?

2. What about the $700,000 distribution to Late Corporation?

3. Would it make any difference if Joan owned 100 percent of the stock of Late Corporation?

4. What will be the consequences to each of the two shareholders? What will be their remaining
   bases in their Early stock after the redemptions? What will be the remaining balance in
   Early's E&P?

Case 3

June Wilson died this year, leaving behind an estate with a gross value of $3,200,000. Included
in the estate was a block of stock in her family corporation valued at $2,000,000. The stock
represents 15 percent of the total outstanding stock of the company. The estate incurred funeral
and administrative expenses of $250,000, and estate and inheritance taxes of $1,000,000. The
family corporation redeemed half of the stock held by the estate for $1.6 million. The estate used
$500,000 of this amount to pay estate and inheritance taxes. The remaining tax liability, along
with all funeral and administrative expenses, was paid from other sources.

1. What portion of the redemption qualifies for sale treatment under Section 303?

2. How would your answer change if the stock held by the estate represented 50 percent of the
   outstanding shares in the family corporation?

3. Assume that the family corporation's E&P at the date of the redemption was $3.8 million and
   that the portion of the redemption not qualifying for sale treatment under Section 303 is
   treated as a dividend. Further assume that June's stock represents 50 percent of the
   outstanding stock of the family corporation. How would the transaction affect the estate for
   tax purposes?

4. What would be the remaining balance in the family corporation's E&P?

Case 4

Robbins Corporation is owned by the following shareholders:

    Bill Robbins              10,000 shares         (basis $100,000)
    Earl Winters               8,000 shares         (basis $96,000)
    Judy Davis                10,000 shares         (basis $115,000)
    Larkins, Inc.              2,000 shares         (basis $30,000)
Bill and Earl are cousins. Judy is Earl's daughter. Larkins, Inc. is wholly-owned by Earl's wife
(Judy's mother). On December 31, when Robbins Corporation's E&P was $450,000, Robbins
redeemed half of Earl's stock for $65,000.

1. How will the redemption affect Earl for tax purposes? What will be his basis in his remaining
   Robbins Corporation stock? What will be his per share basis in the remaining shares?

2. What will be Robbins Corporation's E&P after the redemption?

3. How would your answers change if Robbins distributed land valued at $65,000 to Earl, rather
   than cash, in redemption of the shares. Assume the basis to Robbins Corporation of the land
   distributed was $15,000.

Case 5

Ben Anderson is the sole shareholder of Anderson Mfg. Corporation. His basis in his Anderson
stock is $75,000. On December 31, when Anderson's E&P was $125,000, Anderson distributed
to Ben 1,000 shares of nonvoting preferred stock as a nontaxable stock dividend. After the
distribution, Ben's common stock was worth $200,000, and his preferred stock was worth
$50,000. Six months later, Ben sold the preferred shares to Larry Benson for $48,000. Anderson
later redeemed the shares from Larry for $50,000.

1. What was Ben's basis in the preferred stock sold to Larry?

2. How much income or gain must Ben recognize on the sale and what will be its character?
   What will be his basis in his common stock after the sale?

3. What will be the balance in Anderson Mfg's E&P after Ben's sale to Larry? After the
   redemption of stock held by Larry?

4. How would your answers change if Anderson's E&P had been only $35,000?

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