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 redemption? 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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