Question

Problem 13-43 (LO. 4)

Since Garnet Corporation was formed five years ago, its stock has been held as follows: 525 shares by Frank and 175 shares by Grace. Their basis in the stock is $350,000 for Frank and $150,000 for Grace. As part of a stock redemption, Garnet redeems 125 of Frank's shares for $175,000 and 125 of Grace's shares for $175,000.

Round any division to six decimal places. Round your final answer to the nearest dollar.

a. What are the tax consequences of the stock redemption to Frank and Grace?

Grace has a recognized long-term capital gain of $_______, and Frank has dividend income of $_______.

b. How would the tax consequences to Frank and Grace be different if, instead of the redemption, they each sold 125 shares to Chuck (an unrelated party)? Carry out any division to seven decimal places. Then round your answer to the nearest dollar.

Grace will have a recognized long-term capital gain of $_______, and Frank will have a recognized long-term capital gain of $_______.

Answer 1

a. Tax consequences of the stock redemption to Frank & Grace.

Grace has a recognized long-term capital gain of $67,858, and Frank has dividend income of $175,000.

Calculation of tax for Frank: $175,000*15% = $26250

Calculation of tax for Grace: $67,858 *15% = $10179

When dividend treatment applies, the entire redemption payment counts as taxable income, as in case of Frank. a distribution treated as a dividend will be taxable to the extent of E&P

In contrast, in case of Grace, when stock sale treatment applies, you generally recognize a long-term capital gain equal to the excess of the redemption payment over the tax basis of the redeemed shares. So only part of the redemption payment is taxable. Tax rate on LTCG and dividend is 15%.

Another benefit: You can offset capital gain from a stock sale with capital losses from other sources. However, you can only offset up to $3,000 of dividend income with capital losses ($1,500 if you are married and file separately).

b. Grace will have a recognized long-term capital gain of $67,858, and Frank will have a recognized long-term capital gain of $ 91667.

Calculation of tax for Frank: $91667 *15% = $13750

Calculation of tax for Grace: $67,858 *15% = $10179