Question

In: Accounting

Red Corporation is owned entirely by Alex and Betty (who are unrelated unless otherwise stated). Alex...

Red Corporation is owned entirely by Alex and Betty (who are unrelated unless otherwise stated). Alex owns 60 shares of Red Corporation’s common stock (bought in one transaction for $600). Betty owns 40 shares of Red Corporation’s common stock (with an adjusted basis of $30 per share). The stock’s FMV is $20 per share. Red Corporation’s E&P is $500. Red Corporation uses the accrual method of accounting. What are the results to the parties from the alternative transactions in each of the following situations? Provide the amount and character of shareholder income or loss and the impact on Red Corporation’s E&P.

  1. Alex sells 10 Red Corporation shares to Betty for $200. Alternatively, what should Alex do if $50 of Red’s shares have a $10 per share basis and the other 10 shares have a $20 per share basis? Are there any circumstances in which this sale could be a redemption?
  2. Alex sells 30 shares back to Red Corporation for $600.
  3. Alex sells 20 shares back to Red Corporation for $400.
  4. What would result to Betty if Red redeems 10 of Betty’s shares for $200? What is the minimum number of shares that Betty must have redeemed to ensure sale or exchange treatment?

Solutions

Expert Solution

In the given case Alex owns 60 shares of red corporation for $600

i.e. $10 per share ($600/60)

a) Alex sells 10 Red corporation shares to Betty for $ 200

= $200/10 = $ 20 per share

Therefore, Alex made a profit of $10 per share I.e. from sell of 10 shares he earn $100

In given alternative case Alex should sell 10 shares out of 50 shares which is bought by him for a $10 and earn same profit as above.

This transaction can be a redemption if it sell to red corporation on a FMV of $20 per share.

b) Alex sells 30 shares back to Red corporation for $600.

= $600/30 = $20

Originally bought by Alex for $10 , by this sell Alex made a profit of $10 per share, total of $300.

& Red corporation is in loss of $300

c) Alex sells 20 shares back to Red corporation for $400.

= $400/20 = $20

By this sell Alex made a profit of $10 per share, i.e. total of $200.

& Red corporation is in loss of $200

d) Betty sells 10 shares to red corporation for $200. i.e. $20 per share.

Originally Betty bought shares for $30 per share . Therefore from this sell Betty is in loss of $10 per share i.e. in total of $100.

Red corporation is in profit of $100


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