Question

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?
5. Alex sells 10 shares back to Red for $200. What is instead of an individual, Alex is actually a corporation.
6. Alex sells 30 shares back to Red for $600. Shortly thereafter, Betty sells 10 shares back to Red for $200 in an exchange that had been agreed to in the preceding year. What would result to Betty? What would result to Alex if Betty sold 11 shares, rather than 10?
7. In one transaction, Alex sells 20 Red shares to Betty for $400 and 10 shares back to Red for $200.
8. Alex sells 30 shares back to Red for $600. What would result if Alex and Betty are “related” in the following alternative ways:
   1. Betty is Alex’s brother and their father is living
   2. Betty is Alex’s equal partner in a two-person partnership. What if the partnership owns an option to purchase Betty’s shares in Red?
   3. Betty is a corporation in which Alex owns one half of the stock

Answer 1

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?

Answer : i) No impact on Red CorporationE&P .

ii) Betty earned profit $ 30 and Alex losses $ 30 because the Value of share of Red Corporation is $23 as below

Name of Shareholders	Nos of Share	Amount in $
Alex	60	600
Betty	40	1200
Total	100	1800
Add : E&P of Red Corp		500
Total Shareholder Fund		2300
Total Nos. Of Shares		100
Value per shares		23

iii) Alex Shareholding decrease by 10% and Betty Shareholding increase by 10%.

2. Alex sells 30 shares back to Red Corporation for $600.

Answer: i) Red Corporation E&P increase by $90 [30*$3($23-$20) ]

ii) Alex losses increased by $90 [30*$3($23-$20) ]

3. Alex sells 20 shares back to Red Corporation for $400.

Answer: i) Red Corporation E&P increase by $60 [20*$3($23-$20) ]

ii) Alex losses increased by $60 [20*$3($23-$20) ]

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?

Answer: i) Red Corporation E&P increase by $30 [10*$3($23-$20) ]

ii) Betty losses increased by $30 [10*$3($23-$20) ]

5. Alex sells 10 shares back to Red for $200. What is instead of an individual, Alex is actually a corporation.

Answer: i) Red Corporation E&P increase by $30 [10*$3($23-$20) ]

ii) Alex losses increased by $30 [10*$3($23-$20) ]

6. Alex sells 30 shares back to Red for $600. Shortly thereafter, Betty sells 10 shares back to Red for $200 in an exchange that had been agreed to in the preceding year. What would result to Betty? What would result to Alex if Betty sold 11 shares, rather than 10?

Answer: i) Red Corporation E&P increase by $90 [30*$3($23-$20) ]

ii) Alex losses increased by $90 [30*$3($23-$20) ]

iii) Red Corporation E&P increase by $30 [10*$3($23-$20) ]

iv) Betty losses increased by $30 [10*$3($23-$20) ]

7. In one transaction, Alex sells 20 Red shares to Betty for $400 and 10 shares back to Red for $200.

Answer: i) Betty earning increase by $60 [20*$3($23-$20) ]

ii) Alex losses increased by $60 [20*$3($23-$20) ]

iii) Red Corporation E&P increase by $30 [10*$3($23-$20) ]

iv) Betty losses increased by $30 [10*$3($23-$20) ]