Question

Julio Gonzales is in the 32% tax bracket. He acquired 2,000 shares of stock in Gray Corporation seven years ago at a cost of $50 per share. In the current year, Julio received a payment of $150,000 from Gray Corporation in exchange for 1,000 of his shares in Gray. Gray has E & P of $1,000,000. What income tax liabil-ity would Julio incur on the $150,000 payment in each of the following situations? Assume that Julio has no capital losses.

a. The stock redemption qualifies for sale or exchange treatment.

b. The stock redemption does not qualify for sale or exchange treatment.

c. How would your answer to parts (a) and (b) of Problem 49 differ if Julio were a corporate shareholder rather than an individual shareholder and the stock ownership in Gray Corporation represented a 25% interest?

Answer 1

a. Basis for 1000 shares = $50 * 1000 = $50,000

Long term capital gain = Amount realized - Basis = $150,000 - $50,000 = $100,000

Tax rate is 15% for individual in the 32% tax bracket.

Tax liability = $100,000 * 15% = $15,000

b. If it doesn't qualify as a sale or exchange treatment, then any distributions will be treated as dividend income to the extent of E & P. Dividend is also taxed at the same rate as long term capital gain is taxed.

Tax liability = $150,000 * 15% = $22,500

c. Part (a) Long term capital gain for a corporate shareholder is taxed at the ordinary rates.

Tax rate for corporate = 21%
Long term capital gain = Amount realized - Basis = $150,000 - $50,000 = $100,000

Tax liability = $100,000 * 21% = $21,000

Part (b) Corporation would have dividend income of $150,000

Dividend received deduction is 80% as the stock ownership in Gray Corporation represented a 25% interest.

Dividend received deduction = 80% of $150,000 = $120,000

Taxable dividend = $150,000 - $120,000 = $30,000

Tax liability = $30,000 * 21% = $6,300