Question

Betta Inc. has 100 shares outstanding. As of January 1, 2016 Betta had 200,000 earnings and profits from prior years. On June 30, 2016 Betta paid a dividend of 35 per share to all shareholders. Bob and his three brothers each owned 25 shares of Betta. Each invested $10,000 to start the company and made no further investment in Betta. In November 2016 Bob and his wife got divorced and he needed money to pay her settlement. To raise the cash needed bob sold 10 shares of Betta back to Betta as treasury stock. Betta gave Bob $65,000 in cash and the car he was driving, cost 62,000, fair market value, 38,000, basis $20,000. On December 31, 2016 when Betta closed its books for the year there was a profit of $10,000. Compute Bob’s treatment of the money he received and his basis in the remaining shares he owned. Bob owns 25 shares * $ 400 = $ 10 000 July 1, 2016 received dividend $ 35 * 25 = $ 875 November 1, 2016 sold 10 shares as treasury stock for Cash received from Betta Inc. $ 65 000 And received car basis $ 38 000 Less: Value of investment cost 10 shares * $400 = $ 4 000 Profit earned on sale of 10 shares $ 99 000 ( $ 65 000 + 38 000 – 4000 ) Bob does not able to treat the redemption as an exchange under his change-in-ownership test, because he owns less than 50% of Betta Inc. stock, and his ownership percentage after the redemption (15%) fell below 80% of their ownership percentage prior to the redemption (80%*25%=20%). So, Bob's received dividends $65 000 rather than capital gain. What is company's tax basis?

Answer 1

1. Bob’s treatment of the money he received and his basis in the remaining shares he owned is as follows :

The money received by bob is taxable under the head Capital Gains - Short term capital gains since the shares are not held for more than twelve months. In this case, the company has no tax obligation on buy back of its on shares and the burden of tax is thus shifted on Bob. Hence the entire value of $99000 that Bob received on sale of 10 shares of Betta Inc. is taxable in his hands as short term capital gains. Bob is now entitled to only remaining portion of is holding in both dividends and profits of the company i.e., 16.67%(15/90).

2. Company's tax basis is as follows :

The Shares bought back by the company are tax free in the hands of the company as the same is taxable in the hands of the shareholder. But the company is liable to pay dividend distribution tax on the distributed dividends since the same is exempted in the hands of the shareholders. So the company has to pay dividend distribution tax on $3500 (35*100) on the dividend distributed to the shareholders.