Question

Bonnie and Clyde are the only two shareholders in Getaway Corporation. Bonnie owns 60 shares with a basis of $3,000, and Clyde owns the remaining 40 shares with a basis of $13,000. At year-end, Getaway is considering different alternatives for redeeming some shares of stock. Evaluate whether each of the following stock redemption transactions will qualify for sale and exchange treatment. (Leave no answer blank. Enter zero if applicable.)

Required:

1. Getaway redeems 10 of Bonnie’s shares for $3,000. Getaway has $22,000 of E&P at year-end and Bonnie is unrelated to Clyde.

2. Getaway redeems 32 of Bonnie’s shares for $6,000. Getaway has $22,000 of E&P at year-end and Bonnie is unrelated to Clyde.

3. Getaway redeems 7 of Clyde’s shares for $3,500. Getaway has $22,000 of E&P at year-end and Clyde is unrelated to Bonnie.

Answer 1

a) Bonnie owns 60% before the redemption and 55.55% after the redemption (50/90).Thus, the redemption will fail the 50% test in 302(b)(2). Because Bonnie still has control of the corporation after the redemption (more than 50%) the redemption will likely fail the not essentially equivalent to a dividend test under 302(b)(1).

b) Bonnie owns 60% before the redemption and 41.17% after the redemption (28/68). In addition, Bonnies share of the outstanding stock after the redemption has dropped by more than 80% (80% x 60%= 48%) of her percentage ownership before the redemption (60% before and 41% afterwards). Thus, the redemption passes both the 50% test and the 80% test in 302(b)(2). This means that Bonnie will treat her redeemed shares as though she sold them for $6,000 resulting in a capital gain of $2,800 ($6,000 [(32/60)  x $6,000).

c) Clyde owns 40% before the redemption and 35.48% after the redemption (33/93). However, Clyde’s share ofthe outstanding stock has not dropped by more than 80%(80% x 40%= 32%) since his ownership percentage would have to be below 32%, and his ownership percentage is 35.48%. Thus, the redemption passes the 50% test but fails the 80% test in § 302(b)(2). This redemption might still qualify as a redemption not essentially equivalent to a dividend under § 302(b)(1). Clyde does not have control of the corporation(Bonnie does), and he has suffered a significant reduction in his ownership.