In: Accounting
Since Garnet Corporation was formed five years ago, its stock has been held as follows: 525 shares by Frank and 175 shares by Grace. Their basis in the stock is $350,000 for Frank and $150,000 for Grace. As part of a stock redemption, Garnet redeems 125 of Frank's shares for $175,000 and 125 of Grace's shares for $175,000. Round any division to six decimal places. Round your final answer to the nearest dollar.
a. What are the tax consequences of the stock redemption to Frank and Grace? Grace has a recognized long-term capital gain of $ , and Frank has dividend income of $ 175,000 .
b. How would the tax consequences to Frank and Grace be different if, instead of the redemption, they each sold 125 shares to Chuck (an unrelated party)? Carry out any division to seven decimal places. Then round your answer to the nearest dollar. Grace will have a recognized long-term capital gain of $ , and Frank will have a recognized long-term capital gain of $ .
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a) What are the tax consequences of the stock redemption to Frank and Grace? Grace has a recognized long-term capital gain of $ , and Frank has dividend income of $ 175,000
there are two possible treatments for the stock redemption, dividend treatment and stock sale treatment. Dividend treatment will increase the amount of taxes to be paid because the stock redemption is treated as a taxable dividend. on the other hand, in the stock sale treatment, only part of the redemption payment is taxable because a long-term capital gain can be recognized equal to the excess of the redemption payment over the tax basis of the redeemed shares.
As Fran recognised the redemption as dividend, he will have to pay taxes based on the entire amount of payment ($175,000.00).
As grace recognized a long-term capital gain, she will only have to pay taxes based on the excess of payment she received, and might also be sbject to a more favorable tax rate. Grace long term capital gain =67,857.14
to get the value of grace shares | ||
basis stock/ amount of shares | ||
150000/175= | 857.142857 | per share |
value of the sale per share | ||
payment/amount of redeemed shares | ||
175000/125= | 1400 | |
real value of shares | ||
amount of shares redeemed * value of shares | ||
125*857.142857= | 107142.857 | |
long term capital gain | ||
payment -real value of shares | ||
175000-107142.857 | 67,857.14 | |
b) How would the tax consequences to Frank and Grace be different if, instead of the redemption, they each sold 125 shares to Chuck (an unrelated party)? Carry out any division to seven decimal places. Then round your answer to the nearest dollar. Grace will have a recognized long-term capital gain of $ , and Frank will have a recognized long-term capital gain of $ .
in this scenario, both of them would only pay taxes based on the capital gain resulting from the sale.
For grace, the capital gain would be the same as on part A :$657,857
For frank, the capital gain would be $91,667
to get the value of frank shares | ||
basis stock/ amount of shares | ||
350000/525= | 666.6666667 | per share |
value of the sale per share | ||
payment/amount of redeemed shares | ||
175000/125= | 1400 | |
real value of shares | ||
amount of shares redeemed * value of shares | ||
125*666.666667= | 83,333.3333750 | |
long term capital gain | ||
payment -real value of shares | ||
175000-83333.3333750 | 91,666.67 | |