Question

Paul now owns 500 shares of Martin Inc with a stock basis of $50,000. The total outstanding shares of Martin Inc are 1,000. Of the remaining 500 shares, 50 shares are owned by Mike (son), and the remaining 450 shares of Martin Inc are owned by an unrelated shareholder. Martin Inc has E&P of $640,000.

a.       What are the tax consequences to Paul if in a stock redemption; Martin Inc redeems 100 shares from Paul for $30,000?

b. What are the tax consequences to Paul if in a stock redemption; Martin Inc redeems 400 shares from Paul for $80,000?

c. What are the tax consequences to Paul if in a complete termination of her 500 shares; Martin Inc distributes $140,000 to Paul?

d. If you were advising Paul between the scenarios listed in part a-c above, which scenario would you advise Paul to proceed with? Paul wishes to pay the least amount of tax and has $150,000 of capital loss from other investments.  

Answer 1

IRS only treats distribution as stock redemption and not dividend in only few (4) cases of which the reliable ones are

• Complete Exhaustion of Share holder interest
• Or resulting in a decrease of voting interest by atleast 20% or to a point there is no controlling interest

So,in case

a.) It is treated as dividend and taxed at Martin Inc and distributed to Paul but no decrease in basis. As he still has controlling interest in the form of his son's shares 450/900 through family attribution rule

b.) It is treated as stock redemption and the capital gain of $40,000 less Capital Loss of $ 150,000 means he doesn't have to pay any tax

c.) It is treated as stock redemption and the capital gain of $90,000 less Capital Loss of $ 150,000 means he doesn't have to pay any tax

d.) I would advise paul to not take any of the above scenarios, because the price offered in relation to the worth of the stock is very less. But if he does have to take it he can take option a as it results in a dividend taxed at the Corporation Level