McGraw-Hill's Taxation of Business Entities 3rd Edition by Connie Weaver, Brian Spilker, Edmund Outslay, John Robinson, Ronald Worsham, Benjamin Ayers, John Barrick

Exercise 14

Petoskey Stone Quarry Inc. (PSQ), a calendar-year, accrual-method C corporation, provides landscaping supplies to local builders in northern Michigan. PSQ has always been a family owned business and has a single class of voting common stock outstanding. The 1,000 outstanding shares are owned as follows:

Nick Adams serves as president of PSQ, and his father Sandler serves as chairman of the board. Amy is the company's CFO, and Abigail and Charlie work as employees of the company. Sandler would like to retire and sell his shares back to the company. The fair market value of the shares is $500,000. Sandler's tax basis is $10,000.
The redemption is tentatively scheduled to take place on December 31, 2011. As of January 1, 2011, PSQ had accumulated earnings and profits of $2,500,000. The company projects current E P for 2011 of $200,000. The company intends to pay pro rata cash dividends of $300 per share to its shareholders on December 1, 2011.Required:
a. Assume the redemption takes place as planned on December 31 and no elections are made by the shareholders.
1. What amount of dividend or capital gain will Sandler recognize as a result of the stock redemption
2. How will the tax basis of Sandler's stock be allocated to the remaining shareholders
b. What must Sandler and the other shareholders do to change the tax results
you calculated in question a
c. Compute PSQ's accumulated earnings and profits on January 1, 2012, assuming
the redemption is treated as an exchange.