Comet Corporation is owned equally by Patrick and his sister Pam, each of whom hold 100 shares in the company.Comet redeems 50 of Pam's shares on December 31, year 1, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes.Comet has total E&P of $160,000 on December 31, year 1.What are the tax consequences to Comet as a result of the stock redemption?
A)No reduction in E&P as a result of the exchange.
B)A reduction of $50,000 in E&P as a result of the exchange.
C)A reduction of $40,000 in E&P as a result of the exchange.
D)A reduction of $80,000 in E&P as a result of the exchange.

Question

Quizplus · Accepted Answer

When a shareholder treats a stock redemption as an exchange for tax purposes, the transaction is treated as a sale or exchange of the shares, rather than a distribution. In this case, Pam's basis in the 50 shares redeemed is $50,000 (100 shares / $1,000 per share). Because Comet has $160,000 of E&P and only $50,000 is being distributed to Pam in the redemption, the remaining $110,000 of E&P is not reduced. Therefore, the answer is C: a reduction of $40,000 in E&P as a result of the exchange.

Comet Corporation Is Owned Equally by Patrick and His Sister