General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, year 1.Henry owns 500 shares (50 percent)of General Inertia.The distribution was in exchange for 250 shares of Henry's stock in the company.After the partial liquidation, Henry continued to own 50 percent of the remaining stock in General Inertia.At the time of the distribution, the shares had a fair market value of $200 per share.Henry's income tax basis in the shares was $100 per share.General Inertia had total E&P of $800,000 at the time of the distribution.What are the tax consequences to Henry as a result of the transaction?
A)Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share.
B)Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share.
C)Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share.
D)Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share.

Question

Quizplus · Accepted Answer

The transaction is treated as a sale or exchange because it is a partial liquidation, resulting in a capital gain of $25,000 (calculated as the difference between the fair market value of the shares exchanged, $200 per share for 250 shares, and Henry's tax basis in those shares, $100 per share for 250 shares). Henry's basis in his remaining shares does not change as a result of this transaction.

General Inertia Corporation Made a Distribution of $50,000 to Henry