A corporation is owned 70% by Jones and 30% by Smith. Jones owns 70 shares with a cost of $100 each. Smith owns 30 shares with a cost of $100 per share. The company redeems 5 shares from Smith at a redemption price of $400 per share. No stock is redeemed from Jones. This is not a redemption to pay death taxes, and it is not a partial liquidation. What is the tax impact on Smith?

Question

Quizplus · Accepted Answer

Smith receives $2,000 for the redemption of 5 shares ($400 per share x 5 shares). The cost basis for these shares is $500 ($100 per share x 5 shares). The difference of $1,500 is treated as a dividend because the redemption does not qualify for capital gain treatment under the IRS rules, as it does not significantly reduce Smith's ownership percentage.

A Corporation Is Owned 70% by Jones and 30% by Smith