General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X3. Henry owns 500 shares (50%) 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% of the remainingstock 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. GeneralInertia had total E&P of $800,000 at the time of the distribution. What are the taxconsequences to Henry because of the transaction?

Question

Quizplus · Accepted Answer

Since Henry owns 50% of General Inertia's stock, he is entitled to 50% of the distribution. Therefore, he received $25,000 ($50,000 x 50%) in exchange for 250 shares of stock.

Henry's basis in the 250 shares of stock surrendered is $25,000 ($100 per share x 250 shares). The fair market value of the stock surrendered is $50,000 ($200 per share x 250 shares). Therefore, Henry realized a capital gain of $25,000 ($50,000 - $25,000).

Since the distribution was a partial liquidation, it is treated as a sale of stock. Therefore, the distribution is taxed as a capital gain to the extent of Henry's basis in the stock surrendered (in this case, $25,000). The remaining portion of the distribution ($25,000) is treated as a dividend to the extent of General Inertia's current and accumulated earnings and profits.

Henry's remaining shares in General Inertia have a basis of $100 per share. This is because the basis of the remaining shares is not affected by the partial liquidation, and Henry's original basis in those shares was $100 per share.

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