In 20X5, R received 20 shares of preferred stock as a distribution with respect to his XYZ common.The preferred was worth $10,000 and R assigned a basis of $6,000 to it.At the time of distribution, the corporation had substantial earnings and profits.XYZ redeemed R's preferred stock for $13,000 this year when its earnings and profits were $8,000.R will report
A)Capital gain of $7,000, and his basis for common will be unaffected.
B)Dividend income of $7,000, and his basis for common will increase.
C)Dividend income of $8,000, and his basis for common will increase.
D)Dividend income of $7,000, and his basis for common will be unaffected.
E)None of the above

Question

Quizplus · Accepted Answer

When R received the preferred stock as a distribution, it was not a taxable event since he assigned a basis of $6,000 to it. However, when the preferred stock was redeemed for $13,000, it resulted in a dividend income of $7,000 ($13,000 - $6,000 basis). This is because the redemption amount exceeds the assigned basis. The fact that the corporation had substantial earnings and profits at the time of distribution is irrelevant since it is the earnings and profits at the time of redemption that determine the tax treatment. R's basis for the common stock is unaffected by the redemption of the preferred stock.

In 20X5, R Received 20 Shares of Preferred Stock as a Distribution