Julian, Berta, and Maria own 400 shares, 400 shares, and 200 shares, respectively, in Caramel Corporation (E & P of $750,000). Berta is Julian's sister, and Maria is Julian's aunt. Caramel Corporation redeems all of Julian's stock for
$420,000. Julian paid $200 a share for the stock five years ago. Julian continued to serve on Caramel's board of directors after the redemption. With respect to the redemption:
A) Dividend income is $340,000.
B) Dividend income is $420,000.
C) Long-term capital gain is $340,000.
D) Long-term capital gain is $420,000.
E) None of these.

Question

Quizplus · Accepted Answer

EThe redemption of Julian's stock does not result in dividend income because it can qualify for sale or exchange treatment, given the significant change in ownership percentage and assuming it meets one of the IRS's tests for a qualifying stock redemption. Before the redemption, Julian owned 400 out of 1000 shares (40%), and after the redemption, he owns 0%, which could meet the requirements for a "not essentially equivalent to a dividend" test or another relevant test under IRC Section 302. Therefore, the correct treatment is a long-term capital gain, calculated as the difference between the sale proceeds ($420,000) and the basis in the stock (400 shares * $200 = $80,000), which equals $340,000. However, since the question does not provide enough detail to definitively exclude dividend treatment under all IRS tests, and given the complexity of IRS regulations, "E) None of these" is also a correct choice because it acknowledges the possibility that none of the provided options accurately captures the tax implications without more specific information about the redemption's qualification under IRS rules.

Julian, Berta, and Maria Own 400 Shares, 400 Shares, and 200