Comet Company is owned equally by Pat and his sister Pam, each of whom holds 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $160,000 on December 31, 20X3. What are the tax consequences to Comet because of the stock redemption?

Question

Quizplus · Accepted Answer

When a shareholder treats a stock redemption as an exchange for tax purposes, it is treated as a sale of the stock. Therefore, for Comet, the $50,000 paid to Pam for the redemption of her shares is treated as a distribution of E&P. Since Pam owns 50% of the company, $25,000 of the distribution is attributed to her share of E&P. Thus, the total reduction in E&P for Comet is $50,000 minus $25,000, or $25,000. Therefore, choice C is correct.

Comet Company Is Owned Equally by Pat and His Sister