General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31,year 1.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 remaining stock 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.General Inertia had total E&P of $800,000 at the time of the distribution.What are the tax consequences to Henry as a result of the transaction?
A)Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share.
B)Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share.
C)Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share.
D)Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share.

Question

Quizplus · Accepted Answer

This transaction is a partial liquidation of the company, which means that it is treated as a sale of stock by the shareholder. Henry received a distribution of $50,000, which is the amount realized from the sale of 250 shares of his stock (500 shares x 50%). His tax basis in the shares he sold was $100 per share, so his cost basis in the 250 shares he sold was $25,000 (250 shares x $100). Since he received $50,000 in cash, he had a capital gain of $25,000 ($50,000 - $25,000). 
Henry's remaining shares have a new tax basis of $200 per share because his original tax basis in the company's stock is allocated to the shares he sold in the partial liquidation. Thus, Option B is correct.

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