Perch Corporation has made paint and paint brushes for the past ten years.Perch Corporation is owned equally by Arnold,an individual,and Acorn Corporation.Perch Corporation has $100,000 of accumulated and current E&P.Both Arnold and Acorn Corporation have a basis in their stock of $10,000.Perch Corporation discontinues the paint brush operation and distributes assets worth $10,000 each to Arnold and Acorn Corporation in redemption of 20% of their stock.Due to the distribution,Arnold and Acorn Corporation must report:

Question

Quizplus · Accepted Answer

The distribution of assets worth $10,000 each to Arnold and Acorn Corporation in redemption of 20% of their stock will be treated as a partial liquidation. Therefore, both Arnold and Acorn Corporation will report the distribution as a capital gain to the extent of their stock basis of $10,000, resulting in a $0 taxable gain. The remaining $8,000 ($10,000 distribution minus $2,000 basis) will be treated as a dividend to the extent of Perch Corporation's current and accumulated E&P of $100,000. As both Arnold and Acorn Corporation own 50% of Perch Corporation, they will each report dividends of $4,000 ($8,000 x 50%). The correct answer is B.

Perch Corporation Has Made Paint and Paint Brushes for the Past