Two years ago, Emily, the sole shareholder of Tan Corporation (E & P of $600,000), received a nontaxable stock dividend of 100 shares of preferred stock (fair market value of $100,000) from Tan. As a result of the stock dividend, Emily properly allocated $30,000 of her common stock basis to the preferred stock. One year ago, Emily made a gift of the preferred stock in Tan Corporation to her son, Matt. In the current year, Matt sells one-half of the shares of preferred stock to Betty, an unrelated party, for $50,000. With respect to the sale of the preferred stock by Matt:

Question

Quizplus · Accepted Answer

When Emily received the stock dividend of 100 shares of preferred stock, she properly allocated $30,000 of her common stock basis to the preferred stock. This means that her basis in the preferred stock is $30,000, which is less than the fair market value of $100,000. Therefore, when Emily gifted the preferred stock to her son, Matt, he received a carryover basis of $30,000.

When Matt sells half of the shares to Betty for $50,000, he will recognize ordinary income to the extent of the excess of the amount realized over his adjusted basis, which is $20,000 ($50,000 - $30,000). Therefore, the correct answer is C: Matt will recognize ordinary income of $50,000.

Two Years Ago, Emily, the Sole Shareholder of Tan Corporation