Comet Company is owned equally by Pat and his sister Pam,each of whom hold 100 shares in the company.Comet redeems 50 of Pam's shares on December 31,year 1,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,year 1.What are the tax consequences to Comet as a result of the stock redemption?
A)No reduction in E&P as a result of the exchange.
B)A reduction of $50,000 in E&P as a result of the exchange.
C)A reduction of $40,000 in E&P as a result of the exchange.
D)A reduction of $80,000 in E&P as a result of the exchange.

Question

Quizplus · Accepted Answer

The reduction in E&P is equal to the lesser of the amount distributed ($50,000) or the proportionate share of E&P attributable to the redeemed shares. Since Pam's shares represent 50% of the company, the E&P attributable to her redeemed shares is $80,000 (50% of $160,000). However, the distribution amount is $50,000, so the E&P is reduced by $40,000 (50 shares out of 200 total shares, or 25% of $160,000).

Comet Company Is Owned Equally by Pat and His Sister