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, 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

In a stock redemption treated as an exchange, the distributing corporation reduces E&P by the lesser of the amount paid in the redemption or the % of stock redeemed times E&P at the date of the redemption. In this case, 50% of the total shares were redeemed, so the reduction in E&P would be 50% of $160,000 which is $80,000. However, Pam treated the transaction as an exchange for tax purposes, which means there is no gain or loss recognized. Therefore, the actual reduction in E&P for Comet Company would be the lesser of $80,000 and the amount paid for the redemption, which is $50,000. Thus, the correct answer is C, a reduction of $40,000 in E&P because of the exchange.

Comet Company Is Owned Equally by Pat and His Sister