General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X3. 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 because of the transaction?

Question

Quizplus · Accepted Answer

Under the partial liquidation rules, an individual receives exchange treatment in the transaction. This means that the distribution is treated as a sale or exchange of stock rather than a dividend. Henry received $50,000 in exchange for 250 shares of stock, which had a fair market value of $200 per share at the time of the distribution. Thus, his total consideration received was $50,000, and his basis in the stock surrendered was $50,000 (250 shares x $100 per share). Therefore, his realized gain was $50,000 - $12,500 (his basis in the stock surrendered) = $37,500. Since Henry held the shares for more than one year, the gain is long-term capital gain. His remaining shares have a new basis of $100 per share (the fair market value of the shares surrendered).
Therefore, the correct answer is option B: Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share.

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