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

The redemption of 50 shares at $1,000 per share results in a $50,000 distribution. However, for tax purposes, the reduction in E&P is limited 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 reduction is 50% of $160,000, which is $80,000. However, since the distribution is $50,000, the reduction in E&P is limited to $50,000.

Comet Company Is Owned Equally by Pat and His Sister