What is the solution to this problem? Flintstone Company is owned equally by Fre

Question

What is the solution to this problem?

Flintstone Company is owned equally by Fred Stone and his sister Wilma, each of whom hold 2,400 shares in the company. Wilma wants to reduce her ownership in the company, and it was decided that the company will redeem 480 of her shares for $30,700 per share on December 31 of this year. Wilma’s income tax basis in each share is $7,900. Flintstone has current E&P of $10,930,000 and accumulated E&P of $50,210,000.

a. What is the amount and character (capital gain or dividend) recognized by Wilma as a result of the stock redemption, assuming only the “substantially disproportionate with respect to the shareholder” test is applied?

b.

What is Wilma’s income tax basis in the remaining 1,920 shares she owns in the company?

c.

Assuming the company did not make any dividend distributions this year, by what amount does Flintstone reduce its E&P as a result of the redemption?

b.

What is Wilma’s income tax basis in the remaining 1,920 shares she owns in the company?

Explanation / Answer

a.

Wilma reduces her ownership in Flintstone company from 50 percent to 44.4 percent.     (1920/4320).

Dividend recognized by Wilma is as follows:

$30,700*480 shares= 14,736,000.

Wilma’s ownership after the redemption is more than 40 percent (80%*50%) so she fails the substantially disproportionate test.

So she will recognize dividend only of $14,736,000.

b.

Wilma’s income tax basis in the remaining shares is $18,960,000.

She can add back the unused tax basis of 480 shares redeemed ($3,792,000) to the basis of her remaining shares 1,920 ($15,168,000)

c.

Flintstone will reduce its E&P by the amount of dividend recognized by Wiama which is $14,736,000

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