C and D organized Z corporation 10 years ago, each contributing $40,000 and each

Question

C and D organized Z corporation 10 years ago, each contributing $40,000 and each receiving 400 shares of common stock. Five years ago, in June, Z declared a one for one dividend payable in pure preferred with a $400 fair market value. The value of the common stock after the distribution was $1600 per share. In that year, five years ago, Z had accumulated E&P of $52,000 and current E&P of $12,000. In the current year, Z has accumulated E&P of $112,000 and current E&P of $8000.In the current year, Z redeems all of C’s preferred stock in exchange for $36,000.

a. section 306 applies to this transaction. The entire $36,000 is ordinary income.

b. section 306 applies to this transaction. Of the redemption proceeds, $32,000 is ordinary income.

c. section 306 does not apply because of the complete termination of the preferred stock interest.

d. None of the above.

please explain why you choose this answer

Explanation / Answer

option a is correct, that is section 306 applies to this transaction. The entire $36,000 is ordinary income.

The value of shares as per E&P on five year ago when it declared a one for one dividend payable was 180 per share that is (80000+52000+12000)/ (800 no of shares)

(180-100)80*400=36,000

here the total amount is considered as ordinary income, as there is no charity contribution, hence total 36000 is considered as ordinary income.

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