Buckeye Company is owned equally by James and Terrelle, each of whom own 500 sha

Question

Buckeye Company is owned equally by James and Terrelle, each of whom own 500 shares in the company. Terrelle wants to reduce his ownership in the company, and it was decided that the company will redeem 200 of his shares for $5,000 per share on December 31, 2017. Terrelle's income tax basis in each share is $1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of $20,000,000. What is the amount and character (capital gain or dividend) recognized by Terrelle because of the stock redemption?

1- Amount of taxable income?

2- Character of taxable income? (capital gain or dividend)

Explanation / Answer

Existing Ownership= 500/1000= 50%

Ownership after reduction = 300/800= 37.5%

Terelle qualifies the substantially disproportionate test to treat the transaction as an exchange

Ownership below 50% and his ownership percentage after the redemption is less than 80% of his ownership before the redemption: 80% × 50% = 40%

1. Amount of taxable Income = 1,000,000 - 200,000 = 800,000

2. 800,000 as capital gain

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