Robert and Lori (Robert’s sister) own all of the stock in Swan Corporation (E &

Question

Robert and Lori (Robert’s sister) own all of the stock in Swan Corporation (E & P of $1 million). Each owns 500 shares and has a basis of $85,000 in the shares. Robert wants to sell his stock for $600,000, the fair market value, but he will continue to be employed as an officer of Swan Corporation after the sale. Lori would like to purchase Robert’s shares and, thus, become the sole shareholder in Swan, but Lori is short of funds. What are the tax consequences to Robert, Lori, and Swan Corporation under the following circumstances? a. Swan Corporation distributes cash of $600,000 to Lori, and she uses the cash to purchase Robert’s shares. b. Swan Corporation redeems all of Robert’s shares for $600,000.

Explanation / Answer

a) After the company distributes cash of $600,000 to Lori, it will have to reduce its E&P by $600,000. Also, Lori will have to recognise a dividend income of $600,000 and she would have an adjusted basis of $600,000 . Moreover, she would become the only shareholder in the company. As far as Robert is concerned , he would have to recognise a capital gain of $600,000(Distribution of stock) - $85,000 (Basis in stock) = $515,000

b) In this case, if Swan Corporation redeems all of Robert’s shares for $600,000, then Robert would again have to recognize a capital gain of $600,000(Distribution of stock) - $85,000 (Basins in stock) = $515,000. As in the previous case, Lori would become the only shareholder. As far as the company is concerned, it would have to reduce its E&P by $500,000 [$1,000,000 (E&P) X 50% (redeemed interest)].

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