Question

Chapter 18 , Inc. is a C corporation that has one class of voting common stock, of which 2,000 shares are issued and outstanding. The shares are owned as follows, with none of the shareholders related: The corporation decided to redeem 300 shares owned by Caitlin Clark for $600,000. Caitlin's basis in those 300 shares equaled $125,000. At the time of the redemption, the corporation had $1,000,000 in current earnings and profits and $4,000,000 in accumulated earnings and profits. Answer the following questions based on this information. (Worth 10 points): a. Will this redemption be treated as a sale or distribution? Be sure to provide support for your conclusion. b. Based on your answer in part a, explain the tax consequences of the transaction for Cailin. In other words, calculate the amount of gain/(loss) if a sale or amount of dividend, return of capital, capital gain if a distribution.

Answer 1

a. This redemption will be treated as a distribution because the corporation is buying back its own shares from Caitlin Clark, one of its shareholders. b. Caitlin will receive a dividend of $475,000, which will be reported as ordinary income.

Step-by-step explanation:

a. This redemption will be treated as a distribution because the corporation is buying back its own shares from Caitlin Clark, one of its shareholders.

b. Since the redemption is treated as a distribution, Caitlin's tax consequences will depend on the corporation's earnings and profits. In this case, Caitlin will receive a dividend, which is the distribution of earnings and profits to shareholders. The amount of the dividend will be the $600,000 redemption payment minus Caitlin's basis of $125,000, resulting in a dividend of $475,000. As a shareholder, Caitlin will generally report this dividend as ordinary income on her tax return.