Question

Bobcat Corporation redeems all of Zed’s 4,000 shares and distributes to him 2,000 shares of Van Corporation stock plus $60,000 cash. Zed’s basis in his 20% interest in Bobcat is $100,000 and the stock’s value is $250,000. At the time Bobcat is acquired by Van, the accumulated earnings and profits of Bobcat are $200,000 and of Van are $75,000. How does Zed treat this transaction for tax purposes?

a. No gain is recognized by Zed in this reorganization.
b. Zed reports a $50,000 recognized dividend.
c. Zed reports a $40,000 recognized dividend and a capital gain of $40,000.
d. Zed reports a $40,000 recognized dividend and a $10,000 capital gain.
e. Not enough information is available to determine proper treatment.

Answer 1

Zed's transaction is treated as a dividend to the extent of the cash received ($60,000) since it is less than Bobcat's accumulated earnings and profits. The remaining value is a capital gain, calculated by subtracting the dividend and Zed's basis in Bobcat from the total value received. Zed reports a $60,000 recognized dividend and a $150,000 capital gain.

Step-by-step explanation:

Zed's redemption of shares from Bobcat Corporation and receiving Van Corporation stock plus cash is treated as a partially nontaxable exchange and partially as a dividend for tax purposes. The redemption is considered a corporate reorganization. Zed must compare the cash received to the accumulated earnings and profits of Bobcat Corporation to determine the dividend portion of the transaction.

Since Zed receives $60,000 cash and Bobcat's accumulated earnings and profits are $200,000, the cash received does not exceed the earnings and profits. Therefore, the cash received is treated as a dividend. For the Van Corporation stock part, Zed must recognize a capital gain to the extent that the fair market value of the Van stock and cash exceeds his basis in the Bobcat shares.

The direct answer to this question is complex since we need to consider the basis, fair market value of the shares received, and accumulated earnings and profits. However, we can provide a simplification:

• ​Total value received by Zed: 2,000 shares of Van Corporation stock (valued at $250,000) + $60,000 cash = $310,000 total value.
• ​Zed's basis in Bobcat is $100,000.​
• ​Zed must recognize a recognized dividend of $60,000 because it's less than Bobcat's $200,000 earnings and profits. Therefore, the correct amount of dividend is equivalent to the cash received.
• ​The capital gain is calculated as the excess of the total value received over Zed's basis in the Bobcat shares, minus the cash recognized as a dividend: $310,000 - $60,000 - $100,000 = $150,000 capital gain.