Question

El Toro Corporation declared a common stock distribution to all shareholders of record on June 30, year 1. Shareholders will receive 1 share of El Toro stock for each 2 shares

of stock they already own. Raoul owns 300 shares of El Toro stock with a tax basis of
$60 per share. The fair market value of the El Toro stock was $100 per share on June 30,
year 1. What are the tax consequences of the stock distribution to Raoul?
A) $0 dividend income and a tax basis in the new stock of $60 per share.
B) $0 dividend income and a tax basis in the new stock of $40 per share.
C) $15,000 dividend and a tax basis in the new stock of $100 per share.
D) $0 dividend income and a tax basis in the new stock of $100 per share.

Answer 1

Raoul will experience $0 dividend income from the stock distribution of El Toro Corporation. His tax basis in the new stock will be $40 per share since the basis of the original shares is spread across all shares after the distribution.

Step-by-step explanation:

The tax consequences of the stock distribution to Raoul, who owns 300 shares of El Toro stock, are such that if the corporation declares a stock distribution (commonly known as a stock dividend), he will receive shares without having to pay tax on the distribution at the time it's made.

Since Raoul is receiving 1 additional share for every 2 shares he owns, he will receive 150 new shares of El Toro stock. Given the tax basis of his original shares is $60 per share, and the fair market value is $100 per share on the date of distribution, Raoul's tax basis for the new shares needs to be calculated.

The correct tax consequences for Raoul are option B: $0 dividend income and a tax basis in the new stock of $40 per share. This is because the original basis of $60 per share must be allocated across the total number of shares post-distribution (300 original + 150 new = 450 total shares), resulting in a new basis of $40 per share for all 450 shares.