Question

Oak Corp., a calendar-year corporation, was formed three years ago by its sole shareholder, Glover, and has always operated as a C corporation. However, at the beginning of this year, Glover made a qualifying S election for Oak Corp., effective January 1. Oak Corp. did not have any C corporation earnings and profits on that date. On June 1, Oak Corp. distributed $15,000 to Glover. What are the amount and character of gain Glover must recognize on the distribution, and what is his basis in his Oak Corp. stock in each of the following alternative scenarios?

a. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $35,000.
b. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $8,000.
c. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $0.

Answer 1

Oak Corp distributed $15,000 to Glover and we are required to compute the amount and character of gain Glover must recognize under the scenarios as stated in the question:

a. No gain will be recognized by Glover. Rather, his stock basis will be reduced from $35,000 to $20,000 ($35,000 basis - $15,000 cash distribution). So, gain recognized by him is $0.

b. Long term capital gain of $7,000 ($15,000 - $8,000) will be recognized by Glover and his stock basis will be reduced from $8,000 to $0.

c. The entire $15,000 ($15,000-$0) will be recognized as long term capital gain by Glover and his stock basis will remain $0.