QUESTION 7 Bud and Lou are equal shareholders in Hey, Abbott, Inc. Three years a

Question

QUESTION 7

Bud and Lou are equal shareholders in Hey, Abbott, Inc. Three years ago that each received 100 shares of preferred stock in a tax free dividend. Their respective common was worth $30,000 at distribution, their preferred $10,000. Bud and Lou each have a common stock basis of $4,000. At the time of the distribution the company had E&P of $10,000.

Last year, Bud sold his preferred to a third party for $11,000. What are the tax consequences to Bud?

This year the company redeemed Lou's shares for $10,000. The company's E&P at that time was $12,000.

Explanation / Answer

Bud- since the above is a case pf preffered stock bailout, bud will have a ordinary income treated as dividend equivalent to FMV of the preffered stock on the date of stock dividend i.e., 10000.

Lou- If the company buys the preffered stock, proceeds constitute dividend to the extent of E&P i.e., 10000.

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