Z Corporation has 200 shares of common stock outstanding. A and B, who are unrel

Question

Z Corporation has 200 shares of common stock outstanding. A and B, who are unrelated, each acquired 100 shares of Z upon their issuance at a price of $1,000 per share, and they each thus have an adjusted basis of $100,000 in their Z stock. At the beginning of the current year, Z has $100,000 of accumulated E&P and Z has $100,000 of current E&P from operations (after taxes) during the year. What are the tax consequences to Z if on July 1 it distributes $250,000 cash in redemption of A's shares in a redemption that qualifies as an exchange under §302(a)?

Explanation / Answer

A stock redemption is a purchase by a corporation of its own share from an existing shareholder but unlike a dividend which is a distribution of corporate earning to a shareholder, a stock redemption is a redemption of shareholders share in the corporation. In the current situation when the amount distributed of $250,000 for redemption of A's shares qualifies as an exchange under section 302 (a). In case of redemption under exchange the accumulate earning and profit (E&P) as well as the current E&P get impacted proportionately. Since through redemption Z corporation outstanding shares reduced by 50% so both accumulated E&P and current E&P will be reduced proportionately to the reduction in the number of outstanding shares. So accumulate E&P and Current E&P will be reduced by $50,000.

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