Stock Redemptions For this assignment, read the scenario below and then evaluate

Question

Stock Redemptions

For this assignment, read the scenario below and then evaluate the impact of the stock redemption.

Adams, Inc. is a family-owned business that has one class of stock. There are 600 shares allocated equally to Al Adams, Bev Adams, Curt Adams, Derek Adams, Elroy Adams and Fred Murray. Fred is not related to the Adams family. He would like to sell has shares back to Adams, Inc. Fred's shares have a FMV of $200,000 and a tax basis of $50,000. The redemption is planned for December 31.

- Is it possible to determine if there will be a dividend or capital gain from the information provided? If so, calculate it. If not, what information would you need?

- Would this transaction meet the three IRS change in stock ownership tests? Explain each test and the results.

- Under what circumstances would Fred be deemed to have constructive ownership of more than 100 shares?

Explanation / Answer

1.

There will be capital gain on redemption of shares by Fred and sale of his 200 shares to Adams Family.

Capital Gain is calculated using the cost of acquisition of the shares and fair maket value. Fair market value is deemed to be the full value of consideration for this kind of transfer.

Here, we require the original cost of acquisition of 200 shares owned by Fred Murray, with which it will become possible to calculate the capital gains arising on transfer.

2.

An ownership change occurs with respect to a corporation if it is a loss corporation on a testing date and, immediately after the close of the testing date, the percentage of stock of the corporation owned by one or more 5-percent shareholders has increased by more than 50 percentage points over the lowest percentage of stock of such corporation owned by such shareholders at any time during the testing period. A testing date is any date on which occurs any change in the ownership of loss corporation stock that affects the percentage of stock owned by any 5-percent shareholder (owner shift).

To determine whether a redemption is a stock sale, IRC §302 provides for 2 objective tests.

The 1st test treats the stock redemption as a sale if it terminates the shareholder's entire interest in the corporation.

The 2nd test treats a substantially disproportionate redemption, where the redemption significantly reduces the stockholder's equity stake in the corporation, as a stock sale if the following 2 requirements are met:

Thus, this transaction satisfies the second test.

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