Ramon and Sophie are the sole shareholders of Gull Corporation. Ramon and Sophie each have a basis of $100,000 in their 2,000 shares of Gull common stock. When its E & P was $700,000, Gull Corporation issued a preferred stock dividend on the common shares of Ramon and Sophie, giving each 1,000 shares of preferred stock with a par value of $100 per share. At the time of the stock dividend, fair market value of one share of common stock was $150 and fair market value of one share of preferred stock was $75. If an amount is zero, enter "0". a. What are the tax consequences of the distribution to Ramon and Sophie? in the amount of s Ramon and Sophie have What is the basis for the common stock and preferred stock for each shareholder? Common stock: $ Preferred stock: $ b. What are the tax consequences to Ramon if he later sells his preferred stock to Anthony for $75,000? Anthony is not related to Ramon. A sale of the preferred stock to Anthony will produce s of income. c. Indicate whether the following are tax consequences if, instead of Ramon selling the preferred stock to Anthony, Gull Corporation redeems the stock from Ramon for $75,000. Assume Gull's E & P at the time of the redemption is $650,000. Select "Yes" or "No", whichever is applicable.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

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Problem 6-52 (LO. 3)
Ramon and Sophie are the sole shareholders of Gull Corporation. Ramon and Sophie each have a basis of $100,00o in their 2,000 shares of
Gull common stock. When its E & P was $700,000, Gull Corporation issued a preferred stock dividend on the common shares of Ramon and
Sophie, giving each 1,000 shares of preferred stock with a par value of $100 per share. At the time of the stock dividend, fair market value
of one share of common stock was $150 and fair market value of one share of preferred stock was $75.
If an amount is zero, enter "0".
a. What are the tax consequences of the distribution to Ramon and Sophie?
Ramon and Sophie have
in the amount of $
What is the basis for the common stock and preferred stock for each shareholder?
Common stock: $
Preferred stock:
b. What are the tax consequences to Ramon if he later sells his preferred stock to Anthony for $75,000? Anthony is not related to Ramon.
A sale of the preferred stock to Anthony will produce $
of
income.
c. Indicate whether the following are tax consequences if, instead of Ramon selling the preferred stock to Anthony, Gull Corporation
redeems the stock from Ramon for $75,000. Assume Gull's E & P at the time of the redemption is $650,000. Select "Yes" or "No",
whichever is applicable.
a. The shareholder recognizes dividend income to the extent of the corporation's E & P on the date of
the redemption.
b. The entire $75,000 of redemption proceeds will be dividend income to Ramon.
c. The $20,000 of the basis in the preferred stock is added back to the basis of Ramon's common stock.
d. Gull's E & P is increased by the $75,000 dividend distribution.

Expert Solution

Step 1

a. Neither Ramon nor Sophie recognizes income upon receipt of the preferred stock.

Therefore, Ramon and Sophie have neither gain nor loss in the amount of $0.

It is a non-taxable stock dividend under § 305. However, the stock is classified as § 306 stock.

The $100,000 basis in their original common shares is reallocated between the preferred stock and the common stock based on the relative fair market value of each.

The basis is reallocated as follows:

Fair market value of common: $1, 000 \times $ 150 = $ 150, 000$
Fair market value of preferred: $1, 000 \times $ 75 = $ 75, 000$

Total Value = $$ 150, 000 + $ 75, 000 = $ 225, 000$

Basis of common: $\frac{150}{225} \times $ 100, 000 = $ 66, 666.67$
Basis of preferred: $\frac{100}{225} \times $ 100, 000 = $ 44, 444.44$

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