Milan Corporation is owned by four shareholders. Andy and Bob each own 40% of the outstanding common and preferred stock. Chris and Doug each own 10% of the outstanding common and preferred stock. The shareholders want to retire the preferred stock that was issued five years ago when the corporation was in the midst of a major expansion. Retirement of the preferred stock will eliminate the need to pay annual preferred dividends. Explain the tax consequences of the following two alternatives to the shareholders:
• Milan redeems the $100 par preferred stock for its $120 call price. Each shareholder purchased his preferred stock at its par value five years ago.
• The shareholders exchange each share of the $100 par value preferred stock for $120 of additional common stock.
What nontax advantages might exist for selecting one alternative over the other?