Prime Corporation redeems some of its stock from two of its shareholders on the same date. Frank and his son Sam own 50 and 20 shares, respectively, of the 100 shares outstanding before the redemption. The remaining 30 shares are owned by unrelated individuals. Prime redeems for $50,000 10 of Frank’s shares having a $15,000 basis. All of Sam’s shares, having a $30,000 basis, are redeemed for $100,000. Sam files an agreement with the IRS that he will acquire no interest in the corporation other than as a creditor for 10 years. Prime has current and accumulated E&P of $200,000.
a. What are the tax consequences of the redemption to Frank and Sam?
b. What are the tax consequences of the redemption to Sam if he does not file the agreement or if he violates the agreement during the 10-year period?