Tax Research Project $$ Case B

Albert, Hunter, Hudson, and Beatrice, four unrelated friends come to you with a tax problem. The

Albert, Hunter, and Hudson acquired $100$ shares each of Xylocarp corporate stock and Beatrice acquired

$50$ shares. All four paid $$1,000$ in cash per share, so the Albert, Hunter, and Hudson paid $$100,000$ and

Beatrice paid $$50,000.$ Albert$$s father, Alex, owns $150$ shares; Hunter$$s mother, Jill, owns $150$ shares;

Hudson$$s daughter, York, owns $150$ shares; and Beatrice$$s son, Jerome, owns $200$ shares.

Years ago, Hunter, a peculiar romantic, thought of the sweetest Valentine$$s gift he could give his wife

Wileen, half of his Xylocarp shares! She was so ecstatic!!! Not to be shown up$,$ Hudson the next year

gave his wife, Wioleta, half of his Xylocarp shares for Valentine$$s Day! Her reaction wasn$$t quite so

enthusiastic.

Albert, Hunter, Hudson, and Beatrice are considering redeeming $50,50,40,$ and $50$ of their shares for

$$150,000,$ $$150,000,$ $$120,000,$ and $$150,000$ respectively. If they do this, their old vs$.$ new ownership

will look like the following:

Basis of Shares

Before

Redemption

# of Shares

Before

Redemption

# of Shares

After

Redemption

Albert $$100,00010050$

Alex, Albert$$s Father n$/$a $150150$

Hunter $$50,000500$

Wileen, Hunter$$s Wife $$50,0005050$

Jill, Hunter$$s Mother n$/$a $150150$

Hudson $$50,0005010$

Wioleta, Hudson$$s Wife $$50,0005050$

York, Hudson$$s Daughter n$/$a $150150$

Beatrice $$50,000500$

Jerome, Beatrice$$s Son n$/$a $200200$

Total Shares $1,000810$

The four friends are coming to you for advice and explain to you that they think their redemption will be

a non$-$qualified redemption subject to $302($d$)\mathrm{.}1$ They go on and on about how amazing an experience

their tax class was, but then explain that, for some unknown reason, all of the in$-$class $302($d$)$

redemption examples had very low E&P$?$ This meant that in all of the examples, the entire basis of the

redeemed shares was treated as a return of capital.

They know Xylocarp has been very profitable, has plenty of E&P$,$ so the entire distribution will be

considered a dividend, and therefore there will be no reduction in basis of their redeemed shares. What

they don$$t know, however, is what to do about the unused basis of their redeemed shares??? Does it

create a loss, create an adjustment, get transferred somehow, or simply disappear?

$1$ Assume neither Hunter nor Beatrice will agree to not to acquire shares within the next $10$ years.

Take a position on this Question:

$1.$ Assuming all of Albert$$s $$150,000$ constitutes a dividend, what will happen to the $$50,000$ basis

of Albert$$s $50$ redeemed shares:

a$.$ Disappears temporarily, the basis will come back if he ever repurchases the $50$ shares.

b$.$ Disappears permanently, unused basis in a redemption is just lost and non$-$deductible.

c$.$ Creates a recognized loss, unused basis in a redemption is fully deductible.

d$.$ Creates an adjustment and is transferred to his remaining $50$ unredeemed shares.

e$.$ Creates an adjustment and is transferred to his father$$s $150$ shares.

f$.$ Something not listed above $($explain the correct treatment in the logic section$).$

$2.$ Assuming all of Hunter$$s $$150,000$ constitutes a dividend, what will happen to the $$50,000$ basis

of Hunter$$s $50$ redeemed shares:

a$.$ Disappears temporarily, the basis will come back if he ever repurchases the $50$ shares.

b$.$ Disappears permanently, unused basis in a redemption is just lost and non$-$deductible.

c$.$ Creates a recognized loss, unused basis in a redemption is fully deductible.

d$.$ Creates an adjustment and is transferred to his wife$$s $50$ shares.

e$.$ Creates an adjustment and is transferred to his mother$$s $150$ shares.

f$.$ Something not listed above $($explain the correct treatment in the logic section$).$

$3.$ Assuming all of Hudson$$s $$120,000$ constitutes a dividend, what will happen to the $$40,000$

basis of Hudson$$s $40$ redeemed shares:

a$.$ Disappears temporarily, the basis will come back if he ever repurchases the $40$ shares.

b$.$ Disappears permanently, unused basis in a redemption is just lost and non$-$deductible.

c$.$ Creates a recognized loss, unused basis in a redemption is fully deductible.

d$.$ Creates an adjustment and is transferred to his wife$$s $50$ shares.

e$.$ Creates an adjustment and is transferred to his daughter$$s $150$ shares.

f$.$ Something not listed above $($explain the correct treatment in the logic section$).$

$4.$ Assuming all of Beatrice$$s $$150,000$ constitutes a dividend, what will happen to the $$50,000$

basis of Beatrice$$s $50$ redeemed shares:

a$.$ Disappears temporarily, the basis will come back if he ever repurchases the $50$ shares.

b$.$ Disappears permanently, unused basis in a redemption is just lost and non$-$deductible.

c$.$ Creates a recognized loss, unused basis in a redemption is fully deductible.

d$.$ Creates an adjustment and is transferred to any other stock she directly owns.

e$.$ Creates an adjustment and is transferred to her son$$s $200$ shares.

f$.$ Something not listed