Alice owns 56% of Daisy Corporation's stock and 50% of May Corporation's stock. Alice sells one-half of her interest in May Corporation to Daisy Corporation for $30,000. The E&P balances of Daisy and May are $25,000 and $35,000, respectively. Alice's basis in her Daisy stock is $40,000 and her basis in the May stock is $38,000. What are the tax consequences of the transaction?
What will be an ideal response?
The transaction is recast as a redemption by Daisy Corporation of Alice's Daisy stock that was received as a result of the capital contribution of the May stock. To test for exchange treatment, the Sec. 302(b) rules are applied to Alice's interest in May Corporation. Alice's interest in May Corporation after the distribution is 39% [25% direct ownership + 14% (56% × 25%) indirect ownership]. Since this is less than 80% of her pre-redemption ownership (50% × 0.80 = 40%), the transaction is treated as a substantially disproportionate redemption that is taxed as an exchange. This results in an $11,000 [$30,000 - (0.50 × $38,000)] capital gain being recognized by Alice.
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