Ameriparent Corporation owns a 70% interest in Flag Corporation. The corporations have current and accumulated E&Ps of $25,000 and $40,000, respectively. Taxpayer, who has a $20,000 basis in her 40% ownership interest of Ameriparent Corporation, sells sufficient stock to Flag to reduce her interest in Ameriparent from 40% to 20%. Taxpayer receives $20,000 for the stock she surrenders. What are

Question

the tax consequences of the transaction for Taxpayer?

What will be an ideal response?

Answer 1

The transaction is recast under Sec. 304 as a distribution from Ameriparent in redemption of Taxpayer's stock. The $20,000 purchase is a dividend under Sec. 301 since Taxpayer's interest was not less than 80% of what it was prior to the redemption [20% direct + 14% indirect = 34%,which is not less than the 32% (40% × 80% = 32%) minimum needed for substantially disproportionate treatment]. The redemption might be eligible for capital gain treatment if the distribution is considered to be not essentially equivalent to a dividend. It is possible that this interpretation will be accepted, since Taxpayer goes from one minority position to another minority position.