Daisy Corporation is the sole shareholder of Ostrich Corporation, which it hopes to sell within the next three years. The Ostrich stock (basis of $25 million) is currently worth $30 million, but Daisy believes that it would be easier to find a buyer if it was worth less. To lower the value of its stock, Ostrich distributes $4 million cash to Daisy (sufficient E & P exists to cover the
distribution). At a later date, Daisy sells Ostrich for $26 million.
a. What are the tax consequences to Daisy on the sale?
b. What would be the tax consequences if Ostrich had not first distributed the $4 million in cash and Daisy sold the Ostrich stock for $30 million?
a.
Because Daisy is the sole shareholder of Ostrich, it has a 100% dividends received deduction on the $4 million cash distribution. Thus, Daisy Corporation is not taxed on the $4 million distribution, and it has a gain on the sale of its stock in Ostrich of $1 million [$26 million (sales price) – $25 million (stock basis)].
b. If Daisy had sold the stock for $30 million, Daisy would have a taxable gain on the sale of $5 million [$30 million (sales price) – $25 million (stock basis)].
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