A corporation is owned 70% by Jones and 30% by Smith. Jones owns 70 shares with a cost of $100 each. Smith owns 30 shares with a cost of $100 per share. The company redeems 5 shares from Smith at a redemption price of $400 per share. No stock is redeemed from Jones. This is not a redemption to pay death taxes, and it is not a partial liquidation. What is the tax impact on Smith?
A) $2,000 dividend
B) $2,000 capital gain
C) $1,500 dividend
D) $1,500 capital gain
A) $2,000 dividend
Smith's redemption does not meet the terms of a substantially disproportionate redemption. His ownership is reduced from 30% to 26.3% (25/95 shares). To meet the 80% test, his post-redemption ownership would need to total less than 24%.
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