Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $160,000 on December 31, 20X3. What are the tax consequences to Comet because of the stock redemption? Explain your choice A. No reduction in E&P because of the exchange.
B. A reduction of $50,000 in E&P because of the exchange.
C. A reduction of $40,000 in E&P because of the exchange.
D. A reduction of $80,000 in E&P because of the exchange.

The tax consequences to Comet because of the stock redemption would be a reduction of $40,000 in E&P because of the exchange.

Explanation:

According to the given data we can conclude that the tax consequences to Comet because of the stock redemption would be Reduction of E& P due to exchange. In order to calculate the amount of Reduction we would have to make the following calculation:

Reduction of E& P due to exchange=Total E&P*Total voting Right Sold

According to the given data we have the following:

Total E&P=Comet has total E&P of $160,000

Total voting Right Sold=shares redeem by comet/shares by Pat+shares by Pam

Total voting Right Sold=50/ (100+100)

Total voting Right Sold=25%

Therefore, Reduction of E& P due to exchange=$160,000*25%

Reduction of E& P due to exchange=$40,000

The tax consequences to Comet because of the stock redemption would be a reduction of $40,000 in E&P because of the exchange.

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