What is the impact of a non-qualifying stock redemption on cash flow and how does liquidity affect taxable income?

• Your liquidity or cash flow is enhanced by it.
• Tax is payable on income generated by cash (Redemption).

To comprehend any accounting principle, I first assess whether it is generating or reducing my cash flow. Redemption creates a cash flow and is considered income, which is taxed. The dividend is taxable.

What is nonqualifying stock redemption?

The way a shareholder treats a non-qualifying redemption is the same as how they treat a regular distribution. Dividend payments are made based on earnings and profits (E&P). If there is any unrecovered basis in the redeemed stock, it will be added to the shareholder's retained basis. The unrecovered basis is the amount of cost or investment that is not yet taken into account or paid back through depreciation, amortization, or other tax-related deductions that are associated with an asset. This is the value that remains of the asset for tax purposes.

To explain the significance of nonqualifying stock redemption, we can use an example.

• A taxpayer "P" owns all 1,010 outstanding shares of  corporation E and E's sotock.
• Taxpayer's "P's" Basis in stock is $10,100.
• E and E Corporation's has earnings and profits of $110,000.
• Corporation E and E redeemed/Re-take taxpayer "P's " 450 shares of stock for $98,000.
• Since taxpayer "P" owns 100% of the stock before and after the redemption the transaction is a dividend to the extent tha E and E has E&P.
• Because the distribution is ($98,000) is less than the earnings and profits ($110,000), the entire amount is taxable as a dividend which is $98,000.

What happens when the distribution surpasses Earnings and Profits?

• A dividend is usually taxable to the shareholders when the distribution up to the amount of E&P is included.
• When the distribution goes beyond the E&P, it's usually classified as a capital return that lowers the shareholder's basis in the stock.
• If the distribution exceeds both E&P and the shareholder's basis, the excess is treated as a capital gain, which is taxable.
• In this situation, it could be necessary to make adjustments to the financial statements or tax filings. Certain scenarios may result in the excess portion not being deductible for tax purposes.