A has owned 90 of the 100 shares of CFCT stock since CFCT was organized on March 13, 1989. P has owned the remaining 10 shares since organization, and those 10 shares constitute nonrecently purchased stock in P’s hands within the meaning of section 338(b)(6)(B). On November 1, 1994, P purchases A’s 90 shares of CFCT stock for $90,000 and makes a section 338 election for CFCT. P also makes a gain recognition election under section 338(b)(3)(A) and § 1.338-5(d).
CFCT’s earnings and profits for its short taxable year ending November 1, 1994, are $50,000, determined without taking into account the deemed asset sale. A recognizes gain of $81,000 on the sale of the CFCT stock, and CFCT recognizes gain of $40,000 by reason of its deemed sale of assets under section 338(a)(1).
A’s sale of CFCT stock to P is a transfer to which section 1248 applies. For purposes of section 1248(a), CFCT’s earnings and profits for the short year are $90,000 (the $50,000 determined under § 1.1248-2(e) plus the $40,000 from the deemed sale). A’s entire gain is therefore characterized as a dividend under section 1248 (but see section 338(h)(16)).
P recognizes a gain of $9,000 on the 10 shares of nonrecently purchased CFCT stock by reason of the gain recognition election. Because P is treated as selling that stock for all purposes of the Internal Revenue Code, section 1248 applies, and $9,000 of the $90,000 of earnings and profits is attributable to that block ($90,000 × 10/100). P’s entire gain on the deemed sale of the 10 shares is included under section 1248(a) as a dividend.
Both A’s gain on the sale of its 90 shares and P’s gain on the deemed sale of its 10 nonrecently purchased shares are recharacterized as dividends under section 1248.
For section 1248 the short-year earnings and profits are $90,000 — the $50,000 of operating earnings plus the $40,000 recognized on the deemed sale of assets under section 338(a)(1).
By electing under section 338(b)(3)(A), P is treated as selling its 10 nonrecently purchased shares, so section 1248 applies to the $9,000 of gain attributable to that block.
The earnings attributable to P’s block are $9,000 — the $90,000 of short-year earnings and profits multiplied by 10/100, the block’s share of the CFCT stock.
