C Corp Redemption

1
C Corp Redemption
Redemption C corp buys stock from
shareholder. Big Question Is transaction
treated as exchange or as a dividend governed by
Section 301 rule? If exchange -
Shareholder has no gain to extent of stock
basis. - Excess subject to capital gain
treatment. If dividend under 301 - All
ordinary dividend income to extent of EP then
basis recovery then sale treatment. - Note
with dividend rate now equal to capital gain rate
(15 gift from Bush), only substantive difference
is priority on recovery of basis vis-à-vis EP.
2
Four Options Under 302(b)
(b)(1) - Not essentially equivalent to a
dividend (b)(2) - Substantially
disproportionate (b)(3) - Complete
termination of shareholders interest (b)(4) -
Partial liquidation
3
318 Attribution Rules
Family Attribution - Parents, spouse, children,
grandchildren. No sibling, in-law or grandparent
attribution. Entity from attribution -
Proportional attribution to owner or beneficiary
for stock owned by partnership, estate or trust.
Corporate proportionate attribution (based on FMV
of stock) to shareholder who owns, directly or
via attribution, 50 or more of stock value.
Entity to attribution - Stock owned by partners
or beneficiaries attributed to partnership,
estate or trust. Attribution to corp only for
stock held by 50 or more shareholder. Option
attribution - All stock subject to option deemed
owned by the holder of option. Chain attribution
generally Ok (child to parent to corp), but no
double family attribution (child to parent to
grandparent).
4
Problem 560 -1
Facts W Corp 100 share outstanding GF
25 shares Mother 20 shares Daughter 15
shares adopted Son 10 shares GMs estate
(Mother 50 beneficiary) 30 shares. Mother has
option on 5 shares owned by son. GF
constructive ownership 85 shares 25 personal
20 mother direct 25 from grandchildren 15 from
estate via mother. Daughter constructive
ownership 55 shares 15 personal 20 Mother
direct 5 mother via option 15 estate via
Mother. GM Estate constructive ownership 100
shares 30 direct 70 Mother, including 20
mother, 25 GF and 25 kids.
5
Problem 560 - 2
Facts 100 shares X Corp owned by partnership
four equal partners, A,B,C,D. As wife W owns
all 100 shares of Y Corp stock. (a) A
ownership of X Corp 25 shares via partnership.
W ownership of X Corp 25 shares via A
spouse and partnership. Ws mother 0
because no in-law attribution. (b) Y corp
ownership of X Corp 25 shares via A to W and W
to Y corp (50 or more shareholder). If W owned
10 of Y, no attribution to Y because 50 or more
test not satisfied. (c) Y shares owned by
Partnership All 100 via W to A to Partnership.
B,C D partners No Y shares. No
sideways attribution from partner to
partnership to other partners. X Corp
ownership of Y All 100 shares via partnership
ownership.
6
Four Options Under 302(b)
(b)(1) - Not essentially equivalent to a
dividend (b)(2) - Substantially
disproportionate (b)(3) - Complete
termination of shareholders interest (b)(4) -
Partial liquidation
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302(b)(2) Substantially Disproportionate
Three mechanical requirements 1. After
redemption, shareholder owns less than 50 of
total combined voting power. 2. After
redemption, percent of voting stock less than 80
of percentage of voting before redemption. 3.
After redemption, percent of all common (voting
and non-voting) less than 80 of percentage
before redemption. Note - Full
attribution rules apply. - Multiple
transactions part of common plan are aggregated.
Rev. Rule 85-14.
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302(b)(3) Complete Termination
Requirement Shareholder is finished takes
a permanent hike. Only remaining interest can be
creditor nothing else. The Big Break No
family attribution. Makes it possible to
transition corp stock to next generation.
Special rules - 10 year forward rule
Selling shareholder not acquire any stock for 10
years, except by bequest or inheritance. - 10
year back rule Last 10 years, selling
shareholder acquired stock from 318 relative or
318 relative acquired stock from selling
shareholder. Not apply if tax avoidance not
principal purpose.
9
302(b)(1) Not Essentially Equivalent to
Dividend
Negative Not near as objective or certain as
(b)(2) or (b)(3). What it takes - There
must be percentage reduction after full
attribution. Davis case. Obviously something
less than (b)(2) standards. - Reduction
must be meaningful. - Look to voting
control changes and power. Majority to
minority. - Family discord may be factor
only for meaningful requirement. -
Reduction in nonvoting preferred never qualify.
Rev Rul 85-106.
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Problem 594-1
Basic Facts Inc Stockholdings
Shs A.B. FMV
Common C.D.
Estate (uncle) 8,000
8 mill 8 mill Adam (H)
800 80k
800k Bea (W) (2 Est Ben)
800 80k
800k Ban (Gift 5 yr)
300 30k 300k
Child Trust (Gift 5 yr) 100
10k 100k Nonvoting
Preferred C.D. Estate
500 50k
50k Adam
500 50k 50k
Inc EP 4 mill
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Problem 594-1

• Inc redeems from C.D. estate 6k common shares and
  all preferred shares.
• - Since Bea beneficiary of estate, all her
  shares and family shares attributed to estate.
  Hence estate deemed to own 100 both before and
  after no reduction. Dividend under 301 to
  extent of 4 mill EP, and balance (2 mill, 50k)
  reduction in Estate stock basis.
• - Option Wait until Bea no longer estate
  beneficiary (got all her money, no further claim,
  and remote possibility of estate to seek return
  of property). Then, no attribution from B.
  Estate common shares go from 80 to 50. Not
  qualify still under (b)(1) because not own less
  than 50. But may qualify as not essentially
  equivalent to dividend because reduction that
  may be meaningful because go from majority to
  deadlock. Facts and circumstances.
• - Option 2 Redeem one more share of
  common and fit under (b)(2). Real certainty.
  Preferred can piggyback on common and qualify.

12
Problem 594-1

1. Inc redeems Beas 800 shares, but she remains
   director. No (b)(3) complete termination because
   she director and 2 attribution from estate
   shares. Attribution 2 of estate shares (160),
   all other family shares for total of 2160 shares.
   If terminate estate beneficiary status before
   redemption, percentage owned before is 20
   (2000/10,000) and percentage after is 13.04
   (1200/9200). (b)(2) tests satisfied both 80
   tests for common and voting and less than 50
   voting test.
2. Same as b, but 6 months later redeems 4,200
   shares from estate. If both redemptions part of a
   common plan, Beas earlier redemption not qualify
   because her after percent would be 24
   (1200/5000). If not part of common plan, she
   still OK. Facts and circumstances test.
3. Inc redeems all preferred shares. C.D. estate no
   hope under (b)(1) because majority control both
   before and after. Adam may have long shot (b)(1)
   argument because he had de minimis total
   interest. Rev. Rule 85-106.

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Problem 594- 2
Basic Facts Inc Stockholdings
Shs A.B. FMV
Common Adam (H)
800
80k 800k Bea (W)
800 80k
800k Ban (Gift 5 yr)
300 30k
300k Child Trust (Gift 5 yr)
100 10k
100k Total
2,000 200k 2 mill Inc EP
4 mill (a) Inc redeems B 800 shares for cash.
(b)(3) complete termination qualifies so long as
B holds no other interest. Prior gifts to kids
falls within 10 yr. look back period, but no
evidence of tax avoidance purpose. B must file
agreement to notify if she acquires forbidden
interest with 10 year forward period.
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Problem 594- 2

• What result if B fails to file required
  agreement? Reg.1-302-4(a)(2) gives reasonable
  extension of time if there reasonable cause for
  not filing and request for extension is filed in
  reasonable time. Statute of limitations extended
  for 1 yr from date of notice.
• (c) B remains director after redemption? (b)(3)
  out and B has dividend. What if B inactive
  director? Per Ninth Circuit in Lynch, makes no
  difference.

15
Problem 594- 2

• A B each gift 400 shares to son D, and then
  corp redeems other 400 shares from each with 50k
  cash and 20 yr. 350k note, market interest and
  secured by assets. A B resign all interests,
  except B to remain consultant for 50k per year.
  Issue Is family attribute waived to qualify
  under (b)(3) as complete termination? Three
  issues
• - 20 yr. note Such long term that it may
  be deemed equity, not creditor. IRS ruling
  standard 15 yrs max. Some courts have allowed 20
  yrs. Pushing limit here.
• - B consulting Per Lynch, will kill
  (b)(3) with no family termination. Prohibited
  interest. Some earlier cases contrary for
  independent contractors, but far too risky now.
• - 10 year look back and gift to Dan. No
  tax avoidance purpose if intent to turn-over
  control and retire. Rev. Rule 77-293.

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Problem 594- 3

• Facts Same as 2, except B dies with shares
  valued at 800k and A sole beneficiary.
• B estate shares redeemed for 800k. No (b)(2) or
  (b)(3) because attributed with ownership of all
  other shares through Adam. No waiver of entity
  attribution for complete termination under
  (b)(3). Hence, estate has full dividend. Note
  step up basis no value.
• What if Adams 800 shares redeemed at same time.
  Here no entity attribution from Adam to estate.
  Family attribution waived, so complete redemption
  under (b)(3) if required agreement filed for 10
  yr look-forward rule.

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Problem 594- 4
Facts Same as 2, except A B (800 shares each)
brother and sister, D (300 shares) is A son, and
remaining 100 held by C, cousin unrelated under
318. (a) Inc redeems 100 of A shares. As
interest goes from 55 (1100/2000) to 52.6
(1000/1900). A still have control so no hope
under (b)(1). (b) Inc redeems 200 from D. D
interest goes from 55 (1100/2000) to 50
(900/1800). May argue meaningful reduction under
(b)(1), but unlikely where other stock held by
more than one unrelated party. Not enough
dispersal of power. Different if one unrelated
other 50 party per Rev. Rule 75-502. (c) Inc
redeems 10 shares from C. Cs interest goes from
5 (100/2000) to 4.52 (90/1990). Best argument
under (b)(1) is that any reduction of minority
interest is meaningful per Rev. Rul. 75-512.