302(b)(4)

1
302(b)(4) Partial Liquidation Exception
Applies - Only to noncorporate shareholders
- Even thought distribution pro rata and
otherwise flunks (b)(1) (b)(3). - Based on
impact at corporate level not shareholder
level. - Stock held by partnership, estate or
trust deemed help proportional by partners and
beneficiaries. Requirements 302(e) - Not
essentially equivalent to dividend (determined at
corporate level) - Distribution pursuant to a
plan - Distribution occurs in taxable year
plan adopted or following year.
2
Partial Liquidation Not Essentially Equivalent
to Dividend
Safe Harbor - Distribution attributable to
ceasing to conduct qualified trade or business
operated for 5 years and not acquired during 5
yr period in transaction that recognized gain or
loss. - After distribution, corp still
involved in active conduct of qualified trade
or business. Non- Safe Harbor Scenarios -
Tough must show serious contraction of
business. - Example Fire destruction
corporate cutback and all insurance proceeds
distributed. - Bona fide business reason
unrelated to desire to bail out liquid assets -
No hope if plan is to bail out accumulated
investment assets
3
Problem 600

• Basic Facts A Corp has publishing business
  (Books) , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• A distributes Books (more than 5 yrs owned, as is
  Cram) to shareholders in equal shares and redeems
  50 shares from each.
• - For M P, qualifies for exchange as
  partial liquidation if pursuant to plan, done
  within year of plan or next year. A Corp must
  continue to operate Cram. Both held 5 yrs. Same
  result if no actual share surrender (just
  reallocate basis to stock). Makes no difference
  if pro rata under (b)(4) partial liquidation
  provision.
• - Partial liquidation provision not
  available to corp shareholder. So I Corp stuck
  with dividend under 301 (pro rata kills any hope
  of other three 302(b) provisions). 243 dividend
  deduction of 70 available, but any redemption
  that is part of partial liquidation requires
  stock basis reduction under 1059.

4
Problem 600

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• What impact in (a) if books bought 3 yrs ago for
  cash? Not qualified business because not held 5
  years. All shareholders have 301 dividend.
  Concern is bailing liquid cash through partial
  liquidation. Hence, 5 yr rule. If bought in
  tax-free reorg,where stock used, could qualify if
  business ran for 5 yrs. Here, no liquid asset
  bailout.
• Books destroyed by fire, 1/2 insurance proceeds
  distributed pro rata and other half used to scale
  down book business. I Corp still dividend. For
  P M, not qualify under 302(e)(2) because not
  ceasing business or distributing all assets.
  Could be not essentially equivalent to dividend
  under (e)(1) but need more facts to see if it
  corporate contraction. For ruling purposes, IRS
  requires 20 cut in revenues, FMV and employees.
  Rev. Proc. 2002-3.

5
Problem 600

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• Same as (a) but Books distributed to Michael in
  redemption of all his stock. Valid partial
  liquidation - exchange treatment allowed. Also
  may qualify under (b)(3) (family attribution
  waived) and maybe (b)(1) (attribution interest
  reduced from 67 to 50).
• Same as (a) but Books distributed to I Corp in
  redemption of all stock. Although cant qualify
  under be partial liquidation provision, qualifies
  under (b)(3) as termination of complete interest.
  Exchange treatment allowed.
• Securities portfolio distributed pro rata in
  redemption. No hope. Not partial liquidation or
  corporate contraction. 301 dividend to all
  shareholders.

6
Problem 600

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• A sells stock in B Corp and distributes proceeds
  pro rata. Sub corp stock cant qualify as
  partial liquidation per Rev. Rule 79-184. Hence,
  301 dividend to all shareholders.
• A liquidates B Corp (operated for more than 5
  yrs) and distributes assets in pro rata
  redemption. If liquidated in non-taxable
  transaction under 332 (discussed later in
  course), A picks up all B Corp attributes and may
  qualify as partial liquidation per Rev. Rule
  75-223.

7
Redemption Impact on Corp
Two issues - Gain or loss to corp on
distribution of property other than cash. 311
governs the same as it does for non-liquidating
distributions. Gain is always recognized by
corporation, but losses not recognized. - EP
impact. EP reduced by amount of distribution,
but per 312(n)(7) reduction can not exceed
ratable share of EP attributable to redeemed
stock. So if 1/3 stock redeemed, EP before
redemption can not be reduced more than 1/3. -
Stock acquisition expenses paid by corp
(brokerage commissions, legal fees, etc) are not
deductible per Section 162(k). They are treated
as non-amortizable capital expenditures. Amounts
paid that have no nexus to redemption (employment
agreement amount) are deductible and loan costs
and fees involved in redemption may be amortized
over term of loan.
8
Problem 604

• Basic Facts X Corp shareholders A B 100
  shares each with 100k basis. X EP 120k
  accumulated from prior years, no current EP, net
  worth 400k. X pays A 200k cash for As stock.
  Assume exchange treatment. Consequences to X
  Corp EP?
• Since half shares redeemed, 312(n)(7)
  limits EP reduction to half reduction in EP.
  Thus, remaining EP reduced to 60k as a result of
  redemption.

9
Zenz Bootstrap Acquisitions
Three scenarios all part of common plan
Scenario 1 Shareholder sells some stock and
then has corporation redeem balance of shares.
Qualifies under 302(b)(3) even though corporate E
P distributed to help facilitate acquisition.
Zenz case/ Scenario 2 Corporation sells new
shares to new shareholder and then redeem shares
from existing shareholder. Percentages before
and after both transactions control whether
(b)(2) substantially disproportionate tests
met. Scenario 3 Existing shareholder sell
some shares to new shareholder and then have
corporation redeem shares from existing
shareholder. Percentages before and after both
transactions control whether (b)(2)
substantially disproportionate tests met. Rev.
Rule 75-447
10
Problem 609
Basic Facts S sole shareholder of T Corp., to
be sold to B where B pay 400k for 80 of stock
and Zenz redemption for 20. - Can qualify for
exchange treatment as complete (b)(3) redemption
under Zenz case so long as all part of the same
plan. - Consider EP implications. If
exchange, T Corp EP reduced 20, but not over
100k amount distributed in redemption. If 301
dividend, EP reduced 100k. Thus, if EP less
than 500k before, may get bigger EP reduction (a
good thing for B) with dividend.
11
Corporate Buy-Sell Agreements

• Most important document in many privately-owned
  businesses
• Determines value and exit opportunities for
  shareholders
• Contain buy-out triggers death, disability,
  bankruptcy, expulsion, etc.
• Many tax issues, including estate tax valuation.
• Often rely on (b)(3) exception for family
  businesses
• Constructive dividend trap
• - Co-shareholders become obligated under
  agreement to buy out a departing shareholder.
  Cross-purchase structure.
• - Corporation then discharges obligation
  of co-shareholders by redeeming stock.
• - Result is constructive dividend to
  co-sharholders.
• - Often screwed-up through bad life
  insurance structuring.

12
Corporate Buy-Sell
C Corp
Cash or Property
Constructive dividend
Sells Stock
Shareholder A
Shareholder B
Cross-Purchase Buy-Sell Agreement
13
Problem 615

• Basic Facts A, B C unrelated equal
  shareholders of Y Corp with cross purchase
  buy-sell. Y Corp owns polices on each
  shareholder. B dies, Y Corp collects policy and
  pays proceeds to redeem B stock.
• Premium payments by Y Corp not deductible per
  264(a)(1).
• Premium payments by Y not dividend to any
  shareholders because Y Corp own policy.
• Insurance proceeds received by Y Corp tax free
  per 101(a).
• Y Corp EP increased by excess of insurance
  proceeds over aggregate premiums paid on policy.
• On payment of insurance proceeds in redemption of
  B stock, A C have constructive dividend
  distribution because their obligation to buy
  shares being satisfied by Y Corp. Defective
  buy-sell planning. 301 dividend to extent of
  EP.

14
Marital Dissolution Stock Redemption
C Corp
Cash or Property
Constructive dividend
Sells Stock
Spouse A
Spouse B
Divorce Decree
15
Final Regs Under 1041
Issue If redemption part of divorce, what is
relationship of 1041 (no gain or loss on divorce
property division) and 302 redemption
provisions? Reg. 1.1041-2(c) If
redemption for benefit of non-transferring spouse
under primary and unconditional obligation
standard, then - No gain or loss to
transferring spouse per 1041. -
Constructive dividend to non-transferring
spouse. If primary and unconditional
standard not met for constructive dividend, then
1041 not apply and transferring spouse must
recognize gain or loss. Parties may elect
opposite rule to one that would otherwise apply
if they both agree. Bottom line No
opportunity to whipsaw and both avoid tax.