Stock Redemptions Tx 8120

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Stock RedemptionsTx 8120
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Goals to Achieve
You should be able to

1. Distinguish between stock redemptions and other
   ______,
2. Describe consequences of redemptions to _________
   and __________, and
3. Apply _________ ownership rules in identifying
   redemptions.

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Non-Liquidating Distributions
Property Distribution
Stock Distribution
Stock Redemption
Shareholders
Shareholders
Shareholders
Property
Stock
Stock
Property
Corporation
Corporation
Corporation
Shareholder (distributee) Issues
Corporation (distributor) Issues
1. How much gain or loss do shareholders
recognize? 2. What basis do shareholders take in
property received? 3. When does the holding
period begin in the property received? 4. When
dividends result, what happens to the basis of
redeemed shares?
1. How much gain or loss does the corporation
recognize? 2. How is the corporations EP
affected?
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Section 317(b)
Redemption defined
(b) Redemption of stock. For purposes of this
part, stock shall be treated as redeemed by a
corporation if the corporation acquires its stock
from a shareholder in exchange for property,
whether or not the stock so acquired is
cancelled, retired, or held as treasury stock.
Shareholders
Stock
Property
Corporation
5
Shareholder Reasons
Reasons for redemptions

• Shareholder may cash out to
• Pursue other investment opportunities,
• Shift _____ to family members,
• ______, or
• Pay ______ expenses and death taxes.
• Shareholder cannot sell shares since
• Market for closely-held stock is ____,
• Shares are _____________, or
• Corporation has right of first _______.

Shareholders
Stock
Property
Corporation
6
Corporate Reasons
Reasons for redemptions

• Remove shares from market to fight _______
  ________
• Take a public company _______
• Buyout dissatisfied or ______ shareholder
• Invest in self via ___ ____ with excess funds
• Condition Low _____ price and no better
  investment opportunities
• Result Fewer outstanding shares and higher ___

Shareholders
Stock
Property
Corporation
7
Corporate Reasons(continued)
Reasons for redemptions

• _________ features often facilitate redemption
  strategies of public companies.
• In ______-______ businesses, corporations often
  have right to redeem departing or deceased
  shareholders stock.

Shareholders
Stock
Property
Corporation
8
Corporate Reasons(continued)
Reasons for redemptions

• In a ________ acquisition, third party wishes
  to buy shareholder out but lacks sufficient cash.
• Corporation redeems part of shareholders stock
  to help _______ the buy out and
• Third party buys shareholders _________ shares.

Shareholders
Stock
Property
Corporation
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Section 302(a)
Shareholder issues Gain or loss
recognized Basics

• (a) General rule.
• If a corporation redeems its stock (within the
  meaning of section 317(b)), and if paragraph (1),
  (2), (3), or (4) of subsection (b) applies, such
  redemption shall be treated as a distribution in
  part or full payment in exchange for the stock.

Shareholders
Stock
Property
Corporation
10
Section 267
Shareholder issues Gain or loss
recognized Basics

• (a) In general.

(1) Deduction for losses disallowed. No deduction
shall be allowed in respect of any loss from the
sale or exchange of property between related
persons .
(b) Relationships.
The persons referred to in subsection (a)
are (2) An individual and a corporation more
than 50 percent in value of the outstanding stock
of which is owned, directly or indirectly, by or
for such individual (3) Two corporations which
are members of the same controlled group
Shareholders
Stock
Property
Corporation
11
Section 302(d)
Shareholder issues Gain or loss
recognized Basics

• (d) Redemptions treated as distributions of
  property.
• Except as otherwise provided in this subchapter,
  if a corporation redeems its stock (within the
  meaning of section 317(b)), and if subsection (a)
  of this section does not apply, such redemption
  shall be treated as a distribution of property to
  which section 301 applies.

Shareholders
Stock
Property
Corporation
12
Shareholder issues Gain or loss
recognized Basics
Example Sole Shareholder
Mickey
100
DW Shares (30 basis)
100
DW Corp (EP 300)
Assuming Mickey retains some DW shares, how do
you think Mickey should treat this transaction?
13
Shareholder issues Gain or loss
recognized Basics
Example Two Shareholders
Assuming simultaneous redemptions, how do you
think Mickey and Minnie should treat this
transaction?
Mickey
70
35 DW Shares (140 basis)
210
DW Corp (EP 300)
15 DW Shares (50 basis)
90
30
Minnie
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Stock Redemption Overview
Shareholder issues Gain or loss
recognized Basics
Shareholder recognizes capital gain (or loss
unless ___ disallows)

1. Not essentially equivalent to dividend
2. Substantially disproportionate
3. Termination of holding
4. Partial liquidation
5. Death taxes and related expenses

Exchange treatment per _____
Redemption per _____
Property distribution per _____
Shareholders
Stock
Property
Corporation
Dividend to extent of EP, then return of
capital, then capital gain
15
Shareholder issues Gain or loss
recognized Basics
Example Impact of Rules
Harvey
30 shares before redemption
How much tax does Harvey pay if the redemption is
treated as a property distribution?
10 shares (80 basis)
100
StewartCo (EP 500)
How much tax does Harvey pay if the redemption is
treated as an exchange?
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Section 302(b)(1)
Shareholder issues Gain or loss recognized Not
equivalent to dividend

• (b) Redemptions treated as exchanges.

(1) Redemptions not equivalent to dividends.
Subsection (a) shall apply if the redemption is
not essentially equivalent to a dividend.
Shareholders
Stock
Property
Corporation
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Not Essentially Equivalent
Shareholder issues Gain or loss recognized Not
equivalent to dividend

• Requires a _______ ________ in shareholders
  proportionate interest
• Usually applies to
• _______ _______ called in from shareholders
  owning no common stock and
• Redemptions from ________ shareholders

Shareholders
Stock
Property
Corporation
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Shareholder issues Gain or loss recognized Not
equivalent to dividend
US v. Davis(S.Ct., 1970)
Under 302(b)(1), _______ purpose and whether a
tax ________ motive exists are irrelevant. To
qualify for preferred exchange treatment , a
redemption must result in a ______ _________ of
the shareholders proportionate interest .
Clearly, taxpayer here, who (after application of
the attribution rules) was the sole shareholder
both before and after the redemption, did not
qualify under this test.
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Shareholder issues Gain or loss recognized Not
equivalent to dividend
Wright v. US(CA-8, 1973)
Under state law, a ______ majority (gt 50)
controls a corporations day-to-day activities
through the board of directors. However,
approving a merger or changing the articles of
incorporation requires a ______ majority (67).
Following a redemption, the shareholders voting
power dropped from 85 to 62.
Held However, Rev. Rul. 78-401 indicates that
day-to-day _________ is the proper touchstone
when merger activity is not __________.
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Shareholder issues Gain or loss recognized Not
equivalent to dividend
Rev. Rul. 75-502
A corporation redeems its shareholders common
stock, causing voting power to decline from ___
to ___. A single unrelated shareholder controls
the remaining voting power. Is this a meaningful
reduction?
21
Shareholder issues Gain or loss recognized Not
equivalent to dividend
Rev. Rul. 75-512
A corporation redeems its shareholders common
stock, causing voting power to decline from ___
to ___. This reduction barely misses exchange
treatment via 302(b)(2). Is this a meaningful
reduction?
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Section 302(b)(2)
Shareholder issues Gain or loss
recognized Substantially disproportionate

• (b) Redemptions treated as exchanges.

(2) Substantially disproportionate redemption of
stock.
(A) In general. Subsection (a) shall apply if the
distribution is substantially disproportionate
with respect to the shareholder. (B) Limitation.
This paragraph shall not apply unless immediately
after the redemption the shareholder owns less
than 50 percent of the total combined voting
power of all classes of stock entitled to vote.
Shareholders
Stock
Property
Corporation
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Section 302(b)(2)(continued)
Shareholder issues Gain or loss
recognized Substantially disproportionate
(C) Definitions. The distribution is
substantially disproportionate if--
(i) the ratio which the voting stock of the
corporation owned by the shareholder immediately
after the redemption bears to all the voting
stock of the corporation at such time,
is less than 80 percent of--
(ii) the ratio which the voting stock of the
corporation owned by the shareholder immediately
before the redemption bears to all of the voting
stock of the corporation at such time.
Shareholders
Stock
Property
Corporation
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Section 302(b)(2)(continued)
Shareholder issues Gain or loss
recognized Substantially disproportionate
No distribution shall be treated as
substantially disproportionate unless the
shareholders ownership of the common stock of
the corporation (whether voting or nonvoting)
after and before the redemption also meets the 80
percent requirement . If there is more than
one class of common stock, the determinations
shall be made by reference to fair market value.
Shareholders
Stock
Property
Corporation
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Section 302(b)(2)(continued)
Shareholder issues Gain or loss
recognized Substantially disproportionate
(D) Series of redemptions. This paragraph shall
not apply to any redemption made pursuant to a
plan the purpose or effect of which is a series
of redemptions resulting in a distribution which
(in the aggregate) is not substantially
disproportionate with respect to the shareholder.
Shareholders
Stock
Property
Corporation
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Example Voting Power
Shareholder issues Gain or loss
recognized Substantially disproportionate
Corp issued class A and class B shares, both with
100 outstanding shares. Class A stock carries
sufficient voting power to elect 6 directors.
Class B shareholders can elect 4. Henry owns __
class A shares and __ class B shares. What is
Henrys voting power in Corp?
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Substantially Disproportionate
Shareholder issues Gain or loss
recognized Substantially disproportionate
Shareholders
Stock
Property
Corporation
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Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 85-14
Four unrelated individuals own all common voting
stock of a corporation. Under a repurchase
agreement, any individual who ceases to be
involved in the corporations business must
tender his shares, and the corporation must
purchase them. B (vice president) informs A
(president) that he will resign. Acting on this
information, A has the corporation redeem some of
his shares before Bs redemption. Is As
redemption substantially disproportionate?
Shares Percentage Redeemed Shares Percentage Rede
emed Shares Percentage A 1,466 72.18 902 564 56
4 B 210 210 210 0 C 200 200 200 D
155 155 155 2,031 1,129 919
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Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 85-14(continued)
Under 302(b)(2)(D), a redemption pursuant to a
plan (e.g., a series of redemptions) that has a
purpose or effect of obtaining _______ ________
treatment is not substantially disproportionate.
Here, no joint plan existed. However, the two
redemptions are ______ _______ since A had a
plan related to Bs withdrawal. Thus, As
redemption is ___ substantially disproportionate.
Shares Percentage Redeemed Shares Percentage Rede
emed Shares Percentage A 1,466 72.18 902 564 56
4 B 210 210 210 0 C 200 200 200 D
155 155 155 2,031 1,129 919
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Lind et al., p. 195Problem 1(a)
Alice
Cathy
80 C.S. 100 P.S.
20 C.S. 100 P.S.
Y Corp 100 voting common 200 nonvoting preferred
If Y Corp redeems 75 of Alices preferred shares,
is it substantially disproportionate?
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Lind et al., p. 195Problem 1(b)
Alice
Cathy
80 C.S. 100 P.S.
20 C.S. 100 P.S.
Y Corp 100 voting common 200 nonvoting preferred
If Y Corp redeems 75 of Alices preferred shares
and 60 of her common shares, is it substantially
disproportionate?
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Lind et al., p. 195Problem 1(c)
Alice
Cathy
80 C.S. 100 P.S.
20 C.S. 100 P.S.
Y Corp 100 voting common 200 nonvoting preferred
If Y Corp redeems 75 of Alices preferred shares
and 70 of her common shares, is it substantially
disproportionate?
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Lind et al., p. 195Problem 1(d)
Alice
Cathy
Suppose Y Corp redeems 75 of Alices preferred
shares and 70 of her common shares on Jan. 15. On
Dec. 1, Y Corp redeems 10 of Cathys common
shares. How are these redemptions treated?
80 C.S. 100 P.S.
20 C.S. 100 P.S.
Y Corp 100 voting common 200 nonvoting preferred
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Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 87-88
The FMV per share of a corporations voting and
nonvoting common are equal. Initially,
shareholder A owns 6 voting shares (out of 10
outstanding) and all 30 nonvoting shares. Then,
the corporation redeems 3 voting and 27 nonvoting
shares from A in a single transaction.
Shares Percentage Redemption Shares Percentage A
s Voting Common 6 60 Other Voting Common
4 As Nonvoting Common 30 100
For what part of the redemption can A get
exchange treatment? Only for the voting
common? For both the voting and nonvoting
common? For neither the voting nor nonvoting
common?
35
Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 87-88(continued)
Shares Percentage Redemption Shares Percentage A
s Voting Common 6 60 43 Other Voting Common
4 As Nonvoting Common 30 100 100

• Section 302(b)(2) tripartite requirements
• A owns lt __ ______ power after redemption.
• A owns lt ___ ______ power after redemption as he
  owned before redemption.
• A owns lt __ FMV of _________ after redemption as
  he owned before redemption.
• The 3rd requirement applies on an ________ (not a
  class-by-class) basis.
• So, A receives __________ treatment on the entire
  transaction (not just voting common).

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Shareholder issues Gain or loss
recognized Substantially disproportionate
Zenz v. Quinlivan(CA-6, 1954)
Holding and Rationale Transfer 2 receives ______
treatment. The circuitous approach (i.e., tax
planning) per se does not result in ______. The
initial owner had no continuing interest in the
corporation. Thus, transfer 2 resembles a ___
more than a ______.
2
1
100

• Observations
• The new owner did not wish to buy the ____, a
  source of future ________. The redemption in
  transfer 2 removed all ____.
• An outright sale of all shares to the new owner
  would yield the same result except that ____
  remains.
• Reversing the order by redeeming the shares first
  (if treated as ________ transactions) appears to
  result in __________ to the initial owner.

Corporation (EP)
37
Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 75-447(Situation 1)
Owns 50 shares voting common
Owns 50 shares voting common
B
A
50
50
25 shares voting common
Corporation X (EP)
1
C

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Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 75-447(Situation 1 continued)
Before transfer 2, B owns 50 shares voting common
Before transfer 2, A owns 50 shares voting common


2
B
A
1/3
1/3
25 shares voting common
25 shares voting common
Before transfer 2, C owns 25 shares voting common
Corporation X (EP)
1/3
C
39
Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 75-447(Situation 1 continued)
Focus on Transfer 2
Focus on Overall Result
Before After A 50 shares 40 B 50
shares 40 C 25 shares 20
Before After A 50 shares 50 B 50
shares 50 C
Asserting that Zenz stands for the proposition
that the sequence of transfers in an overall plan
does not matter, the IRS indicated that only the
overall result matters. Indeed, if the redemption
had preceded the sale, the tax result would be
the same (i.e., exchange treatment).
40
Shareholder issues Gain or loss
recognized Substantially disproportionate
Rev. Rul. 75-447(Situation 2)
Another route to the same result involves (1) A
and B both sell C 15 shares each and (2) X
redeems 5 shares from both A and B.
Focus on Transfer 2
Focus on Overall Result
Before After A 35 shares 35 B 35
shares 35 C 30 shares 30
Before After A 50 shares 50 B 50
shares 50 C
41
Shareholder issues Gain or loss
recognized Termination
Section 302(b)(3)
(b) Redemptions treated as exchanges.
(3) Termination of shareholders interest.
Subsection (a) shall apply if the redemption is
in complete redemption of all of the stock of the
corporation owned by the shareholder.
Shareholders
Stock
Property
Corporation
42
Shareholder issues Gain or loss
recognized Termination
Section 302(c)
(c) Constructive ownership of stock. (1) In
general. Except as provided in paragraph (2) of
this subsection, section 318(a) shall apply in
determining the ownership of stock for purposes
of this section. (2) For determining termination
of interest.
(A) In the case of a distribution described in
subsection (b)(3), section 318(a)(1) shall not
apply if--
(i) Immediately after the distribution the
distributee has no interest in the corporation
(including an interest as officer, director, or
employee), other than an interest as a creditor
Shareholders
Stock
Property
Corporation
43
Shareholder issues Gain or loss
recognized Termination
Complete Termination

• Overlaps with substantially disproportionate test
  but also applies when
• ________ _______ is redeemed or
• Shareholder constructively owns stock via ______
• Family attribution ignored if shareholder
• Terminates _____ interest (other than ______) and
• Acquires no interest in __ years except via
  __________

44
Shareholder issues Gain or loss
recognized Termination
Lynch v. CIR(CA-9, 1986)
As sole shareholders, Mom and Dad sold some
shares to their son and resigned as directors and
officers. Two weeks later, the corporation
redeemed all of Mom and Dads shares, and Dad
entered into a consulting agreement with the
corporation. Dad continued to share office space
with his son and also received medical coverage
from the corporation. Applying the ____ ________
doctrine, the court found that Dads status as an
independent contractor was a __________ interest.
So, the redemption did not qualify for __________
treatment as a complete termination.
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Shareholder issues Gain or loss
recognized Termination
Rev. Rul. 77-293
Dad owns all corporate shares but wishes to leave
the business to his son. Dad _____ half his
shares to the son (nontaxable under 102),
resigns as board chair and president, has the
corporation _______ his remaining shares, and
terminates all business connections. Per
302(c)(2)(B)(ii), a complete termination does
not occur if

1. Son owns stock attributable to Dad under ____,
2. Son acquired stock from Dad within past ___
   years,
3. Corporation is not redeeming _____ shares, and
4. A __________ purpose is tax ___________.

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Shareholder issues Gain or loss
recognized Termination
Rev. Rul. 77-293(continued)
Tainted purpose evident when ____________
transfer to relative (to retain effective
_______) and Later redemption from self or
relative (for __________ treatment). Dads sole
purpose in the transfers was to turn the business
over to his son. Since retaining effective ______
was not a _________ purpose, the two transactions
together had no tax _________ motive. So, Dad
receives nontaxable treatment for the gift and
___________ treatment for the redemption.
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Shareholder issues Gain or loss
recognized Partial liquidation
Section 302(b)(4)
(b) Redemptions treated as exchanges.
(4) Redemption from noncorporate shareholder in
partial liquidation. Subsection (a) shall apply
to a distribution if such distribution is--
(A) in redemption of stock held by a shareholder
who is not a corporation, and (B) in partial
liquidation of the distributing corporation.
Shareholders
Stock
Property
Corporation
48
Partial Liquidation302(e)
Shareholder issues Gain or loss
recognized Partial liquidation

• Part of liquidation plan adopted in _______ or
  _________ year and
• Not essentially equivalent to dividend
  (________-level test, so ___ ____ okay), which
  includes distributions related to
• Corporation ______ to conduct a business and
• Corporation _________ to conduct a business.

Both terminated and continued businesses must
have operated for __ years.
49
Imler v. CIR(TC, 1948)
Shareholder issues Gain or loss
recognized Partial liquidation
Reg. 1.346-1(a)(2) now embodies this _______
__________ theory.
Fire destroyed the top floors of a corporations
building that had been rented to another company.
Rather than rebuilding the floors with insurance
proceeds, the corporation ________ _______ to
shareholders. The government argued for _______
treatment, but the court held that the bona fide
________ in the business merited __________
treatment.
Shareholders
Stock
Property
Corporation
50
Estate of Chandler v. CIR(TC, 1954)
Shareholder issues Gain or loss
recognized Partial liquidation
A family-owned corporation operated a general
department store consisting of ladies wear,
mens wear, childrens wear, and a bargain
basement department. Due to the president and
managers poor health, the corporation sold its
merchandise, furniture and fixtures, and its
lease. Then, they opened a ladies ready-to-wear
shop down the street. Vis-à-vis the department
store, the new shop requires __ as much floor
space, __ as much fire insurance, and __ of the
employees. Since the corporation needs only ____
of its existing capital, it redeems ______ of
each shareholders stock.
51
Estate of Chandler v. CIR(TC, 1954)
Shareholder issues Gain or loss
recognized Partial liquidation
The court noted that ________ of business is not
sufficient to ensure exchange treatment as a
partial liquidation. In this case, the
corporations _____ _____ existed before the
contraction and was not due to the downsizing.
The amount of capital required for the new
ladies shop was almost the same as the capital
the prior department store required. The
redemption was ________ __________ to a dividend.
52
Shareholder issues Gain or loss
recognized Partial liquidation
Rev. Rul. 79-184
Corporation P owns all the stock of Corporation
S, both of which conduct businesses. Pursuant to
a plan, P sells all shares in S and distributes
the proceeds to Ps shareholders in partial
redemption of their shares. Does this represent a
_______ ___________ of business that P conducts
indirectly via S?
No basis exists for _________ Ss business
activities to P. S and P are ______ and ________
entities. Thus, the redemption is ___ a partial
liquidation entitled to exchange treatment.
53
Lind et al., p. 230part (a)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
Earlier this year, Alpha devised a plan regarding
Books. If Alpha distributes all assets of Books
among the 3 shareholders in return for 50 Alpha
shares from each, what is the shareholder-level
effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta Processing Business
In the same transaction, what if no shareholders
surrender shares?
54
Lind et al., p. 230part (b)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
Would the results in part (a) differ if Alpha had
acquired Books three years ago in a cash purchase?
Alpha Corp
Books Business
Cram Business
Alpha has operated Books (Cram) for 3 (gt 5) years.
100
Diversified Securities Portfolio
What is Alpha acquired Books three years ago in a
tax-free reorganization using its voting stock as
payment?
Beta Corp
Beta Processing Business
55
Lind et al., p. 230part (c)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
A tornado destroys all assets of Books. Alpha
distributes half the insurance proceeds pro rata
to the 3 shareholders in return for 25 shares
from each. Alpha uses remaining proceeds to
continue Books on a smaller scale. How do these
events affect the shareholders?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta Processing Business
56
Lind et al., p. 230part (d)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
If Alpha distributes all assets of Books to Mike
in return for all his Alpha shares, what is the
shareholder-level effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Suppose Alpha did not distribute the assets
pursuant to a plan. Can Mike still obtain
exchange treatment?
Beta Corp
Beta Processing Business
57
Lind et al., p. 230part (e)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
If Alpha distributes all assets of Books to Iris
Corp in return for all its Alpha shares, what is
the shareholder-level effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta Processing Business
58
Lind et al., p. 230part (f)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
If Alpha distributes the securities portfolio to
its 3 shareholders in return for 20 Alpha shares
from each, what is the shareholder-level effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta Processing Business
59
Lind et al., p. 230part (g)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
If Alpha sells all its Beta stock and distributes
the proceeds pro rata to the 3 owners, what is
the shareholder-level effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta has operated business more than 5 years.
Beta Processing Business
60
Lind et al., p. 230part (h)
Iris Corp (unrelated to Senns)
Pamela (Mikes wife)
Mike Senn
1/3
1/3
1/3
If Alpha liquidates Beta (nontaxable per 332)
and distributes Betas assets pro rata to the 3
owners, what is the shareholder-level effect?
Alpha Corp
Books Business
Cram Business
Alpha has operated both businesses more than 5
years.
100
Diversified Securities Portfolio
Beta Corp
Beta has operated business more than 5 years.
Beta Processing Business
61
Shareholder issues Gain or loss recognized
Death taxes and expenses
S. Rep. No. 81-237581st Cong., 2d Sess. (1951)
at 54
The problem of __________ the estate tax is
acute in the case of estates consisting largely
of shares in a _________ corporation. The
_________ for such shares is usually very
limited, and it is frequently difficult, if not
impossible, to dispose of a minority interest.
If, therefore, the estate tax cannot be financed
through the sale of the other assets in the
estate, the executors will be forced to _______
of the family business. In many cases the result
will be the absorption of a family enterprise by
larger competitors, thus tending to accentuate
the degree of concentration of industry in this
country.
62
Shareholder issues Gain or loss
recognized Death taxes and expenses
Section 303(a)
(a) In general. A distribution of property to a
shareholder by a corporation in redemption of
part or all of the stock of such corporation
which is included in determining the gross
estate of a decedent, to the extent that the
amount of such distribution does not exceed the
sum of--
(1) the estate, inheritance, legacy, and
succession taxes imposed because of such
decedents death, and (2) the amount of funeral
and administration expenses allowable as
deductions to the estate
shall be treated as a distribution in full
payment in exchange for the stock so redeemed.
63
Shareholder issues Gain or loss
recognized Death taxes and expenses
Death Taxes Rationale

• Typical situation
• Owner in family business ____
• Estates shares are ______ portion of estate
• Payment of _______ taxes and related expenses
  must come from corporate shares
• Without exchange treatment
• Redemption results in ________ or
• Estate must sell family business to ________

64
Shareholder issues Gain or loss
recognized Death taxes and expenses
Death Taxes Conditions

• Shares held gt __ of adjusted gross estate
• Gross estate less ________/administrative
  expenses, debts, and ________ losses
• Value of multiple corporate holdings aggregated
  (for 35 test) when __ of each corporations
  value included in estate
• Exchange treatment limited to ____ taxes plus
  _____/administrative expenses

65
Shareholder issues Gain or loss
recognized Death taxes and expenses
Rev. Rul. 87-132
Owns 150 shares voting common
Owns 150 shares voting common
Unrelated
Estate
A
Objectives

1. Maintain estates relative _____ ______ in family
   business
2. Distribute cash for _____ _____
3. Obtain 303 ________ treatment

50
50
Corporation X (EP)
Plan

1. Distribute ______ ______ pro rata to each owner,
   305(a)
2. Redeem some _______ ________ from estate, 303

Issue
Is the stock distribution nontaxable given that
some shares will be redeemed immediately
afterwards as part of a plan?
66
Shareholder issues Gain or loss
recognized Death taxes and expenses
Rev. Rul. 87-132
Owns 150 shares voting common
Owns 150 shares voting common
Unrelated
Estate
A
Conclusion

1. Stock distribution is ________
2. Redemption is a 303 _________

50
50
Corporation X (EP)
Rationale

1. Sec. 303(c) treats stock with ________ basis same
   as original stock and, thus, was enacted with
   this transaction in mind
2. Sec. 305 applies _________ 303 even though two
   steps part of one _____

67
Section 301(d)
Shareholder issues Basis of property received
(d) Basis. The basis of property received in a
distribution to which subsection (a) applies
shall be the fair market value of such property.
Shareholders
Stock
Property
Corporation
68
Shareholder issues Holding period of property
received
Section 1223(2)
For purposes of this subtitle-- (2) In
determining the period for which the taxpayer has
held property however acquired there shall be
included the period for which such property was
held by any other person, if under this chapter
such property has, for the purpose of determining
gain or loss from a sale or exchange, the same
basis in whole or in part in his hands as it
would have in the hands of such other person.
Shareholders
Stock
Property
Corporation
69
Shareholder issues Basis of redeemed shares
Save the Basis!

• When dividends result, shareholders add basis in
  ________ shares to basis of _________ or
  constructively-owned shares, Reg. 1.302-2(c).
• Before 1986, corporate shareholders could ___
  _______ and then _____ ____ EP as untaxed
  dividends (via DRD).

Shareholders
Stock
Property
Corporation
70
Shareholder issues Basis of redeemed shares
Section 1059(a)
(a) General rule. If any corporation receives
any extraordinary dividend with respect to any
share of stock and such corporation has not held
such stock for more than 2 years before the
dividend announcement date--
(1) Reduction in basis. The basis of such
corporation in such stock shall be reduced (but
not below zero) by the nontaxed portion of such
dividends. (2) Amounts in excess of basis. If the
nontaxed portion of such dividends exceeds such
basis, such excess shall be treated as gain .
Shareholders
Stock
Property
Corporation
71
Corporate issues Gain or loss recognized
Section 311(b)
(b) Distributions of appreciated property. (1)
In general. If--
(A) a corporation distributes property (other
than an obligation of such corporation) to a
shareholder in a distribution to which subpart A
applies, and (B) the fair market value of such
property exceeds its adjusted basis (in the hands
of the distributing corporation),
Shareholders
then gain shall be recognized to the distributing
corporation as if such property were sold to the
distributee at its fair market price.
Stock
Property
Corporation
72
Corporate issues EP impact
Section 312(n)(7)
(n) Adjustments to earnings and profits to more
accurately reflect economic gain or loss.
(7) Redemptions. If a corporation distributes
amounts in a redemption to which section 302(a)
or 303 applies, the part of such distribution
which is properly chargeable to earnings and
profits shall be an amount which is not in excess
of the ratable share of the available earnings
and profits attributable to the stock so
redeemed.
Shareholders
Stock
Property
Corporation
73
Watch EP
Corporate issues EP impact

• For redemptions treated as ______ _______, EP
  decreases by greater of FMV or adjusted basis,
  312(a)(3), (b)(2).
• For redemptions treated as exchanges, the
  decrease in EP equals lesser of
• Greater of ____ or adjusted basis or
• ____ _____ portion of EP, 312(n)(7)

Shareholders
Stock
Property
Corporation
74
Constructive Ownership302(c)(1)

• Consider when determining if redemption treated
  as _________
• Not essentially equivalent to dividend requires
  _________ ________ in proportionate interest
• Substantially disproportionate requires
• Post-ownership lt __ and
• Post-ownership must be lt __ of pre-ownership
• Not applicable to _____ ____ redemptions nor
  ________ ___________

75
Constructive Ownership302(c)(2)

• Family ownership rules inapplicable to _______
  ________ if
• Shareholder has no ___________ interest in
  corporation (including as employee, officer, or
  director) other than as __________,
• Shareholder acquires no interest in corporation
  within __ years (other than by ________), and
• Shareholder agrees to ______ IRS of such
  acquisition and ________ relevant records

76
Constructive Ownership

• Attribution from
• Family
• Transparent entities
• Corporations
• Attribution to
• Transparent entities
• Corporations
• Attribution via options

77
Attribution from Family318(a)(1)
Constructive ownership

• Individuals constructively own stock owned
  directly or indirectly by
• _______,
• Parents,
• Children, and
• ____________.
• No re-attribution to another family member

78
Example Family Business
Constructive ownership
a. How much does Bob own?
b. How much does Bobs sister own?
Bob
30
C
5
Bobs granddaughter
Bobs father
7
10
Bobs sister
c. How much does Bobs father own?
d. How much does Bobs granddaughter own?
79
Example Family Business
Constructive ownership
a. How much does Ron own?
b. How much does Nancy own?
Ron
40
Maureen (Rons daughter by prior marriage)
Nancy (Rons Wife)
C
10
30
20
c. How much does Jack own?
Jack (Rons Dad)
d. How much does Maureen own?
80
Attribution from Transparent Entity318(a)(2)(A)
Constructive ownership

• ____________ attribution
• Re-attribution

Partner
Beneficiary
Shareholder
PS
Estate
S
C
C
C
81
Attribution from Corporation318(a)(2)(C)
Constructive ownership

• Proportionate attribution only if SH owns ___

• Re-attribution

Shareholder
50
C1
C2
82
Examples Attribution from Rules
Constructive ownership
Partner
Shareholder
Beneficiary
20
70
60
PS
Estate
C1
20
20
10
C
C2
C
83
Examples Attribution from Rules
Constructive ownership
Partner
Shareholder
Shareholder
5
25
50
PS
C1
C1
40
40
2
C
C2
C2
84
Example Ownership Rules
Constructive ownership
How much of B does Ricardo own?
70
How much of C does Ricardo own?
80
A
X
90
60
How much of Y does Lucille own?
B
Y
20
40
How much of Z does Lucille own?
C
Z
85
Example Ownership Rules
Constructive ownership
How much of C2 does Ricardo own?
5
80
C1
How much of C2 does Lucille own?
40
C2
86
Example Ownership Rules
Constructive ownership
How much of C does PS1 own?
Directly owns Constructively owns
20
PS1
How much of C does Ricardo own?
50
PS2
40
30
C
87
Example Ownership Rules
Constructive ownership
How much of B does Lucille own?
Via P/S Via A
60
40
40
60
P/S
P/S
A
Y
20
80
20
80
B
Z
How much of Z does Ricardo own?
Via P/S Via Y
88
Attribution to Transparent Entity318(a)(3)(A)
Constructive ownership

• ______ attribution
• No re-attribution via attribution ____ rules

Partner
Beneficiary
Shareholder
PS
Estate
C
S
C
C
89
Attribution to Corporation318(a)(3)(C)
Constructive ownership

• _____ attribution if SH owns ___

• No re-attribution via attribution ____ rules

Shareholder
50
C1
C2
90
Examples Attribution to Rules
Constructive ownership
Shareholder
Partner
Partner
10
5
10
5
40
50
PS
PS
C1
C2
C
C
Shareholder
Partner
Shareholder
50
5
50
5
60
90
PS
C1
C2
C
C1
C2
91
Example Ownership Rules
Constructive ownership
How much of C does the P/S own?
50
70
20
30
PS
C
92
Constructive ownership
Attribution via Options318(a)(4)

• Any _______ with an option to buy stock is
  treated as directly owning the stock.
• Many planning opportunities
• Can increase __________ shares
• Issuing stock options to one shareholder can make
  it easier for another shareholder to receive a
  substantially _______________ distribution

93
Lind et al., p. 191Problem 1
Grandfather (25 shares)
Wham Corporation (100 shares)
Grandmother (0 shares)
Mother (20 shares)
Mothers Cousin (0 shares)
Option to Buy (5 of adopted sons shares)
50 beneficiary
50 beneficiary
Daughter (15 shares)
Adopted Son (10 shares)
Grandmothers Estate (30 shares)
How much Wham stock does Grandfather own?
94
Lind et al., p. 191Problem 1
Grandfather (25 shares)
Wham Corporation (100 shares)
Grandmother (0 shares)
Mother (20 shares)
Mothers Cousin (0 shares)
Option to Buy (5 of adopted sons shares)
50 beneficiary
50 beneficiary
Daughter (15 shares)
Adopted Son (10 shares)
Grandmothers Estate (30 shares)
How much Wham stock does Mothers Daughter own?
95
Lind et al., p. 191Problem 1
Grandfather (25 shares)
Wham Corporation (100 shares)
Grandmother (0 shares)
Mother (20 shares)
Mothers Cousin (0 shares)
Option to Buy (5 of adopted sons shares)
50 beneficiary
50 beneficiary
Daughter (15 shares)
Adopted Son (10 shares)
Grandmothers Estate (30 shares)
How much Wham stock does Grandmothers Estate own?
96
Redemption-Related Expenses

• In 1986, Congress wanted to deny deductions for
  ________ expenses that corporations incur in
  redeeming shares as a means of fighting ______
  ______ attempts.
• Section _____ disallows deductions for corporate
  expenses incurred to ________ shares.
• But, ________ incurred to finance such a
  redemption is _________.