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 E&P; 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 E&P.
LLM - Corporate Tax
Instructor: Dwight Drake
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
LLM - Corporate Tax
Instructor: Dwight Drake
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).
LLM - Corporate Tax
Instructor: Dwight Drake
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.
LLM - Corporate Tax
Instructor: Dwight Drake
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.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 213 -1
Facts: W Corp 100 share outstanding:
GF – 25 shares; Mother – 20 shares; Daughter – 15 shares; adopted
Son – 10 shares; GM’s 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.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 213 - 2
Facts: 100 shares X Corp owned by partnership – four equal partners,
A,B,C,D. A’s 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.
W’s 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.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 217 - 1
Facts: Y Corp has 100 shares common voting, 200 shared nonvoting preferred.
A owns 80 common, 100 preferred. C owns 20 common, 100 preferred. A
and C unrelated. Issue is 302(b)(2).
(a) 1/15 – T redeems 75 of A’s preferred shares. No hope under 302(b)(2)
because only nonvoting redeemed. Reg. 1.302-3(a).
(b) Y also redeems 60 of A’s common shares. No hope under (b)(2) because A
own 50% of voting common after redemption – 20 out of 40 shares. Must
own less than 50% voting per 302(b)(2)(B).
(c) Y redeems 70 of A’s common shares. 302(b)(2) satisfied. Less than 50%
voting after (33%); percentage voting after (33%) less than 80% of
percentage voting before (80%); total percentage after (35/155 or 23%) less
than 80% of total percentage before (180/300 or 60%). Preferred stock
redemption gets “piggybacked” and qualifies under 302(b)(2) per Reg.
1.302-3(a).
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 217 - 1
Facts: Y Corp has 100 shares common voting, 200 shared nonvoting preferred.
A owns 80 common, 100 preferred. C owns 20 common, 100 preferred. A
and C unrelated. Issue is 302(b)(2).
(d) On 12/1, 10 shares of C’s common stock redeemed. Issue is whether they
are linked. If not, A’s redemption qualifies under (b)(2) per above. If they
are linked, A own 50% of common after (10 of 20) and thus would not
qualify. Note, the 80% “substantially disproportionate” tests are satisfied,
not the 50% test.
Is 302(b)(2)(D) applicable where only issue is 50% test? Technically “No”.
Standard step-transaction principles would be applied. Big question: Were
events linked and planned together?
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 217 - 2
Facts: Z Corp has 100 shares common voting, 200 shared nonvoting common.
Each share FMV $100. D owns 60 voting, 100 nonvoting. J owns rest. D &
J unrelated. Z redeems 30 of D’s common. Issue is 302(b)(2).
- D voting interest goes from 60% to 42.8% - thus overall 50% voting test and
voting 80% test satisfied.
- D total percentage before was 53.3% (160/300) and is 48.1% after. Flunk
overall 80% test. Thus, not qualify under 302(b)(2).
- Note: Likely would qualify under 302(b)(1) by virtue of loss of control.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 -1
Facts: R Corp owned by J (100 shares common), J’s daughter A (50 shares), J’s
son C (25 shares). Issue is 302(b)(3).
(a) R redeems A’s 50 shares. Qualifies under 302(b)(3) with waiver of family
attribution under 302(c)(2). Must timely file agreement per 302(c)(2)(A)(iii).
(b) Same, but A fails to file agreement. Per Reg. 1.302-4(a)(2), A will get
reasonable extension if (1) reasonable cause for not filing, and (2) request
filed within reasonable time. Statute of limitations extended one year after
notification.
(c) Same, but price paid to A dependant on R’s profits. No 302(b)(3) because
no waiver of family attribution. Profits interest is forbidden interest – more
than just a creditor. Reg. 1.302-4(d). Amount or certainty can’t be
contingent on profits.
(d) R redeems 20 A’s shares year 1, 30 shares year 2. Year 2 redemption
qualifies under (b)(3). Year 1 qualifies only if it part of “firm and fixed” plan
to redeem all. Need not be in writing or binding to be “firm and fixed”.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 - 1
Facts: R Corp owned by J (100 shares common), J’s daughter A (50 shares), J’s
son C (25 shares). Issue is 302(b)(3).
(e) Same, but A remains director. No hope under (b)(3) because no waiver of
family attribution. A holds interest more than a creditor. 302(c)(2)(A)(i).
Even as inactive director, probably cooked in 9th circuit.
(f) Same, but two years later R forms sub that employs A. No hope under
(b)(3). Can have no interest for ten years and this extends to activity of
subsidiary. Reg. 1.302-4(c).
(g) Same, but C dies in two years and leaves stock to A. 302(b)(3) and waiver
of family attribution still good per parenthetical exception in 302(c)(2)(A)(ii).
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 - 2
Facts: C, 10 year old company owned by B and B, husband and wife. Plan to
gift 30 shares to inside child and have C corp redeem balance (120 shares) by
paying 50k down and paying balance over per 20 year note. Restrictive
covenants in effect during note term. Note secured by C assets. B & B
continue to rent plant to C, but C has 5 yr. option to buy for FMV.
(a) Will redemption qualify under 302(b)(3)?
- 20 year note term outside IRS ruling standard (15 year). Some courts have
allowed as long as 20 yrs, but risky. Better to keep at 15 yrs.
- Creditor covenants and security permitted. Rev. Rule 59-119.
- Continued rental and option permitted if not dependant on profits and
terms are arms-length terms. Rev. Rule 77-467.
- Child 30 share gift not violate 302(c)(2)(B)(ii) unless principal purpose tax
avoidance. Since Son worked for company and is targeted successor, should
have no problem here. Rev. Rule 77-293.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 - 2
Facts: C, 10 year old company owned by B and B, husband and wife. Plan to
gift 30 shares to inside child and have C corp redeem balance (120 shares) by
paying 50k down and paying balance over per 20 year note. Restrictive
covenants in effect during note term. Note secured by C assets. B & B
continue to rent plant to C, but C has 5 yr. option to buy for FMV.
(b) Same, but B establishes consulting firm after leaving and firm is hired by C.
Per Lynch case and Rev. Rule 70-104, consulting deal would kill 302(b)(3).
Some limited authority to contrary where accounting services provided as
independent contractor. Very risky. Dead in 9th cir.
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 - 3
Facts: C corp has 100 share common. J owns 50 shares; J’s sister M owns 30
shares; J’s fathers estate “Estate” owns 20 shares; J’s mother B sole
beneficiary of Estate.
(a) C redeems 20 shares owned by Estate. 302(b)(3) works if both Estate and B
satisfy waiver of family attribution requirements and sign required
agreement. 302(c)(2)(C).
(b) Same, but B residuary beneficiary of Estate and J and M each receive
specific legacies. No hope for waiver of family attribution for estate per
302(c)(2)(C) if redemption with estate. Best to distribute legacies to J and
M, then redeem from Estate.
(c) Same, but J and M are residuary beneficiaries of Estate. No hope under
302(b)(3), as J and M’s stock attributed to Estate.
(d) 20 shares left to QTIP, income to B for life, then to third child N. C redeems
shares. 302(b)(3) permitted if B and trust join waiver agreement. Note, K as
sibling not deemed “related” under 318(a)(1).
LLM - Corporate Tax
Instructor: Dwight Drake
Problem 233 - 3
Facts: C corp has 100 share common. J owns 50 shares; J’s sister M owns 30
shares; J’s fathers estate “Estate” owns 20 shares; J’s mother B sole
beneficiary of Estate.
(e) Same as (d), but N acquires stock of C three years after redemption. Violates
10 year look-back rule of 302(c)(2)(A(ii) because N’s stock attributed to
trust under 318(a)(3)(A). Only family attribution waived under 302(c)(2),
not entity attribution.
LLM - Corporate Tax
Instructor: Dwight Drake