CORPORATE TAXATION I

Today
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Review Section 305 – Stock Dividends
Problems on Page 308
Chamberlin v. Commissioner
S Corp Eligibility
Problems on Page 690
Problems on Page 695
1
Section 305 – Stock Distributions

Is a distribution of Stock a taxable event?
• Is this just increasing the number of
“certificates” without a meaningful change
in ownership percentage? Eisner v.
Macomber
• General Rule is NO! [§ 305(a)]
 Exceptions
2
Section 305 – Stock Distributions

General Rule is NO! [§ 305(a)]
• Exceptions:
 Stock dividends where any shareholder may elect to
receive either cash or property instead of the stock [§
305(b)(1)]
 Stock dividends that have the effect of increasing the
stock of some shareholders and property of others [§
305(b)(2)]
 Stock dividends that result in some shareholders getting
preferred an some getting common stock[§ 305(b)(3)]
 Any distribution as to preferred stock [§ 305(b)(4)]
• Other than an increase to compensate for a stock split
 Distribution of convertible preferred stock that is
convertible [§ 305(b)(5)]
• Unless no disproportionate result (company’s burden) 3
Problems on Page 308, Problem 1
Frank
100 Class A
Fay
50 Class B
Joyce
50 Class B
Hill Corporation
4
Problems on Page 308

1(a) – Distribution of Convertible stock pro-rata
• NO PROBLEM

1(b) – Pro rata distribution, but option to take cash
in lieu of the stock
• Violates § 305(b)(1)

1(c) – Distribution of A on A and Cash on B
• Violates § 305(b)(2)

1(d) – Distribution of preferred stock to Class A
holders
• Violates § 305(b)(2) – it has the effect of increasing
Class A shareholders’ ownership of Hill E&P and Assets
5
Problems on Page 308

1(e) – Distribution of preferred stock to Class A
holders that is subordinated to Class B
shareholders
• NO PROBLEM, since it does not affect Class B shareholders

1(f) – Stock split without an adjustment of the
conversion ration of the preferred shareholders
• Violates § 305(b)(2)

1(g) – Stock split with an adjustment of the
conversion ration of the preferred shareholders
• NO PROBLEM, it falls within the exception to § 305(b)(4)

1(h) – Distribution of Class A on Class A and nonconvertible preferred on Class B.
• Violates § 305(b)(3)
6
Problems on Page 308

1(i) – Distribution of Class A on Class A and
convertible (any time over the next 20 years at
today’s prices) preferred on Class B.
• Issue is whether the company can establish to the
Commissioner that the preferred will be converted §
305(b)(5)
20-years
 Current Prices
• Probably OK!

7
Problems on Page 308, Problem 2
A
500 Shares
(50%)
B
300 Shares
(30%)
C
200 Shares
(20%)
Z Corporation
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Problems on Page 308, Problem 2
A
450 Shares
(50% -> 47%)
B
300 Shares
(30% -> 32%)
C
200 Shares
(20% -> 21%)
50 Shares
Z Corporation
Does the Redemption of the 50 shares qualify
for exchange treatment under § 302(b)?
If not, would it cause any problems for B & C
under § 305(c)
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Problems on Page 308, Problem 2
A
400 Shares
(47% -> 44%)
B
300 Shares
(32% -> 33%)
C
200 Shares
(21% -> 22%)
50 Shares
Z Corporation
Does the Redemption of the 50 shares qualify
for exchange treatment under § 302(b)?
If not, would it cause any problems for B & C
under § 305(c)
10
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
Chamberlin
Family
Common Stock
Metal Moulding Corporation
11
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
Chamberlin
Family
Common Stock
Preferred Stock
Metal Moulding Corporation
12
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
Chamberlin
Family
Preferred Stock
Common Stock
$$$
Insurance
Company
Metal Moulding Corporation
13
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
Chamberlin
Family
Common Stock
Insurance
Company
Preferred Stock
Metal Moulding Corporation
14
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
Chamberlin
Family
Common Stock
Insurance
Company
$$$$
Preferred Stock
Metal Moulding Corporation
15
Chamberlin v. Commissioner
The “Preferred Stock Bailout”
NET
RESULT:
Preferred
Stock
Bailout
Chamberlin
Family
$$$
Common Stock
Metal Moulding Corporation
16
S Corp Eligibility

Small Business Corporations ONLY
• No more than 100 shareholders
 For Nominee, Guardians, Custodians, or Agents each
beneficiary is counted toward the 100 shareholder
limitation
• Only shareholders who are individuals, estates, certain
types of trusts, and tax exempt organizations
• No corporate, partnership, ineligible trusts, or
nonresident alien shareholders
• No more than ONE class of stock

S Corporations may NOW have subsidiaries
• For S subsidiaries, the Parent must make a Q-Sub
Election (Qualified Subchapter S Subsidiary Election)
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Problems on Page 690

1(a) – 99 Shareholders plus A and his brother, B
• If a family election is made then the corporation has not
violated the 100 shareholder limitation

1(b) – 99 Shareholders plus A and his wife, B
(some of the shares are held as separate
property)
• Husband and wife are a single shareholder for purposes
of the 100 shareholder limitation regardless of how the
shares are held

1(c) – Same as (b) above, except that B leaves
the shares when she dies to her friend, F
• OK, until F actually takes ownership of the shares
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Problems on Page 690

1(d) – 99 Shareholders plus a voting trust with
three beneficial owners.
• Each beneficial owner is counted toward the 100
shareholder limitation; therefore, this would blow the
election

1(e) – 99 Shareholders plus a revocable, grantor
trust.
• revocable, grantor trust is deemed to be owned by the
grantor only. He still must be a “qualified” individual
(citizen or resident alien)
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Problems on Page 690

1(f) –99 Shareholders plus a “qualifies
subchapter S trust”
• Ok provided that it meets the definitions of §
1361(d)(3)
 Only one income beneficiary during the life of the
current income beneficiary
 Any corpus distributed during the life of the
beneficiary may only be distributed to the beneficiary
 Income beneficiary’s interest will terminate on death
or termination of the trust
 If terminated during the life of the income
beneficiary, all assets must be distributed to the
income beneficiary
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Problems on Page 690

1(g) – 100 Shareholders and the S corporation
forms a partnership with other 100 shareholder S
corporations.
• The partnership does not blow the election

1(h) – 2 classes of common stock outstanding
with the same financial rights, but different
voting rights. A 3rd class of stock with different
financial rights that is unissued.
• Only concerned with outstanding shares. The different
voting rights to NOT create a second “class” of stock for
purposes of § 1361(c)(4)
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Problems on Page 690

1(i) – 2 classes of common stock outstanding
with the same financial rights, except that they
are intended to compensate for different tax
rates.
• The different financial rights (i.e. they are not identical)
to DO create a second “class” of stock for purposes of §
1361(c)(4)

1(j) – 4 shareholders who each own a bond from
the corporation in proportionate amounts that
pay fixed interest.
• Although the bonds are probably going to be viewed as
“equity”, they do not create a 2nd class of stock.
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