Stock Redemptions
Tx 8120
Goals to Achieve
You should be able to:
1.
2.
3.
Distinguish between stock
redemptions and other
______________,
Describe consequences of
redemptions to _________ and
__________, and
Apply _________ ownership
rules in analyzing redemptions.
Non-Liquidating Distributions
Property Distribution
Stock Distribution
Stock Redemption
Shareholders
Shareholders
Shareholders
Property
Corporation
Stock
Corporation
Stock
Property
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 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 corporation’s E&P affected?
Redemption defined
Section 317(b)
(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
Reasons for redemptions
Shareholder Reasons
• Shareholder may “cash out” to:
–
–
–
–
Pursue other investment opportunities,
Shift _____ to family members,
______, or
Pay ______ expenses and death taxes.
• Shareholder cannot sell shares since:
Shareholders
Stock
Property
Corporation
– Market for closely-held stock is ____,
– Shares are _____________, or
– Corporation has right of first _______.
Reasons for redemptions
Corporate Reasons
• Remove shares from market to fight
_______ ________
• Take a public company _______
• Buyout dissatisfied or ______
shareholder
• Invest excess funds in self via “___
____”
Shareholders
Stock
Property
Corporation
– Condition: Low _____ price and no better
investment opportunities
– Result: Fewer outstanding shares and
higher ___
Reasons for redemptions
Corporate Reasons
(continued)
• _________ 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
Reasons for redemptions
Corporate Reasons
(continued)
• In a “________ acquisition,”
third party wishes to buy
shareholder out but lacks
sufficient cash.
– Corporation redeems part of
shareholder’s stock to help
_______ the buy out and
– Third party buys shareholder’s
_________ shares.
Shareholders
Stock
Property
Corporation
Shareholder issues
Gain or loss recognized
Basics
Section 302(a)
(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
Shareholder issues
Gain or loss recognized
Basics
Section 267
(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 …
Shareholder
Stock
Property
Corporation
Shareholder issues
Gain or loss recognized
Basics
Shareholders May Prefer §301
Shareholders
Stock
Property
Corporation
• Capital losses might not be
__________.
• If stock basis is ____, capital gain
may be only slightly less than
dividends.
• Absent ____, capital gain might
be smaller under §301.
• Corporate shareholders may want
dividends and the _____.
Shareholder issues
Gain or loss recognized
Basics
Section 302(d)
(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
Shareholder issues
Gain or loss recognized
Basics
Example: Sole Shareholder
Mickey
DW Shares
($30 basis)
100%
$100
DW Corp
(E&P $300)
Assuming Mickey retains some DW shares, how do you think
Mickey should treat this transaction?
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
35 DW Shares
($140 basis)
70%
$210
DW Corp
(E&P $300)
15 DW Shares
($50 basis)
$90
30%
Minnie
Shareholder issues
Gain or loss recognized
Basics
Stock Redemption Overview
Shareholder recognizes capital gain
(or loss unless §___ disallows)
1. Not essentially equivalent to dividend
Exchange treatment
per §_____
2. Substantially disproportionate
3. Termination of holding
4. Partial liquidation
Redemption
per §_____
5. Death taxes and related expenses
Property distribution
per §_____
Shareholders
Stock
Dividend to extent of E&P, then
return of capital, then capital gain
Property
Corporation
Shareholder issues
Gain or loss recognized
Basics
Example: Impact of Rules
Harvey
10 shares
($80 basis)
30 shares
before redemption
$100
How much tax does Harvey pay
if the redemption is treated as a
property distribution?
StewartCo
(E&P $500)
How much tax does Harvey pay if the redemption is treated as an exchange?
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Section 302(b)(1)
(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
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Not Essentially Equivalent
• Requires a “_______ ________”
in shareholder’s proportionate
interest
• Usually applies to:
Shareholders
Stock
Property
Corporation
– _______ _______ “called in” from
shareholders owning no common
stock and
– Redemptions from ________
shareholders
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. “[T]o qualify for
preferred [exchange] treatment …, a redemption must
result in a ______ _________ of the shareholder’s
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.”
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Wright v. US
(CA-8, 1973)
Under state law, a ______ majority (> 50%) controls a
corporation’s 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 shareholder’s 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 “__________.”
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Rev. Rul. 75-502
A corporation redeems its shareholder’s common stock,
causing voting power to decline from ___% to ___%. A
single unrelated shareholder controls the remaining voting
power. Is this a meaningful reduction?
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Rev. Rul. 75-512
A corporation redeems its shareholder’s common stock,
causing voting power to decline from ___% to ___%. This
reduction barely misses exchange treatment via §302(b)(2).
Is this a meaningful reduction?
Shareholder issues
Gain or loss recognized
Not equivalent to dividend
Rev. Rul. 76-364
Taxpayer owns ___% of a corporation with the remaining
shares equally distributed among three unrelated
shareholders. A redemption of taxpayer’s shares reduces
his voting power to ___%. Is this a meaningful reduction?
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Section 302(b)(2)
(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
Shareholders
shareholder owns less than 50 percent of the
total combined voting power of all classes of
Stock
stock entitled to vote.
Corporation
Property
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Section 302(b)(2)
(continued)
(C) Definitions. … [T]he 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
Shareholders
the corporation owned by the
Stock
shareholder immediately before the
redemption bears to all of the voting
Corporation
stock of the corporation at such time.
Property
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Section 302(b)(2)
(continued)
[N]o distribution shall be treated as substantially
disproportionate unless the shareholder’s ownership of the
common stock of the corporation (whether voting or
nonvoting) after and before the redemption also meets the
80 percent requirement …. [I]f there is more than one class
of common stock, the determinations shall be made by
reference to fair market value.
Shareholders
Stock
Property
Corporation
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Section 302(b)(2)
(continued)
(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
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Example: Voting Power
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 Henry’s voting
power in Corp?
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Substantially Disproportionate
Shareholders
Stock
Property
Corporation
Shareholder's Post- Voting Power
< 50%
Total Post- Voting Power
Shareholder's Post- Voting Power
Shareholder's Pre- Voting Power
< 80%
Total Post- Voting Power
Total Pre- Voting Power
Shareholder's Post-Common Stock FMV
Shareholder's Pre- Common Stock FMV
< 80%
Total Post-Common Stock FMV
Total Pre-Common Stock FMV
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 corporation’s 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 B’s redemption. Is A’s redemption substantially disproportionate?
A
B
C
D
Shares
Percentage
1,466
210
200
155
2,031
72.18%
Redeemed
Shares
902
564
210
200
155
1,129
Percentage
Redeemed
210
Shares
564
0
200
155
919
Percentage
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 favorable ________
treatment is not substantially disproportionate. Here, no joint plan existed.
However, the two redemptions are “_________ ________” since A had a plan
related to B’s withdrawal. Thus, A’s redemption is ___ substantially
disproportionate.
A
B
C
D
Shares
Percentage
1,466
210
200
155
2,031
72.18%
Redeemed
Shares
902
564
210
200
155
1,129
Percentage
Redeemed
210
Shares
564
0
200
155
919
Percentage
Lind et al., p. 217
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 Alice’s preferred shares, is it
substantially disproportionate?
Could the redemption be “not essentially equivalent to a
dividend” under §302(b)(1)?
Problem 1(a)
Lind et al., p. 217
Alice
Cathy
80 C.S.
100 P.S.
Problem 1(b)
20 C.S.
100 P.S.
Y Corp
100 voting common
200 nonvoting preferred
If Y Corp redeems 75 of Alice’s preferred shares and 60 of her
common shares, is it substantially disproportionate?
Lind et al., p. 217
Alice
Cathy
80 C.S.
100 P.S.
Problem 1(c)
20 C.S.
100 P.S.
Y Corp
100 voting common
200 nonvoting preferred
If Y Corp redeems 75 of Alice’s preferred shares and 70 of her
common shares, is it substantially disproportionate?
Lind et al., p. 217
Alice
Cathy
80 C.S.
100 P.S.
20 C.S.
100 P.S.
Y Corp
100 voting common
200 nonvoting preferred
Problem 1(d)
Suppose Y Corp redeems 75 of
Alice’s preferred shares and 70 of
her common shares on Jan. 15. On
Dec. 1, Y Corp redeems 10 of
Cathy’s common shares. How are
these redemptions treated?
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Rev. Rul. 87-88
The FMV per share of a corporation’s 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.
A’s Voting Common
Other Voting Common
A’s Nonvoting Common
Shares
Percentage
Redemption
Shares
Percentage
6
4
30
60%
3
43%
100%
27
3
4
3
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?
100%
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Rev. Rul. 87-88
(continued)
A’s Voting Common
Other Voting Common
A’s Nonvoting Common
Shares
Percentage
Redemption
Shares
Percentage
6
4
30
60%
43%
100%
100%
Section 302(b)(2) tripartite requirements:
a. A owns < __% ______ power after redemption.
b. A owns < ___% ______ power after redemption as he owned before
redemption.
c. A owns < __% 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).
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:
a. The new owner did not wish to “buy” the ____, a
source of future ________. The redemption in transfer
#2 removed all ____.
b. An outright sale of all shares to the new owner would
yield the same result except that ____ remains.
c. Reversing the order by redeeming the shares first (if
treated as ________ transactions) appears to result in
__________ to the initial owner.
Corporation
(E&P)
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Rev. Rul. 75-447
(Situation 1)
Owns 50 shares
voting common
Owns 50 shares
voting common
A
B
50%
50%
Corporation X
(E&P)
25 shares
voting common
#1
C
$$$
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Rev. Rul. 75-447
(Situation 1 continued)
Before transfer #2,
A owns 50 shares
voting common
$$$
Before transfer #2,
B owns 50 shares
voting common
$$$
#2
A
25 shares
voting common
B
1/3
1/3
Corporation X
(E&P)
25 shares
voting common
Before transfer #2,
C owns 25 shares
voting common
1/3
C
Shareholder issues
Gain or loss recognized
Substantially disproportionate
Rev. Rul. 75-447
(Situation 1 continued)
Focus on Transfer #2
A
B
C
Before
50 shares 40%
50 shares 40%
25 shares 20%
Focus on Overall Result
After
A
B
C
Before
50 shares 50%
50 shares 50%
After
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
A
B
C
Before
35 shares 35%
35 shares 35%
30 shares 30%
Focus on Overall Result
After
A
B
C
Before
50 shares 50%
50 shares 50%
After
Shareholder issues
Gain or loss recognized
Termination
Section 302(b)(3)
(b) Redemptions treated as exchanges.
(3) Termination of shareholder’s 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
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
Shareholders
distributee has no interest in the
Stock
corporation (including an interest as
officer, director, or employee), other than
Corporation
an interest as a creditor …
Property
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
__________
Shareholder issues
Gain or loss recognized
Termination
Lynch v. CIR
(CA-9, 1986)
As sole shareholders, Mom and Dad sold some shares to son
and resigned as directors and officers. Two weeks later, the
corporation redeemed all of Mom and Dad’s 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 Dad’s status as an
independent contractor was a __________ interest. So, the
redemption did not qualify for __________ treatment as a
complete termination.
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.
2.
3.
4.
Son owns stock attributable to Dad under §____,
Son acquired stock from Dad within past ___ years,
Corporation is not redeeming _____ shares, and
A __________ purpose is tax ___________.
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).
Dad’s 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.
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
Shareholder issues
Gain or loss recognized
Partial liquidation
Partial Liquidation
§302(e)
• Part of liquidation plan adopted in
_______ or _________ year and
• Not essentially equivalent to dividend
(________-level test, so ___ ____
okay), which includes distributions
related to:
Both terminated and
continued businesses must
– Corporation ______ to conduct a
have operated for __ years.
business and
– Corporation _________ to conduct a
business.
Shareholder issues
Gain or loss recognized
Partial liquidation
Imler v. CIR
(TC, 1948)
Reg. §1.346-1(a)(2) now
embodies this “_______
__________” theory.
Fire destroyed the top floors of a corporation’s building that
had been rented to another company. Rather than rebuilding
the floors with insurance proceeds, the corporation distributed
proceeds to shareholders. The government argued for
_______ treatment, but the court held the “bona fide
________ in the business” merited __________ treatment.
Shareholders
Stock
Property
Corporation
Shareholder issues
Gain or loss recognized
Partial liquidation
Estate of Chandler v. CIR
(TC, 1954)
A family-owned corporation operated a general department
store consisting of ladies’ wear, men’s wear, children’s wear,
and a bargain basement department. Due to the president and
manager’s 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.
Shareholder issues
Gain or loss recognized
Partial liquidation
Estate of Chandler v. CIR
(TC, 1954)
The court noted that ________ of business is not sufficient to
ensure exchange treatment as a partial liquidation. In this case,
the corporation’s _____ _____ existed before contraction and
was not due to the downsizing. The capital required for the
new ladies’ shop was almost the same as capital the prior
department store required. The redemption was ________
__________ to a dividend.
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 P’s shareholders in partial
redemption of their shares. Does this represent a “_______
___________” of business that P conducts indirectly via S?
No basis exists for _________ S’s business activities to P. S and
P are ______ and ________ entities. Thus, the redemption is
___ a partial liquidation entitled to exchange treatment.
Lind et al., p. 252
part (a)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
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?
100%
Beta Corp
Beta Processing Business
In the same transaction, what if no
shareholders surrender shares?
Lind et al., p. 252
part (b)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
Books (Cram) for
3 (> 5) years.
Iris Corp
Would the results in part (a) differ if
Alpha had acquired Books three years
ago in a cash purchase?
Cram
Business
100%
Beta Corp
Beta Processing Business
What is Alpha acquired Books three
years ago in a tax-free reorganization
using its voting stock as payment?
Lind et al., p. 252
part (c)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
100%
Beta Corp
Beta Processing Business
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?
Lind et al., p. 252
part (d)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
If Alpha distributes all assets of Books
to Mike in return for all his Alpha
shares, what is the shareholder-level
effect?
100%
Beta Corp
Beta Processing Business
Suppose Alpha did not distribute the
assets pursuant to a “plan.” Can Mike
still obtain exchange treatment?
Lind et al., p. 252
part (e)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
100%
Beta Corp
Beta Processing Business
If Alpha distributes all assets of Books
to Iris Corp in return for all its Alpha
shares, what is the shareholder-level
effect?
Lind et al., p. 252
part (f)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
100%
Beta Corp
Beta Processing Business
If Alpha distributes the securities
portfolio to its 3 shareholders in return
for 20 Alpha shares from each, what is
the shareholder-level effect?
Lind et al., p. 252
part (g)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
If Alpha sells all its Beta stock and
distributes the proceeds pro rata to the 3
owners, what is the shareholder-level
effect?
100%
Beta Corp
Beta Processing Business
Beta has operated
business more
than 5 years.
Lind et al., p. 252
part (h)
Mike Senn
1/3
Pamela
(Mike’s wife)
1/3
Diversified
Securities Portfolio
Books
Business
(unrelated to Senns)
1/3
Alpha Corp
Alpha has operated
both businesses
more than 5 years.
Iris Corp
Cram
Business
If Alpha liquidates Beta (nontaxable per
§332) and distributes Beta’s assets pro
rata to the 3 owners, what is the
shareholder-level effect?
100%
Beta Corp
Beta Processing Business
Beta has operated
business more
than 5 years.
Shareholder issues
Gain or loss recognized
Death taxes and expenses
S. Rep. No. 81-2375
81st Cong., 2d Sess. (1951) at 54
[T]he 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.
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 decedent’s 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.
Shareholder issues
Gain or loss recognized
Death taxes and expenses
Death Taxes: Rationale
• Typical situation
– Owner in family business ____
– Estate’s 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 ________
Shareholder issues
Gain or loss recognized
Death taxes and expenses
Death Taxes: Conditions
• Shares held > __% of adjusted gross estate
– Gross estate less ________/administrative
expenses, debts, and casualty losses
– Value of multiple corporate holdings
aggregated (for 35% test) when ≥ __% of
each corporation’s value included in estate
• Exchange treatment limited to ____ taxes
plus _____/administrative expenses
Shareholder issues
Gain or loss recognized
Death taxes and expenses
Rev. Rul. 87-132
Owns 150 shares
voting common
A
Owns 150 shares
voting common
Estate
Unrelated
Objectives
1. Maintain estate’s relative _____
______ in family business
2. Distribute cash for _____ _____
3. Obtain §303 ________ treatment
50%
50%
Corporation X
(E&P)
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?
Shareholder issues
Gain or loss recognized
Death taxes and expenses
Rev. Rul. 87-132
Owns 150 shares
voting common
A
Owns 150 shares
voting common
Estate
Unrelated
Conclusion
1. Stock distribution is ________
2. Redemption is a §303
_________
Rationale
1. Sec. 305 applies _________ §303 even
though two steps part of one _____
2. Sec. 303(c) treats stock with ________
basis same as original stock and, thus,
was enacted with this transaction in mind
50%
50%
Corporation X
(E&P)
Shareholder issues
Basis of property received
Section 301(d)
(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
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
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 _____ ____ E&P as
untaxed dividends (via DRD).
Shareholders
Stock
Property
Corporation
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.
Shareholders
Stock
Property
Corporation
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),
then gain shall be recognized to the
distributing corporation as if such property
were sold to the distributee at its fair market
price.
Shareholders
Stock
Property
Corporation
Corporate issues
E&P impact
Section 312(n)(7)
Shareholders
Stock
Property
Corporation
(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.
Corporate issues
E&P impact
Watch E&P
• For redemptions treated as ______
_______, E&P decreases by greater of
FMV or adjusted basis, §312(a)(3), (b)(2).
• For redemptions treated as exchanges, the
decrease in E&P equals lesser of:
– Greater of ____ or adjusted basis or
– ____ _____ portion of E&P, §312(n)(7)
Shareholders
Stock
Property
Corporation
Limit on E & P reduction = E & P x
Constructive Ownership
§302(c)
• Applies when determining if redemption is:
– ____ essentially equivalent to dividend
– Substantially disproportionate
– Complete termination (except ______
attribution rules sometimes waived)
• Inapplicable to:
– Partial liquidations and
– ______ tax redemptions
Constructive Ownership
• Attribution from
– Family
– Transparent entities
– Corporations
• Attribution to
– Transparent entities
– Corporations
• Attribution via options
Constructive ownership
Attribution from Family
§318(a)(1)
• Individuals constructively
own stock owned directly or
indirectly by:
–
–
–
–
_______,
Parents,
Children, and
____________.
• No re-attribution to another
family member
Constructive ownership
Example: Family Business
a. How much does Bob own?
b. How much does Bob’s sister own?
Bob
30%
Bob’s father
5%
C
7%
Bob’s granddaughter
10%
Bob’s sister
c. How much does Bob’s father own?
d. How much does Bob’s granddaughter own?
Constructive ownership
Example: Family Business
a. How much does Ron own?
b. How much does Nancy own?
Ron
40%
Maureen
(Ron’s daughter by
prior marriage)
10%
C
Nancy
30%
(Ron’s Wife)
20%
Jack
c. How much does Jack own?
(Ron’s Dad)
d. How much does Maureen own?
Constructive ownership
Attribution from Transparent Entity
§318(a)(2)(A)
• ____________ attribution
• Re-attribution
Partner
PS
C
Beneficiary
Shareholder
Estate
S
C
C
Constructive ownership
Attribution from Corporation
§318(a)(2)(C)
• Proportionate attribution only if SH owns ≥ ___%
• Re-attribution
Shareholder
C1
C2
Constructive ownership
Examples: Attribution from Rules
Partner
20%
PS
20%
C
Shareholder
Beneficiary
70%
C1
60%
Estate
20%
C2
10%
C
Constructive ownership
Examples: Attribution from Rules
Partner
Shareholder
5%
PS
25%
C1
40%
C
Shareholder
50%
C1
40%
C2
2%
C2
Constructive ownership
Example: Ownership Rules
How much of B does Ricardo own?
Ricardo
70%
Lucille
A
X
90%
60%
How much of Y does Lucille own?
B
Y
20%
C
80%
How much of C does Ricardo own?
40%
How much of Z does Lucille own?
Z
Constructive ownership
Example: Ownership Rules
Ricardo
Lucille
80%
How much of C2 does Ricardo own?
5%
C1
How much of C2 does Lucille own?
40%
C2
Constructive ownership
Example: Ownership Rules
How much of C does PS1 own?
Ricardo
20%
How much of C does Ricardo own?
PS1
50%
40%
PS2
30%
C
Constructive ownership
Example: Ownership Rules
How much of B does Lucille own?
Via P/S:
Via A:
Lucille
40%
Ricardo
60%
60%
40%
A
P/S
Y
P/S
80%
20%
80%
20%
B
Z
How much of Z does Ricardo own?
Via P/S:
Via Y:
Constructive ownership
Attribution to Transparent Entity
§318(a)(3)(A)
• ______ attribution
• No re-attribution via “attribution ____” rules
Partner
PS
Beneficiary
C
Estate
Shareholder
C
S
C
Constructive ownership
Attribution to Corporation
§318(a)(3)(C)
• _____ attribution if SH owns ≥ ___%
• No re-attribution via “attribution ____” rules
Shareholder
C1
C2
Constructive ownership
Examples: Attribution to Rules
Partner
10%
Shareholder
5%
10%
C
PS
50%
C1
5%
C1
Shareholder
Partner
C2
40%
C
PS
Partner
5%
C2
50%
PS
50%
Shareholder
5%
60%
C
C1
90%
C2
Constructive ownership
Example: Ownership Rules
How much of C does the P/S own?
Ricardo
Lucille
50%
70%
20%
PS
30%
C
Constructive ownership
Attribution via Options
§318(a)(4)
• Any person 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
Lind et al., p. 213
Grandfather
Grandmother
(25 shares)
(0 shares)
Problem 1
Wham
Corporation
(100 shares)
Mother
Option to Buy
Mother’s Cousin
(20 shares)
(5 of adopted son’s shares)
(0 shares)
50% beneficiary
50% beneficiary
Daughter
Adopted Son
Grandmother’s Estate
(15 shares)
(10 shares)
(30 shares)
How much Wham stock does Grandfather own?
Lind et al., p. 213
Grandfather
Grandmother
(25 shares)
(0 shares)
Problem 1
Wham
Corporation
(100 shares)
Mother
Option to Buy
Mother’s Cousin
(20 shares)
(5 of adopted son’s shares)
(0 shares)
50% beneficiary
50% beneficiary
Daughter
Adopted Son
Grandmother’s Estate
(15 shares)
(10 shares)
(30 shares)
How much Wham stock does Mother’s Daughter own?
Lind et al., p. 213
Grandfather
Grandmother
(25 shares)
(0 shares)
Problem 1
Wham
Corporation
(100 shares)
Mother
Option to Buy
Mother’s Cousin
(20 shares)
(5 of adopted son’s shares)
(0 shares)
50% beneficiary
50% beneficiary
Daughter
Adopted Son
Grandmother’s Estate
(15 shares)
(10 shares)
(30 shares)
How much Wham stock does Grandmother’s Estate own?
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 _________.