Problem 249 -1(a)
Z
Corp
D
C
24 Shrs
23 Shrs
Redeem 7 Shrs
B
25 Shrs
A
28 Shrs
(a) Z redeems 7 of A’s shares. Prior to redemption, A
could control with any other single shareholder.
After, A owns 21 of 93 shares and could no longer
control with just one. Good case for (b)(1). Rev.
Rule 76-364 (OK under similar facts.)
LLM Corporate Tax
Instructor: Dwight Drake
Problem 249 -1(b)
Z
Corp
D
C
24 Shrs
23 Shrs
Redeem 5 Shrs
B
25 Shrs
A
28 Shrs
Mother / Daughter
(b) Z redeems 5 shares from A; A and D are mother – daughter.
Before with attribution, A owned 52% (52 / 100). After, A
own 49.4% (47 / 95). This loss of control probably enough
to get under (b)(1) where balance of stock owned only be a
few (no big dispersion). Rev. Rule 95-502.
LLM Corporate Tax
Instructor: Dwight Drake
Problem 249 -1(c), (d)
Z
Corp
D
C
24 Shrs
23 Shrs
Redeem 5 Shrs
B
25 Shrs
A
28 Shrs
Mother / Daughter
(c) Z redeems 5 shares from A; A and B mother – daughter. 53% before (53 /
100) and 50.5% after (48 / 90), with attribution. No hope under (b)(1).
(d) Same as (c), but A and B not spoken since B married outside of faith. Issue:
Does hostile family situation negate family attribution of 318? IRS has said
“no.” Rev. Rule 80-26. First Circuit once allowed, but most have held no.
Even if attribution negated, still have (b)(1) issue. Before redemption, A had
29 shares and could control with any one of other three. After redemption of 5
shares, could control only with B, who she doesn’t talk to. Should family
hostility be issue for (b)(1) purposes? Tax Court in Cerone v. Comm, 87 T.C.
LLM Corporate Tax
1 (1986) said “yes”.
Instructor: Dwight Drake
Problem 249 -2(a), (b)
Y
Corp
Redeem 5 Pref
E
0 Com,
20 Pref.
D
C
B
A
15 Com, 25 Com, 20 Com, 40 Com,
15 Pref. 10 Pref. 55 Pref. 0 Pref.
(a) Y redeems 5 preferred shared from E. (b)(1) qualified because E never
had any control. Reg. 1.302-2(a); Rev. Rule 77-426.
(b) Y redeems all preferred stock. Each shareholder analyzed. E qualifies
under (b)(3) – complete redemption. Others technically all fail
because no change in voting control; thus no hope under (b)(2) or
(b)(1). But is this right as to B, who has taken big hit in economic
interest – from 37.5% of all shares to 10%?
LLM Corporate Tax
Instructor: Dwight Drake
Problem 249- 3
Basic Facts: A owns 10 shares common, basis 15k.
- What is basis impact if 5 shares are redeemed in transaction treated as
dividend? Basis of remaining 5 shares is 15k. Reg 1.302-2(c).
- What basis impact if all 10 shares redeemed in transaction treated as dividend?
Would happen where (b)(3) not available because family attribution waiver
not available. Here, basis is transferred to shares belonging to others that
were attributed to A and killed (b)(3). Reg. 1.302-2(c), Ex 2.
302(b)(4) – Partial Liquidation Exception
Applies:
- Only to noncorporate shareholders
- Even thought distribution pro rata and otherwise flunks (b)(1) – (b)(3).
- Based on impact at corporate level – not shareholder level.
- Stock held by partnership, estate or trust deemed help proportional by partners
and beneficiaries.
Requirements: 302(e)
- Not essentially equivalent to dividend (determined at corporate level)
- Distribution pursuant to a plan
- Distribution occurs in taxable year plan adopted or following year.
Partial Liquidation – Not Essentially Equivalent to Dividend
Safe Harbor:
- Distribution attributable to ceasing to conduct “qualified trade or business” –
operated for 5 years and not acquired during 5 yr period in transaction that
recognized gain or loss.
- After distribution, corp still involved in active conduct of “qualified trade or
business.”
Non- Safe Harbor Scenarios
- Tough – must show serious contraction of business.
- Example: Fire destruction; corporate cutback and all insurance proceeds
distributed.
- Bona fide business reason unrelated to desire to bail out liquid assets
- No hope if plan is to bail out accumulated investment assets
Problem 253-(a)
Books distributed /
Redeem 50 Shrs
from each
A Corp
Books & Cram
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(a) A distributes Books (more than 5 yrs owned, as is Cram) to shareholders in
equal shares and redeems 50 shares from each.
- For M &P, qualifies for exchange as partial liquidation if pursuant to “plan”,
done within year of plan or next year. A Corp must continue to operate Cram.
Both held 5 yrs. Same result if no actual share surrender (just reallocate basis
to stock). Makes no difference if pro rata under (b)(4) partial liquidation
provision.
- Partial liquidation provision not available to corp shareholder. So I Corp
stuck with dividend under 301 (pro rata kills any hope of other three 302(b)
provisions). 243 dividend deduction of 70% available, but any redemption
that is part of partial liquidation
stock basis reduction under 1059.
LLM requires
Corporate Tax
Instructor: Dwight Drake
Problem 253-(b)
Books distributed /
Redeem 50 Shrs
from each
A Corp
Books & Cram
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(b) What impact if Books bought 3 yrs ago for cash? Not qualified
business because not held 5 years. All shareholders have 301
dividend. Concern is bailing liquid cash through partial liquidation.
Hence, 5 yr rule. If bought in tax-free reorg, would have used stock
and could qualify if business ran for 5 yrs. No liquid asset bailout.
LLM Corporate Tax
Instructor: Dwight Drake
Problem 253-(c)
Books destroyed /
Half proceeds used in
prorata redemption
A Corp
Books & Cram
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(c) Books destroyed by fire, 1/2 insurance proceeds distributed pro rata
and other half used to scale down book business. I Corp still dividend.
For P & M, not qualify under 302(e)(2) because not ceasing business
or distributing all assets. Could be “not essentially equivalent to
dividend” under (e)(1) but need more facts to see if it corporate
contraction. For ruling purposes, IRS requires 20% cut in revenues,
FMV and employees. Rev. Proc. 2002-3.
LLM Corporate Tax
Instructor: Dwight Drake
Problem 253-(d)
A Corp
Books & Cram
Books distributed
to M for all stock
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(d) Books distributed to Michael in redemption of all his stock. Valid
partial liquidation - exchange treatment allowed. Also may qualify
under (b)(3) (family attribution waived) and maybe (b)(1)
(attribution interest reduced from 67% to 50%).
LLM Corporate Tax
Instructor: Dwight Drake
Problem 253-(e)
Books distributed
to I Corp for all
stock
A Corp
Books & Cram
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(e) Books distributed to I Corp in redemption of all stock. Although
can’t qualify under partial liquidation provision, qualifies under
(b)(3) as termination of complete interest. Exchange treatment
allowed.
LLM Corporate Tax
Instructor: Dwight Drake
Problem 253-(f), (g), (h)
A Corp
Books & Cram
M
1/3 Com
100%
P
I Corp
1/3 Com
1/3 Com
Beta
(f) Securities portfolio distributed pro rata in redemption. No hope. Not
partial liquidation or corporate contraction. 301 dividend to all
shareholders.
(g) A sells stock in B Corp and distributes proceeds pro rata. Sub corp
stock can’t qualify as partial liquidation per Rev. Rule 79-184. Hence,
301 dividend to all shareholders.
(h) A liquidates B Corp (operated for more than 5 yrs) and distributes assets
in pro rata redemption. If liquidated in non-taxable transaction under
332 (discussed later in course), A picks up all B Corp attributes and
may qualify as partial liquidation per Rev. Rule 75-223.
LLM Corporate Tax
Instructor: Dwight Drake
Redemption Impact on Corp
Three issues:
- Gain or loss to corp on distribution of property other than cash. 311 governs
the same as it does for non-liquidating distributions. Gain is always
recognized by corporation, but losses not recognized.
- E&P impact. E&P reduced by amount of distribution, but per 312(n)(7)
reduction can not exceed ratable share of E&P attributable to redeemed
stock. So if 1/3 stock redeemed, E&P before redemption can not be reduced
more than 1/3.
- Stock acquisition expenses paid by corp (brokerage commissions, legal fees,
etc) are not deductible per Section 162(k). They are treated as nonamortizable capital expenditures. Amounts paid that have no nexus to
redemption (employment agreement amount) are deductible and loan costs
and fees involved in redemption may be amortized over term of loan.
Problem 260
250k for all
A’s stock
X Corp
A
100k Acc. E&P
100k Cur. E&P
B
100 Com
100k Basis
100 Com
100k Basis
A shares redeemed for 250k cash. Since cash, X recognizes no gain or
loss on exchange. Since half of shares redeemed, 312(n)(7) permits
half reduction in E&P. Thus, E&P reduced 100k and remaining E&P
100k.
LLM Corporate Tax
Instructor: Dwight Drake
Zenz Bootstrap Acquisitions
Three scenarios all part of common plan:
Scenario 1: Shareholder sells some stock and then has corporation redeem
balance of shares. Qualifies under 302(b)(3) even though corporate E & P
distributed to help facilitate acquisition. Zenz case/
Scenario 2: Corporation sells new shares to new shareholder and then redeem
shares from existing shareholder. Percentages before and after both
transactions control whether (b)(2) “substantially disproportionate” tests met.
Scenario 3: Existing shareholder sell some shares to new shareholder and then
have corporation redeem shares from existing shareholder. Percentages
before and after both transactions control whether (b)(2) “substantially
disproportionate” tests met. Rev. Rule 75-447
Problem 265
T Corp
100k for 20%
of S’s stock
S
Sale 80%
for 400k
B
100% Com
Can qualify for exchange treatment as complete (b)(3) redemption under
Zenz case so long as all part of the same plan. Do we care if capital
gains and dividend rates the same? If S’s stock basis over 400k, (b)(3)
treatment will result is less income. With dividend scenario, have 100k
dividend and capital loss
E&P implications? If exchange, T Corp E&P reduced 20%, but not over
100k amount distributed in redemption. If 301 dividend, E&P reduced
100k. Thus, if E&P less than 500k before, may get bigger E&P
reduction (a good thing) with dividend.
LLM Corporate Tax
Instructor: Dwight Drake
Corporate Buy-Sell Agreements
-
Most important document in many privately-owned businesses
-
Determines value and exit opportunities for shareholders
-
Contain buy-out triggers: death, disability, bankruptcy, expulsion, etc.
-
Many tax issues, including estate tax valuation.
-
Often rely on (b)(3) exception for family businesses
-
Constructive dividend trap
- Co-shareholders become obligated under agreement to buy out a departing
shareholder. Cross-purchase structure.
- Corporation then discharges obligation of co-shareholders by redeeming
stock.
- Result is constructive dividend to co-sharholders.
- Often screwed-up through bad life insurance structuring.
Corporate Buy-Sell
C Corp
Cash or
Property
Constructive
dividend
Sells Stock
Shareholder
A
Shareholder
B
Cross-Purchase Buy-Sell Agreement
Problem 271
Basic Facts: A, B & C unrelated equal shareholders of Y Corp with cross
purchase buy-sell. Y Corp owns polices on each shareholder. B dies, Y Corp
collects policy and pays proceeds to redeem B stock.
-
Premium payments by Y Corp not deductible per 264(a)(1).
-
Premium payments by Y not dividend to any shareholders because Y Corp
own policy.
-
Insurance proceeds received by Y Corp tax free per 101(a). Likely AMT tax
trigger.
-
Y Corp E&P increased by excess of insurance proceeds over aggregate
premiums paid on policy.
-
On payment of insurance proceeds in redemption of B stock, A & C have
constructive dividend distribution because their obligation to buy shares
being satisfied by Y Corp. Defective buy-sell planning. 301 dividend to
extent of E&P.
Insurance Cross-Purchase
C Corp
15 Million
80%
Shareholder A
3 mill policy on B
20%
Shareholder B
12 mill policy on A
Cross-Purchase Agreement
Insurance Cross-Purschase
A dies - B sells business for 15 million
A family return:
Payment from B
12 million
Estate Taxes
5 million
Net return
7 million
B’s Return
Sales Proceeds
15 million
Income Tax
.6 million
Net return
14.4 million
A Goes Ballistic!
Restructured Insurance Program
C Corp
15 Million
80%
Shareholder A
3 mill policy on B
Life Ins. Trust
12 mill policy
20%
Shareholder B
One Leg Cross-Purchase Agreement
Restructured Insurance Program
A dies - B sells business for 15 million
A family return:
Payment on sale
12 million
Estate Taxes
5 million
Net return on sale
7 million
Tax Free Insurance
12 million
Total yield
19 million
B’s Return
Sales Proceeds
3 million
Income Tax
.6 million
Net return
2.4 million