corporate & partner tax instructor: dwight drake c corp redemption redemption: c corp buys stock...

Corporate & Partner Tax Instructor: Dwight Drake

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.


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


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).


Problem 560 -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.


Problem 560 - 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.


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


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.


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.


302(b)(1) – “Not Essentially Equivalent to Dividend”

Negative: Not near as objective or certain as (b)(2) or (b)(3).

What it takes:

- There must be percentage reduction after full attribution. Davis case. Obviously something less than (b)(2) standards.

- Reduction must be meaningful.

- Look to voting control changes and power. Majority to minority.

- Family discord may be factor only for “meaningful” requirement.

- Reduction in nonvoting preferred never qualify. Rev Rul 85-106.


Problem 594-1

Basic Facts:

Inc Stockholdings Shs A.B. FMV

Common C.D. Estate (uncle) 8,000 8 mill 8 mill Adam (H) 800 80k 800k Bea (W) (2% Est Ben) 800 80k 800k Ban (Gift 5 yr) 300 30k 300k Child Trust (Gift 5 yr) 100 10k 100k Nonvoting Preferred C.D. Estate 500 50k 50k Adam 500 50k 50k

Inc E&P – 4 mill


Problem 594-1

(a) Inc redeems from C.D. estate 6k common shares and all preferred shares.

- Since Bea beneficiary of estate, all her shares and family shares attributed to estate. Hence estate deemed to own 100 % both before and after – no reduction. Dividend under 301 to extent of 4 mill E&P, and balance (2 mill, 50k) reduction in Estate stock basis.

- Option: Wait until Bea no longer estate beneficiary (got all her money, no further claim, and remote possibility of estate to seek return of property). Then, no attribution from B. Estate common shares go from 80% to 50%. Not qualify still under (b)(1) because not own less than 50%. But may qualify as “not essentially equivalent to dividend” because reduction that may be meaningful because go from majority to deadlock. Facts and circumstances.

- Option 2: Redeem one more share of common and fit under (b)(2). Real certainty. Preferred can “piggyback” on common and qualify.


Problem 594-1

(b) Inc redeems Bea’s 800 shares, but she remains director. No (b)(3) complete termination because she director and 2% attribution from estate shares. Attribution: 2% of estate shares (160), all other family shares for total of 2160 shares. If terminate estate beneficiary status before redemption, percentage owned before is 20% (2000/10,000) and percentage after is 13.04% (1200/9200). (b)(2) tests satisfied – both 80% tests for common and voting and less than 50% voting test.

(c) Same as b, but 6 months later redeems 4,200 shares from estate. If both redemptions part of a common plan, Bea’s earlier redemption not qualify because her after percent would be 24% (1200/5000). If not part of common plan, she still OK. Facts and circumstances test.

(d) Inc redeems all preferred shares. C.D. estate no hope under (b)(1) because majority control both before and after. Adam may have long shot (b)(1) argument because he had de minimis total interest. Rev. Rule 85-106.


Problem 594- 2

Basic Facts:

Inc Stockholdings Shs A.B. FMV

Common Adam (H) 800 80k 800k Bea (W) 800 80k 800k Ban (Gift 5 yr) 300 30k 300k Child Trust (Gift 5 yr) 100 10k 100k Total 2,000 200k 2 millInc E&P – 4 mill

(a) Inc redeems B 800 shares for cash. (b)(3) complete termination qualifies so long as B holds no other interest. Prior gifts to kids falls within 10 yr. look back period, but no evidence of tax avoidance purpose. B must file agreement to notify if she acquires forbidden interest with 10 year forward period.


Problem 594- 2

(b) What result if B fails to file required agreement? Reg.1-302-4(a)(2) gives reasonable extension of time if there reasonable cause for not filing and request for extension is filed in reasonable time. Statute of limitations extended for 1 yr from date of notice.

(c) B remains director after redemption? (b)(3) out and B has dividend. What if B “inactive director”? Per Ninth Circuit in Lynch, makes no difference.


Problem 594- 2

(d) A & B each gift 400 shares to son D, and then corp redeems other 400 shares from each with 50k cash and 20 yr. 350k note, market interest and secured by assets. A & B resign all interests, except B to remain consultant for 50k per year. Issue: Is family attribute waived to qualify under (b)(3) as complete termination? Three issues:

- 20 yr. note: Such long term that it may be deemed equity, not creditor. IRS ruling standard 15 yrs max. Some courts have allowed 20 yrs. Pushing limit here.

- B consulting: Per Lynch, will kill (b)(3) with no family termination. Prohibited interest. Some earlier cases contrary for independent contractors, but far too risky now.

- 10 year look back and gift to Dan. No tax avoidance purpose if intent to turn-over control and retire. Rev. Rule 77-293.


Problem 594- 3

Facts: Same as 2, except B dies with shares valued at 800k and A sole beneficiary.

(a) B estate shares redeemed for 800k. No (b)(2) or (b)(3) because attributed with ownership of all other shares through Adam. No waiver of entity attribution for complete termination under (b)(3). Hence, estate has full dividend. Note: step up basis no value.

(b) What if Adams 800 shares redeemed at same time. Here no entity attribution from Adam to estate. Family attribution waived, so complete redemption under (b)(3) if required agreement filed for 10 yr look-forward rule.


Problem 594- 4 Facts: Same as 2, except A & B (800 shares each) brother and sister, D

(300 shares) is A son, and remaining 100 held by C, cousin unrelated under 318.

(a) Inc redeems 100 of A shares. A’s interest goes from 55% (1100/2000) to 52.6% (1000/1900). A still have control so no hope under (b)(1).

(b) Inc redeems 200 from D. D interest goes from 55% (1100/2000) to 50% (900/1800). May argue meaningful reduction under (b)(1), but unlikely where other stock held by more than one unrelated party. Not enough dispersal of power. Different if one unrelated other 50% party per Rev. Rule 75-502.

(c) Inc redeems 10 shares from C. C’s interest goes from 5% (100/2000) to 4.52% (90/1990). Best argument under (b)(1) is that any reduction of minority interest is meaningful per Rev. Rul. 75-512.

corporate & partner tax instructor: dwight drake c corp redemption redemption: c corp buys stock...

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