Stock Redemptions Tx 8120

Stock RedemptionsTx 8120

Goals to Achieve

1. Distinguish between stock redemptions and other ______,

2. Describe consequences of redemptions to _________ and __________, and

3. Apply _________ ownership rules in identifying redemptions.

You should be able to:

Non-Liquidating Distributions

Shareholders

Corporation

Property

Shareholders

Corporation

Stock

Shareholders

Corporation

Stock Property

Property Distribution Stock Distribution Stock Redemption

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 the 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?

Shareholder (distributee) Issues Corporation (distributor) Issues

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

Corporation

Stock Property

Redemption defined

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:– Market for closely-held stock is ____,– Shares are _____________, or– Corporation has right of first _______.

Shareholders

Corporation

Stock Property

Reasons for redemptions

Corporate Reasons• Remove shares from market to fight

_______ ________• Take a public company _______ • Buyout dissatisfied or ______

shareholder• Invest in self via “___ ____” with

excess funds– Condition: Low _____ price and no

better investment opportunities– Result: Fewer outstanding shares and

higher ___

Shareholders

Corporation

Stock Property


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

Corporation

Stock Property


Shareholders

Corporation

Stock Property

• 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.

Corporate Reasons(continued)


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

Corporation

Stock Property

Shareholder issuesGain 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 …

Shareholders

Corporation

Stock Property


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

Corporation

Stock Property


Basics

Example: Sole Shareholder

Assuming Mickey retains some DW shares, how do you think Mickey should treat this transaction?

Mickey

DW Corp

(E&P $300)

DW Shares($30 basis)

$100100%


Basics

Example: Two Shareholders

Assuming simultaneous redemptions, how do you think Mickey and Minnie should treat this transaction?

Mickey

DW Corp

(E&P $300)

35 DW Shares($140 basis)

$21070%

Minnie

15 DW Shares($50 basis)

30%


Basics

$90

Stock Redemption Overview

Exchange treatmentper §_____

Property distributionper §_____

Redemptionper §_____

Shareholders

Corporation

Stock Property

Shareholder recognizes capital gain (or loss unless §___ disallows)

Dividend to extent of E&P, then return of capital, then capital gain

1. Not essentially equivalent to dividend

2. Substantially disproportionate

3. Termination of holding

4. Partial liquidation

5. Death taxes and related expenses


Basics

Harvey

StewartCo(E&P $500)

10 shares($80 basis)

$100How much tax does Harvey pay if the redemption is treated as a property distribution?

30 sharesbefore redemption

Example: Impact of Rules


Basics

How much tax does Harvey pay if the redemption is treated as an exchange?

Section 302(b)(1)

(b) Redemptions treated as exchanges.

Shareholders

Corporation

Stock Property

(1) Redemptions not equivalent to dividends. Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.


Not equivalent to dividend

Not Essentially Equivalent

Shareholders

Corporation

Stock Property

• Requires a “_______ ________” in shareholder’s proportionate interest

• Usually applies to:– _______ _______ “called in” from

shareholders owning no common stock and

– Redemptions from ________ shareholders



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.”



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 “__________.”

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?



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?



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 shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote.

Shareholders

Corporation

Stock Property


Substantially disproportionate

Section 302(b)(2)(continued)

Shareholders

Corporation

Stock Property

(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,

(ii) the ratio which the voting stock of the corporation owned by the shareholder immediately before the redemption bears to all of the voting stock of the corporation at such time.

is less than 80 percent of--




Shareholders

Corporation

Stock Property

[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

Corporation

Stock Property

(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.



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?



Substantially DisproportionateShareholders

Corporation

Stock Property

€

Shareholder's Post-Voting PowerTotal Post-Voting Power < 50%

€

Shareholder's Post-Voting PowerTotal Post-Voting Power < 80% Shareholder's Pre-Voting Power

Total Pre-Voting Power

€

Shareholder's Post-Common Stock FMVTotal Post-Common Stock FMV < 80% Shareholder's Pre-Common Stock FMV

Total Pre-Common Stock FMV



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?



Shares Percentage Redeemed Shares Percentage Redeemed Shares PercentageA 1,466 72.18% 902 564 564B 210 210 210 0C 200 200 200D 155 155 155

2,031 1,129 919

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 _______ ________ 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.



Shares Percentage Redeemed Shares Percentage Redeemed Shares PercentageA 1,466 72.18% 902 564 564B 210 210 210 0C 200 200 200D 155 155 155

2,031 1,129 919

Alice

Y Corp

100 voting common200 nonvoting preferred

Lind et al., p. 195Problem 1(a)Cathy

If Y Corp redeems 75 of Alice’s preferred shares, is it substantially disproportionate?

80 C.S.100 P.S.

20 C.S.100 P.S.

Alice

Y Corp


Cathy

If Y Corp redeems 75 of Alice’s preferred shares and 60 of her common shares, is it substantially disproportionate?

80 C.S.100 P.S.

20 C.S.100 P.S.

Lind et al., p. 195Problem 1(b)

Alice

Y Corp


Cathy

If Y Corp redeems 75 of Alice’s preferred shares and 70 of her common shares, is it substantially disproportionate?

80 C.S.100 P.S.

20 C.S.100 P.S.

Lind et al., p. 195Problem 1(c)

Alice

Y Corp


Lind et al., p. 195Problem 1(d)Cathy

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?

80 C.S.100 P.S.

20 C.S.100 P.S.

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.

Shares Percentage Redemption Shares PercentageA’s Voting Common 6 60%Other Voting Common 4A’s Nonvoting Common 30 100%

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?




Shares Percentage Redemption Shares PercentageA’s Voting Common 6 60% 43%Other Voting Common 4A’s Nonvoting Common 30 100% 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).

Zenz v. Quinlivan(CA-6, 1954)



Corporation

(E&P)

100%

#1 #2

Holding and RationaleTransfer #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 ______.

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.

Rev. Rul. 75-447(Situation 1)



Corporation X

(E&P)

25 sharesvoting common

$$$

#1

Owns 50 sharesvoting common

C

B

50% 50%

A


Rev. Rul. 75-447(Situation 1 continued)



Corporation X

(E&P)


$$$

#2

C

B

1/3 1/3

A

Before transfer #2, C owns 25 sharesvoting common1/3

$$$


Before transfer #2,B owns 50 sharesvoting common

Before transfer #2,A owns 50 sharesvoting common

Rev. Rul. 75-447(Situation 1 continued)



Focus on Transfer #2 Focus on Overall Result

Before After A 50 shares 40%B 50 shares 40%C 25 shares 20%

Before After A 50 shares 50%B 50 shares 50%C

Asserting that Zenz stands for the proposition that the sequence of transfers in an overall plan does not matter, the IRS indicated that only the overall result matters. Indeed, if the redemption had preceded the sale, the tax result would be the same (i.e., exchange treatment).

Rev. Rul. 75-447(Situation 2)



Focus on Transfer #2 Focus on Overall Result

Before After A 35 shares 35%B 35 shares 35%C 30 shares 30%

Before After A 50 shares 50%B 50 shares 50%C

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.

Section 302(b)(3)


Shareholders

Corporation

Stock Property

(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.


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--

Shareholders

Corporation

Stock Property

(i) Immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee), other than an interest as a creditor …


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

__________


Termination


Termination

Lynch v. CIR(CA-9, 1986)

As sole shareholders, Mom and Dad sold some shares to their 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.


Termination

Rev. Rul. 77-293Dad 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. Son owns stock attributable to Dad under §____,2. Son acquired stock from Dad within past ___ years,3. Corporation is not redeeming _____ shares, and4. A __________ purpose is tax ___________.


Termination


Tainted purpose evident when:____________ transfer to relative (to retain effective _______) andLater 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.

Section 302(b)(4)


Shareholders

Corporation

Stock Property

(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.


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:– Corporation ______ to conduct a

business and– Corporation _________ to conduct a

business.

Both terminated and continued businesses must have operated for __ years.


Partial liquidation

Imler v. CIR(TC, 1948)

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 ________ _______ to shareholders. The government argued for _______ treatment, but the court held that the “bona fide ________ in the business” merited __________ treatment.

Shareholders

Corporation

Stock Property


Partial liquidation

Reg. §1.346-1(a)(2) now embodies this “_______

__________” theory.

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.


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 the contraction and was not due to the downsizing. The amount of capital required for the new ladies’ shop was almost the same as the capital the prior department store required. The redemption was ________ __________ to a dividend.


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?


Partial liquidation

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.

Mike Senn

Alpha Corp

Lind et al., p. 230part (a)

Pamela(Mike’s wife)

1/3

BooksBusiness

CramBusiness

Beta Corp

Beta Processing Business

Iris Corp(unrelated to Senns)

1/3 1/3

100%

Alpha has operated both businesses

more than 5 years.

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?

In the same transaction, what if no shareholders surrender shares?

Diversified Securities Portfolio

Mike Senn

Alpha Corp

Lind et al., p. 230part (b)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3

100%

Alpha has operated Books (Cram) for

3 (> 5) years.

Would the results in part (a) differ if Alpha had acquired Books three years ago in a cash purchase?

What is Alpha acquired Books three years ago in a tax-free reorganization using its voting stock as payment?


Mike Senn

Alpha Corp

Lind et al., p. 230part (c)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3

100%


more than 5 years.

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?


Mike Senn

Alpha Corp

Lind et al., p. 230part (d)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3

100%


more than 5 years.

If Alpha distributes all assets of Books to Mike in return for all his Alpha shares, what is the shareholder-level effect?

Suppose Alpha did not distribute the assets pursuant to a “plan.” Can Mike still obtain exchange treatment?


Mike Senn

Alpha Corp

Lind et al., p. 230part (e)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3

100%


more than 5 years.

If Alpha distributes all assets of Books to Iris Corp in return for all its Alpha shares, what is the shareholder-level effect?


Mike Senn

Alpha Corp

Lind et al., p. 230part (f)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3

100%Diversified Securities Portfolio


more than 5 years.

If Alpha distributes the securities portfolio to its 3 shareholders in return for 20 Alpha shares from each, what is the shareholder-level effect?

Mike Senn

Alpha Corp

Lind et al., p. 230part (g)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3



more than 5 years.

If Alpha sells all its Beta stock and distributes the proceeds pro rata to the 3 owners, what is the shareholder-level effect?

Beta has operated business more than 5 years.

Mike Senn

Alpha Corp

Lind et al., p. 230part (h)


1/3

BooksBusiness

CramBusiness

Beta Corp



1/3 1/3


Beta has operated business more than 5 years.

If Alpha liquidates Beta (nontaxable per §332) and distributes Beta’s assets pro rata to the 3 owners, what is the shareholder-level effect?


more than 5 years.

S. Rep. No. 81-237581st 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.


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.



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 ________



Death Taxes: Conditions

• Shares held > __% of adjusted gross estate– Gross estate less ________/administrative

expenses, debts, and ________ 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



Rev. Rul. 87-132



1. Maintain estate’s relative _____ ______ in family business

2. Distribute cash for _____ _____3. Obtain §303 ________ treatment

Objectives

Plan1. Distribute ______ ______ pro

rata to each owner, §305(a)2. Redeem some _______

________ from estate, §303

Corporation X

(E&P)


Estate

50% 50%

A


Unrelated

IssueIs the stock distribution nontaxable given that some shares will be redeemed immediately afterwards as part of a plan?

Rev. Rul. 87-132



1. Stock distribution is ________2. Redemption is a §303

_________

Conclusion

Rationale1. Sec. 303(c) treats stock with ________

basis same as original stock and, thus, was enacted with this transaction in mind

2. Sec. 305 applies _________ §303 even though two steps part of one _____

Corporation X

(E&P)


Estate

50% 50%

A


Unrelated

Shareholder issuesBasis of property received

Shareholders

Corporation

Stock Property

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.

Shareholder issuesHolding period of property received

Shareholders

Corporation

Stock Property

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.

Save the Basis!

Shareholders

Corporation

Stock Property

Shareholder issuesBasis of redeemed shares

• 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).

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--

Shareholders

Corporation

Stock Property

(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.(2) Amounts in excess of basis. If the nontaxed portion of such dividends exceeds such basis, such excess shall be treated as gain ….

Shareholder issuesBasis of redeemed shares

Corporate issuesGain 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

Corporation

Stock Property

Corporate issuesE&P impact

Shareholders

Corporation

Stock Property

Section 312(n)(7)

(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.

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)

Corporate issuesE&P impact

Shareholders

Corporation

Stock Property

€

Limit on E & P reduction = E & P x

Constructive Ownership§302(c)(1)

• Consider when determining if redemption treated as _________– Not essentially equivalent to dividend requires

_________ ________ in proportionate interest– Substantially disproportionate requires:

• Post-ownership < __% and• Post-ownership must be < __% of pre-ownership

• Not applicable to _____ ____ redemptions nor ________ ___________

Constructive Ownership§302(c)(2)

• Family ownership rules inapplicable to _______ ________ if:– Shareholder has no ___________ interest in

corporation (including as employee, officer, or director) other than as __________,

– Shareholder acquires no interest in corporation within __ years (other than by ________), and

– Shareholder agrees to ______ IRS of such acquisition and ________ relevant records

Constructive Ownership

• Attribution from– Family– Transparent entities– Corporations

• Attribution to– Transparent entities– Corporations

• Attribution via options

Attribution from Family§318(a)(1)

Constructive ownership

• Individuals constructively own stock owned directly or indirectly by:– _______,– Parents,– Children, and– ____________.

• No re-attribution to another family member

Example: Family Business

C

a. How much does Bob own?

30%

Bob

Bob’s sister

Bob’s granddaughter7%

10%

5%


b. How much does Bob’s sister own?

c. How much does Bob’s father own?

Bob’s father

d. How much does Bob’s granddaughter own?

Example: Family Business

C

a. How much does Ron own?

40%

Ron

Jack(Ron’s Dad)

Nancy(Ron’s Wife)30%

20%

10%


b. How much does Nancy own?

c. How much does Jack own?

d. How much does Maureen own?

Maureen(Ron’s daughter by

prior marriage)

Attribution from Transparent Entity§318(a)(2)(A)

C

PS

Partner

• ____________ attribution• Re-attribution

C

Beneficiary

C

Shareholder

Estate S


Attribution from Corporation§318(a)(2)(C)

• Proportionate attribution only if SH owns ≥ ___%

C2

Shareholder

C1

≥ 50%

• Re-attribution


Examples: Attribution from Rules

C

20%

20%

PS

Partner

C2

Shareholder

C1

20%

70%

C

Beneficiary

Estate

10%

60%


Examples: Attribution from Rules

C

40%

5%

PS

Partner

C2

Shareholder

C1

40%

25%

C2

Shareholder

C1

2%

50%


Example: Ownership Rules

A

B

C

90%

20%

How much of B does Ricardo own?

70% How much of C does Ricardo own?


X

Y

Z

60%

40%

80%

How much of Y does Lucille own?

How much of Z does Lucille own?


How much of C2 does Ricardo own?

How much of C2 does Lucille own?C1

C2

40%

5%80%



How much of C does PS1 own?Directly ownsConstructively owns

How much of C does Ricardo own?

C

30%

20%

PS1

50%

PS240%



B

20%

P/S

80%

A

How much of B does Lucille own?Via P/S:Via A:


60%40%

How much of Z does Ricardo own?Via P/S: Via Y:

Z

20%

P/S

80%

Y

40%60%

Attribution to Transparent Entity§318(a)(3)(A)

CPS

Partner

• ______ attribution• No re-attribution via “attribution ____” rules

Beneficiary Shareholder

Estate S C C


Attribution to Corporation§318(a)(3)(C)

• _____ attribution if SH owns ≥ ___%

Shareholder

C1 C2

≥ 50%

• No re-attribution via “attribution ____” rules


Examples: Attribution to Rules

Shareholder

C1 C2

10%

C PS

Partner

C PS

Partner

Shareholder

C1 C2 C PS

PartnerShareholder

C1 C2

5% 10% 5% 40% 50%

50% 5% 50% 5% 60% 90%



C

50%

20% 30%

PS

70%

How much of C does the P/S own?


Attribution via Options§318(a)(4)


• Any _______ 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

Grandfather(25 shares)

Wham Corporation

(100 shares)

Lind et al., p. 191Problem 1

Mother(20 shares)

Daughter(15 shares)

Adopted Son(10 shares)

Mother’s Cousin(0 shares)

Option to Buy(5 of adopted son’s shares)

Grandmother’s Estate(30 shares)

Grandmother(0 shares)

50% beneficiary50% beneficiary

How much Wham stock does Grandfather own?


Wham Corporation

(100 shares)


Mother(20 shares)

Daughter(15 shares)







How much Wham stock does Mother’s Daughter own?


Wham Corporation

(100 shares)


Mother(20 shares)

Daughter(15 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 _________.

Date post:	23-Feb-2016
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Stock Redemptions Tx 8120

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