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Stock Redemptions Tx 8120. Goals to Achieve 1.Distinguish between stock redemptions and other ______________, 2.Describe consequences of redemptions to.

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Presentation on theme: "Stock Redemptions Tx 8120. Goals to Achieve 1.Distinguish between stock redemptions and other ______________, 2.Describe consequences of redemptions to."— Presentation transcript:

1 Stock Redemptions Tx 8120

2 Goals to Achieve 1.Distinguish between stock redemptions and other ______________, 2.Describe consequences of redemptions to _________ and __________, and 3.Apply _________ ownership rules in analyzing redemptions. You should be able to:

3 Non-Liquidating Distributions Shareholders Corporation Property Shareholders Corporation Stock Shareholders Corporation StockProperty Property DistributionStock DistributionStock 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 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) IssuesCorporation (distributor) Issues

4 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 StockProperty Redemption defined

5 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 StockProperty Reasons for redemptions

6 Corporate Reasons Remove shares from market to fight _______ ________ Take a public company _______ Buyout dissatisfied or ______ shareholder Invest excess funds in self via “___ ____” –Condition: Low _____ price and no better investment opportunities –Result: Fewer outstanding shares and higher ___ Shareholders Corporation StockProperty Reasons for redemptions

7 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 StockProperty Reasons for redemptions

8 Shareholders Corporation StockProperty 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) Reasons for redemptions

9 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 StockProperty Shareholder issues Gain or loss recognized Basics

10 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 Corporation StockProperty Shareholder issues Gain or loss recognized Basics

11 Shareholders May Prefer §301 Shareholders Corporation StockProperty Shareholder issues Gain or loss recognized Basics 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 _____.

12 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 StockProperty Shareholder issues Gain or loss recognized Basics

13 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) $ % Shareholder issues Gain or loss recognized Basics

14 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) $210 70% Minnie 15 DW Shares ($50 basis) 30% Shareholder issues Gain or loss recognized Basics $90

15 Stock Redemption Overview Exchange treatment per §_____ Property distribution per §_____ Redemption per §_____ Shareholders Corporation StockProperty 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 Shareholder issues Gain or loss recognized Basics

16 Harvey StewartCo (E&P $500) 10 shares ($80 basis) $100 How much tax does Harvey pay if the redemption is treated as a property distribution? 30 shares before redemption Example: Impact of Rules Shareholder issues Gain or loss recognized Basics How much tax does Harvey pay if the redemption is treated as an exchange?

17 Section 302(b)(1) (b) Redemptions treated as exchanges. Shareholders Corporation StockProperty (1) Redemptions not equivalent to dividends. Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend. Shareholder issues Gain or loss recognized Not equivalent to dividend

18 Not Essentially Equivalent Shareholders Corporation StockProperty Requires a “_______ ________” in shareholder’s proportionate interest Usually applies to: –_______ _______ “called in” from shareholders owning no common stock and –Redemptions from ________ shareholders Shareholder issues Gain or loss recognized Not equivalent to dividend

19 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

20 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%. Shareholder issues Gain or loss recognized Not equivalent to dividend Held: However, Rev. Rul indicates that day-to-day _________ is the proper touchstone when merger activity is not “__________.”

21 Rev. Rul 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

22 Rev. Rul 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

23 Rev. Rul 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 Not equivalent to dividend

24 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 StockProperty Shareholder issues Gain or loss recognized Substantially disproportionate

25 Section 302(b)(2) (continued) Shareholders Corporation StockProperty (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-- Shareholder issues Gain or loss recognized Substantially disproportionate

26 Section 302(b)(2) (continued) Shareholders Corporation StockProperty [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. Shareholder issues Gain or loss recognized Substantially disproportionate

27 Section 302(b)(2) (continued) Shareholders Corporation StockProperty (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. Shareholder issues Gain or loss recognized Substantially disproportionate

28 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

29 Substantially Disproportionate Shareholders Corporation StockProperty Shareholder issues Gain or loss recognized Substantially disproportionate

30 Rev. Rul 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? Shareholder issues Gain or loss recognized Substantially disproportionate SharesPercentageRedeemedSharesPercentageRedeemedSharesPercentage A1, % B C D ,0311,129919

31 Rev. Rul (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. Shareholder issues Gain or loss recognized Substantially disproportionate SharesPercentageRedeemedSharesPercentageRedeemedSharesPercentage A1, % B C D ,0311,129919

32 Alice Y Corp 100 voting common 200 nonvoting preferred Lind et al., p. 217 Problem 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. Could the redemption be “not essentially equivalent to a dividend” under §302(b)(1)?

33 Alice Y Corp 100 voting common 200 nonvoting preferred 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. 217 Problem 1(b)

34 Alice Y Corp 100 voting common 200 nonvoting preferred 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. 217 Problem 1(c)

35 Alice Y Corp 100 voting common 200 nonvoting preferred Lind et al., p. 217 Problem 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.

36 Rev. Rul Shareholder issues Gain or loss recognized Substantially disproportionate 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. 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? SharesPercentageRedemptionSharesPercentage A’s Voting Common660%3343% Other Voting Common 44 A’s Nonvoting Common30100%273100%

37 Rev. Rul (continued) Shareholder issues Gain or loss recognized Substantially disproportionate SharesPercentageRedemptionSharesPercentage A’s Voting Common660%43% Other Voting Common 4 A’s Nonvoting Common30100%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).

38 Zenz v. Quinlivan (CA-6, 1954) Shareholder issues Gain or loss recognized Substantially disproportionate Corporation (E&P) 100% #1 #2 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 ______. 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.

39 Rev. Rul (Situation 1) Shareholder issues Gain or loss recognized Substantially disproportionate Corporation X (E&P) 25 shares voting common $$$ #1 Owns 50 shares voting common C B 50% A Owns 50 shares voting common

40 Rev. Rul (Situation 1 continued) Shareholder issues Gain or loss recognized Substantially disproportionate Corporation X (E&P) 25 shares voting common $$$ #2 C B 1/3 A Before transfer #2, C owns 25 shares voting common 1/3 $$$ 25 shares voting common Before transfer #2, B owns 50 shares voting common Before transfer #2, A owns 50 shares voting common

41 Rev. Rul (Situation 1 continued) Shareholder issues Gain or loss recognized Substantially disproportionate Focus on Transfer #2Focus on Overall Result Before After A50 shares40% B50 shares40% C25 shares20% Before After A50 shares50% B50 shares50% C

42 Rev. Rul (Situation 2) Shareholder issues Gain or loss recognized Substantially disproportionate Focus on Transfer #2Focus on Overall Result Before After A35 shares35% B35 shares35% C30 shares30% Before After A50 shares50% B50 shares50% 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.

43 Section 302(b)(3) (b) Redemptions treated as exchanges. Shareholders Corporation StockProperty (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. Shareholder issues Gain or loss recognized Termination

44 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 … Shareholder issues Gain or loss recognized Termination

45 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

46 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.

47 Shareholder issues Gain or loss recognized Termination Rev. Rul 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.Son owns stock attributable to Dad under §____, 2.Son acquired stock from Dad within past ___ years, 3.Corporation is not redeeming _____ shares, and 4.A __________ purpose is tax ___________.

48 Shareholder issues Gain or loss recognized Termination Rev. Rul (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.

49 Section 302(b)(4) (b) Redemptions treated as exchanges. Shareholders Corporation StockProperty (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. Shareholder issues Gain or loss recognized Partial liquidation

50 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. Shareholder issues Gain or loss recognized Partial liquidation

51 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 distributed proceeds to shareholders. The government argued for _______ treatment, but the court held the “bona fide ________ in the business” merited __________ treatment. Shareholders Corporation StockProperty Shareholder issues Gain or loss recognized Partial liquidation Reg. § (a)(2) now embodies this “_______ __________” theory.

52 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

53 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

54 Rev. Rul 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? Shareholder issues Gain or loss recognized 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.

55 Mike Senn Alpha Corp Lind et al., p. 252 part (a) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 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

56 Mike Senn Alpha Corp Lind et al., p. 252 part (b) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 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? Diversified Securities Portfolio

57 Mike Senn Alpha Corp Lind et al., p. 252 part (c) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Alpha has operated both businesses 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? Diversified Securities Portfolio

58 Mike Senn Alpha Corp Lind et al., p. 252 part (d) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Alpha has operated both businesses 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? Diversified Securities Portfolio

59 Mike Senn Alpha Corp Lind et al., p. 252 part (e) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Alpha has operated both businesses 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? Diversified Securities Portfolio

60 Mike Senn Alpha Corp Lind et al., p. 252 part (f) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Diversified Securities Portfolio Alpha has operated both businesses 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?

61 Mike Senn Alpha Corp Lind et al., p. 252 part (g) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Diversified Securities Portfolio Alpha has operated both businesses 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.

62 Mike Senn Alpha Corp Lind et al., p. 252 part (h) Pamela (Mike’s wife) 1/3 Books Business Cram Business Beta Corp Beta Processing Business Iris Corp (unrelated to Senns) 1/3 100% Diversified Securities Portfolio 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? Alpha has operated both businesses more than 5 years.

63 S. Rep. No st 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

64 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

65 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

66 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

67 Rev. Rul Shareholder issues Gain or loss recognized Death taxes and expenses 1.Maintain estate’s relative _____ ______ in family business 2.Distribute cash for _____ _____ 3.Obtain §303 ________ treatment Objectives Plan 1.Distribute ______ ______ pro rata to each owner, §305(a) 2.Redeem some _______ ________ from estate, §303 Corporation X (E&P) Owns 150 shares voting common Estate 50% A Owns 150 shares voting common Unrelated Issue Is the stock distribution nontaxable given that some shares will be redeemed immediately afterwards as part of a plan?

68 Rev. Rul Shareholder issues Gain or loss recognized Death taxes and expenses 1.Stock distribution is ________ 2.Redemption is a §303 _________ Conclusion 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 Corporation X (E&P) 50% Unrelated Owns 150 shares voting common EstateA Owns 150 shares voting common

69 Shareholder issues Basis of property received Shareholders Corporation StockProperty 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.

70 Shareholder issues Holding period of property received Shareholders Corporation StockProperty 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.

71 Save the Basis! Shareholders Corporation StockProperty Shareholder issues Basis of redeemed shares When dividends result, shareholders add basis in ________ shares to basis of _________ or constructively-owned shares, Reg. § (c). Before 1986, corporate shareholders could ___ _______ and then _____ ____ E&P as untaxed dividends (via DRD).

72 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 StockProperty (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. Shareholder issues Basis of redeemed shares

73 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 Corporation Stock Property

74 Corporate issues E&P impact Shareholders Corporation StockProperty 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.

75 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 issues E&P impact Shareholders Corporation StockProperty

76 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

77 Constructive Ownership Attribution from –Family –Transparent entities –Corporations Attribution to –Transparent entities –Corporations Attribution via options

78 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

79 Example: Family Business C a. How much does Bob own? 30% Bob Bob’s sister Bob’s granddaughter 7% 10% 5% Constructive ownership 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?

80 Example: Family Business C a. How much does Ron own? 40% Ron Jack (Ron’s Dad) Nancy (Ron’s Wife) 30% 20% 10% Constructive ownership 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)

81 Attribution from Transparent Entity §318(a)(2)(A) C PS Partner ____________ attribution Re-attribution C Beneficiary C Shareholder Estate S Constructive ownership

82 Attribution from Corporation §318(a)(2)(C) Proportionate attribution only if SH owns ≥ ___% C2 Shareholder C1 Re-attribution Constructive ownership

83 Examples: Attribution from Rules C 20% PS Partner C2 Shareholder C1 20% 70% C Beneficiary Estate 10% 60% Constructive ownership

84 Examples: Attribution from Rules C 40% 5% PS Partner C2 Shareholder C1 40% 25% C2 Shareholder C1 2% 50% Constructive ownership

85 Example: Ownership Rules A B C 90% 20% How much of B does Ricardo own? 70% How much of C does Ricardo own? Constructive ownership X Y Z 60% 40% 80% How much of Y does Lucille own? How much of Z does Lucille own? RicardoLucille

86 Example: Ownership Rules How much of C2 does Ricardo own? How much of C2 does Lucille own? C1 C2 40% 5%80% Constructive ownership RicardoLucille

87 Example: Ownership Rules How much of C does PS1 own? How much of C does Ricardo own? C 30% 20% PS1 50% PS2 40% Constructive ownership Ricardo

88 Example: Ownership Rules B 20% P/S 80% A How much of B does Lucille own? Via P/S: Via A: Constructive ownership 60%40% How much of Z does Ricardo own? Via P/S: Via Y: Z 20% P/S 80% Y 40%60% RicardoLucille

89 Attribution to Transparent Entity §318(a)(3)(A) C PS Partner ______ attribution No re-attribution via “attribution ____” rules BeneficiaryShareholder Estate SCC Constructive ownership

90 Attribution to Corporation §318(a)(3)(C) _____ attribution if SH owns ≥ ___% Shareholder C1C2 No re-attribution via “attribution ____” rules Constructive ownership

91 Examples: Attribution to Rules Shareholder C1C2 10% C PS Partner C PS Partner Shareholder C1C2 C PS PartnerShareholder C1C2 5%10%5%40%50% 5%50%5%60%90% Constructive ownership

92 Example: Ownership Rules C 50% 20%30% PS 70% How much of C does the P/S own? Constructive ownership RicardoLucille

93 Attribution via Options §318(a)(4) Constructive ownership 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

94 Grandfather (25 shares) Wham Corporation (100 shares) Lind et al., p. 213 Problem 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% beneficiary How much Wham stock does Grandfather own?

95 Grandfather (25 shares) Wham Corporation (100 shares) Lind et al., p. 213 Problem 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% beneficiary How much Wham stock does Mother’s Daughter own?

96 Grandfather (25 shares) Wham Corporation (100 shares) Lind et al., p. 213 Problem 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% beneficiary How much Wham stock does Grandmother’s Estate own?

97 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 _________.


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