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Stock Redemptions Tx 8120.

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Presentation on theme: "Stock Redemptions Tx 8120."— Presentation transcript:

1 Stock Redemptions Tx 8120

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

3 Non-Liquidating Distributions
Property Distribution Stock Distribution Stock Redemption Shareholders Shareholders Shareholders Property Stock Stock Property Corporation Corporation Corporation Shareholder (distributee) Issues Corporation (distributor) Issues 1. How much gain or loss do shareholders recognize? 2. What basis do shareholders take in property received? 3. When does the holding period begin in property received? 4. When dividends result, what happens to the basis of redeemed shares? 1. How much gain or loss does the corporation recognize? 2. How is the corporation’s E&P affected?

4 Section 317(b) (b) Redemption of stock.
Redemption defined Section 317(b) (b) Redemption of stock. For purposes of this part, stock shall be treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock. Shareholders Stock Property Corporation

5 Shareholder Reasons Shareholder may “cash out” to:
Reasons for redemptions Shareholder Reasons Shareholder may “cash out” to: Pursue other investment opportunities, Shift _____ to family members, ______, or Pay ______ expenses and death taxes. Shareholder cannot sell shares since: Market for closely-held stock is ____, Shares are _____________, or Corporation has right of first _______. Shareholders Stock Property Corporation

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

7 Corporate Reasons (continued)
Reasons for redemptions Corporate Reasons (continued) _________ features often facilitate redemption strategies of public companies. In ______-______ businesses, corporations often have right to redeem departing or deceased shareholders’ stock. Shareholders Stock Property Corporation

8 Corporate Reasons (continued)
Reasons for redemptions Corporate Reasons (continued) In a “________ acquisition,” third party wishes to buy shareholder out but lacks sufficient cash. Corporation redeems part of shareholder’s stock to help _______ the buy out and Third party buys shareholder’s _________ shares. Shareholders Stock Property Corporation

9 Section 302(a) (a) General rule.
Shareholder issues Gain or loss recognized Basics Section 302(a) (a) General rule. If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock. Shareholders Stock Property Corporation

10 Shareholder issues Gain or loss recognized Basics Section 267 (a) In general. (1) Deduction for losses disallowed. No deduction shall be allowed in respect of any loss from the sale or exchange of property … between [related] persons …. (b) Relationships. The persons referred to in subsection (a) are: (2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; (3) Two corporations which are members of the same controlled group … Shareholder Stock Property Corporation

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

12 Section 302(d) (d) Redemptions treated as distributions of property.
Shareholder issues Gain or loss recognized Basics Section 302(d) (d) Redemptions treated as distributions of property. Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301 applies. Shareholders Stock Property Corporation

13 Example: Sole Shareholder
Shareholder issues Gain or loss recognized Basics Example: Sole Shareholder Mickey 100% DW Shares ($30 basis) $100 DW Corp (E&P $300) Assuming Mickey retains some DW shares, how do you think Mickey should treat this transaction?

14 Example: Two Shareholders
Shareholder issues Gain or loss recognized Basics Example: Two Shareholders Assuming simultaneous redemptions, how do you think Mickey and Minnie should treat this transaction? Mickey 70% 35 DW Shares ($140 basis) $210 DW Corp (E&P $300) 15 DW Shares ($50 basis) $90 30% Minnie

15 Stock Redemption Overview
Shareholder issues Gain or loss recognized Basics Stock Redemption Overview Shareholder recognizes capital gain (or loss unless §___ disallows) Not essentially equivalent to dividend Substantially disproportionate Termination of holding Partial liquidation Death taxes and related expenses Exchange treatment per §_____ Redemption per §_____ Property distribution per §_____ Shareholders Stock Property Corporation Dividend to extent of E&P, then return of capital, then capital gain

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

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

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

19 Shareholder issues Gain or loss recognized Not equivalent to dividend US v. Davis (S.Ct., 1970) Under §302(b)(1), _______ purpose and whether a tax ________ motive exists are irrelevant. “[T]o qualify for preferred [exchange] treatment …, a redemption must result in a ______ _________ of the shareholder’s proportionate interest …. Clearly, taxpayer here, who (after application of the attribution rules) was the sole shareholder … both before and after the redemption, did not qualify under this test.”

20 Shareholder issues Gain or loss recognized Not equivalent to dividend Wright v. US (CA-8, 1973) Under state law, a ______ majority (> 50%) controls a corporation’s day-to-day activities through the board of directors. However, approving a merger or changing the articles of incorporation requires a ______ majority (67%). Following a redemption, the shareholder’s voting power dropped from 85% to 62%. Held: However, Rev. Rul indicates that day-to-day _________ is the proper touchstone when merger activity is not “__________.”

21 Shareholder issues Gain or loss recognized Not equivalent to dividend 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?

22 Shareholder issues Gain or loss recognized Not equivalent to dividend 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?

23 Shareholder issues Gain or loss recognized Not equivalent to dividend 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?

24 Section 302(b)(2) (b) Redemptions treated as exchanges.
Shareholder issues Gain or loss recognized Substantially disproportionate Section 302(b)(2) (b) Redemptions treated as exchanges. (2) Substantially disproportionate redemption of stock. (A) In general. Subsection (a) shall apply if the distribution is substantially disproportionate with respect to the shareholder. (B) Limitation. This paragraph shall not apply unless immediately after the redemption the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote. Shareholders Stock Property Corporation

25 Section 302(b)(2) (continued)
Shareholder issues Gain or loss recognized Substantially disproportionate Section 302(b)(2) (continued) (C) Definitions. … [T]he distribution is substantially disproportionate if-- (i) the ratio which the voting stock of the corporation owned by the shareholder immediately after the redemption bears to all the voting stock of the corporation at such time, is less than 80 percent of-- (ii) the ratio which the voting stock of the corporation owned by the shareholder immediately before the redemption bears to all of the voting stock of the corporation at such time. Shareholders Stock Property Corporation

26 Section 302(b)(2) (continued)
Shareholder issues Gain or loss recognized Substantially disproportionate Section 302(b)(2) (continued) [N]o distribution shall be treated as substantially disproportionate unless the shareholder’s ownership of the common stock of the corporation (whether voting or nonvoting) after and before the redemption also meets the 80 percent requirement …. [I]f there is more than one class of common stock, the determinations shall be made by reference to fair market value. Shareholders Stock Property Corporation

27 Section 302(b)(2) (continued)
Shareholder issues Gain or loss recognized Substantially disproportionate Section 302(b)(2) (continued) (D) Series of redemptions. This paragraph shall not apply to any redemption made pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substantially disproportionate with respect to the shareholder. Shareholders Stock Property Corporation

28 Shareholder issues Gain or loss recognized Substantially disproportionate Example: Voting Power Corp issued class A and class B shares, both with 100 outstanding shares. Class A stock carries sufficient voting power to elect 6 directors. Class B shareholders can elect 4. Henry owns __ class A shares and __ class B shares. What is Henry’s voting power in Corp?

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

30 Shareholder issues Gain or loss recognized Substantially disproportionate 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? Shares Percentage Redeemed Shares Percentage Redeemed Shares Percentage A 1, % B C D 2, ,

31 Shareholder issues Gain or loss recognized Substantially disproportionate 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. Shares Percentage Redeemed Shares Percentage Redeemed Shares Percentage A 1, % B C D 2, ,

32 Lind et al., p. 217 Problem 1(a) Alice Cathy 80 C.S. 100 P.S. 20 C.S. 100 P.S. Y Corp 100 voting common 200 nonvoting preferred If Y Corp redeems 75 of Alice’s preferred shares, is it substantially disproportionate? Could the redemption be “not essentially equivalent to a dividend” under §302(b)(1)?

33 Lind et al., p. 217 Problem 1(b) Alice Cathy 80 C.S. 100 P.S. 20 C.S. 100 P.S. Y Corp 100 voting common 200 nonvoting preferred If Y Corp redeems 75 of Alice’s preferred shares and 60 of her common shares, is it substantially disproportionate?

34 Lind et al., p. 217 Problem 1(c) Alice Cathy 80 C.S. 100 P.S. 20 C.S. 100 P.S. Y Corp 100 voting common 200 nonvoting preferred If Y Corp redeems 75 of Alice’s preferred shares and 70 of her common shares, is it substantially disproportionate?

35 Lind et al., p. 217 Problem 1(d) Alice 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. Y Corp 100 voting common 200 nonvoting preferred

36 Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul 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 Percentage A’s Voting Common 6 60% % Other Voting Common A’s Nonvoting Common % % 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?

37 Rev. Rul. 87-88 (continued) Section 302(b)(2) tripartite requirements:
Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul (continued) Shares Percentage Redemption Shares Percentage A’s Voting Common 6 60% 43% Other Voting Common 4 A’s Nonvoting Common % 100% Section 302(b)(2) tripartite requirements: A owns < __% ______ power after redemption. A owns < ___% ______ power after redemption as he owned before redemption. 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) #1 #2 Holding and Rationale
Shareholder issues Gain or loss recognized Substantially disproportionate Zenz v. Quinlivan (CA-6, 1954) Holding and Rationale Transfer #2 receives ______ treatment. The “circuitous approach” (i.e., tax planning) per se does not result in ______. The initial owner had no continuing interest in the corporation. Thus, transfer #2 resembles a ___ more than a ______. #1 #2 100% Observations: The new owner did not wish to “buy” the ____, a source of future ________. The redemption in transfer #2 removed all ____. An outright sale of all shares to the new owner would yield the same result except that ____ remains. Reversing the order by redeeming the shares first (if treated as ________ transactions) appears to result in __________ to the initial owner. Corporation (E&P)

39 Rev. Rul. 75-447 (Situation 1) #1 $$$ Shareholder issues
Gain or loss recognized Substantially disproportionate Rev. Rul (Situation 1) Owns 50 shares voting common Owns 50 shares voting common A B 50% 50% 25 shares voting common Corporation X (E&P) #1 C $$$

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

41 Rev. Rul. 75-447 (Situation 1 continued)
Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul (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

42 Focus on Overall Result
Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul (Situation 2) Another route to the same result involves: (1) A and B both sell C 15 shares each and (2) X redeems 5 shares from both A and B. Focus on Transfer #2 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

43 Section 302(b)(3) (b) Redemptions treated as exchanges.
Shareholder issues Gain or loss recognized Termination Section 302(b)(3) (b) Redemptions treated as exchanges. (3) Termination of shareholder’s interest. Subsection (a) shall apply if the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder. Shareholders Stock Property Corporation

44 Section 302(c) (c) Constructive ownership of stock.
Shareholder issues Gain or loss recognized Termination Section 302(c) (c) Constructive ownership of stock. (1) In general. Except as provided in paragraph (2) of this subsection, section 318(a) shall apply in determining the ownership of stock for purposes of this section. (2) For determining termination of interest. (A) In the case of a distribution described in subsection (b)(3), section 318(a)(1) shall not apply if-- (i) Immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee), other than an interest as a creditor … Shareholders Stock Property Corporation

45 Shareholder issues Gain or loss recognized Termination Complete Termination Overlaps with substantially disproportionate test but also applies when: ________ _______ is redeemed or Shareholder constructively owns stock via ______ Family attribution ignored if shareholder: Terminates _____ interest (other than ______) and Acquires no interest in __ years except via __________

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: Son owns stock attributable to Dad under §____, Son acquired stock from Dad within past ___ years, Corporation is not redeeming _____ shares, and A __________ purpose is tax ___________.

48 Rev. Rul. 77-293 (continued) Tainted purpose evident when:
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.
Shareholder issues Gain or loss recognized Partial liquidation Section 302(b)(4) (b) Redemptions treated as exchanges. (4) Redemption from noncorporate shareholder in partial liquidation. Subsection (a) shall apply to a distribution if such distribution is-- (A) in redemption of stock held by a shareholder who is not a corporation, and (B) in partial liquidation of the distributing corporation. Shareholders Stock Property Corporation

50 Partial Liquidation §302(e)
Shareholder issues Gain or loss recognized Partial liquidation Partial Liquidation §302(e) Part of liquidation plan adopted in _______ or _________ year and Not essentially equivalent to dividend (________-level test, so ___ ____ okay), which includes distributions related to: Corporation ______ to conduct a business and Corporation _________ to conduct a business. Both terminated and continued businesses must have operated for __ years.

51 Reg. §1.346-1(a)(2) now embodies this “_______ __________” theory.
Shareholder issues Gain or loss recognized Partial liquidation Imler v. CIR (TC, 1948) Reg. § (a)(2) now embodies this “_______ __________” theory. Fire destroyed the top floors of a corporation’s building that had been rented to another company. Rather than rebuilding the floors with insurance proceeds, the corporation distributed proceeds to shareholders. The government argued for _______ treatment, but the court held the “bona fide ________ in the business” merited __________ treatment. Shareholders Stock Property Corporation

52 Estate of Chandler v. CIR (TC, 1954)
Shareholder issues Gain or loss recognized Partial liquidation Estate of Chandler v. CIR (TC, 1954) A family-owned corporation operated a general department store consisting of ladies’ wear, men’s wear, children’s wear, and a bargain basement department. Due to the president and manager’s poor health, the corporation sold its merchandise, furniture and fixtures, and its lease. Then, they opened a ladies’ ready-to-wear shop down the street. Vis-à-vis the department store, the new shop requires __% as much floor space, __% as much fire insurance, and __% of the employees. Since the corporation needs only ____ of its existing capital, it redeems ______ of each shareholders’ stock.

53 Estate of Chandler v. CIR (TC, 1954)
Shareholder issues Gain or loss recognized Partial liquidation Estate of Chandler v. CIR (TC, 1954) The court noted that ________ of business is not sufficient to ensure exchange treatment as a partial liquidation. In this case, the corporation’s _____ _____ existed before contraction and was not due to the downsizing. The capital required for the new ladies’ shop was almost the same as capital the prior department store required. The redemption was ________ __________ to a dividend.

54 Shareholder issues Gain or loss recognized Partial liquidation 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? 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 Lind et al., p. 252 part (a) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 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? Alpha Corp Alpha has operated both businesses more than 5 years. Books Business Cram Business 100% Diversified Securities Portfolio Beta Corp Beta Processing Business In the same transaction, what if no shareholders surrender shares?

56 Lind et al., p. 252 part (b) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 Would the results in part (a) differ if Alpha had acquired Books three years ago in a cash purchase? Alpha Corp Alpha has operated Books (Cram) for 3 (> 5) years. Books Business Cram Business 100% Diversified Securities Portfolio What is Alpha acquired Books three years ago in a tax-free reorganization using its voting stock as payment? Beta Corp Beta Processing Business

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

58 Lind et al., p. 252 part (d) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 If Alpha distributes all assets of Books to Mike in return for all his Alpha shares, what is the shareholder-level effect? Alpha Corp Alpha has operated both businesses more than 5 years. Books Business Cram Business 100% Diversified Securities Portfolio Suppose Alpha did not distribute the assets pursuant to a “plan.” Can Mike still obtain exchange treatment? Beta Corp Beta Processing Business

59 Lind et al., p. 252 part (e) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 If Alpha distributes all assets of Books to Iris Corp in return for all its Alpha shares, what is the shareholder-level effect? Alpha Corp Alpha has operated both businesses more than 5 years. Books Business Cram Business 100% Diversified Securities Portfolio Beta Corp Beta Processing Business

60 Lind et al., p. 252 part (f) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 If Alpha distributes the securities portfolio to its 3 shareholders in return for 20 Alpha shares from each, what is the shareholder-level effect? Alpha Corp Alpha has operated both businesses more than 5 years. Books Business Cram Business 100% Diversified Securities Portfolio Beta Corp Beta Processing Business

61 Lind et al., p. 252 part (g) Iris Corp
(unrelated to Senns) Pamela (Mike’s wife) Mike Senn 1/3 1/3 1/3 If Alpha sells all its Beta stock and distributes the proceeds pro rata to the 3 owners, what is the shareholder-level effect? Alpha Corp Alpha has operated both businesses more than 5 years. Books Business Cram Business 100% Diversified Securities Portfolio Beta Corp Beta has operated business more than 5 years. Beta Processing Business

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

63 S. Rep. No. 81-2375 81st Cong., 2d Sess. (1951) at 54
Shareholder issues Gain or loss recognized Death taxes and expenses 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.

64 Section 303(a) (a) In general.
Shareholder issues Gain or loss recognized Death taxes and expenses Section 303(a) (a) In general. A distribution of property to a shareholder by a corporation in redemption of part or all of the stock of such corporation which … is included in determining the gross estate of a decedent, to the extent that the amount of such distribution does not exceed the sum of-- (1) the estate, inheritance, legacy, and succession taxes … imposed because of such decedent’s death, and (2) the amount of funeral and administration expenses allowable as deductions to the estate … shall be treated as a distribution in full payment in exchange for the stock so redeemed.

65 Death Taxes: Rationale
Shareholder issues Gain or loss recognized Death taxes and expenses Death Taxes: Rationale Typical situation Owner in family business ____ Estate’s shares are ______ portion of estate Payment of _______ taxes and related expenses must come from corporate shares Without exchange treatment Redemption results in ________ or Estate must sell family business to ________

66 Death Taxes: Conditions
Shareholder issues Gain or loss recognized Death taxes and expenses Death Taxes: Conditions Shares held > __% of adjusted gross estate Gross estate less ________/administrative expenses, debts, and casualty losses Value of multiple corporate holdings aggregated (for 35% test) when ≥ __% of each corporation’s value included in estate Exchange treatment limited to ____ taxes plus _____/administrative expenses

67 Rev. Rul. 87-132 Objectives Plan Issue
Shareholder issues Gain or loss recognized Death taxes and expenses Rev. Rul Owns 150 shares voting common Owns 150 shares voting common A Estate Unrelated Objectives Maintain estate’s relative _____ ______ in family business Distribute cash for _____ _____ Obtain §303 ________ treatment 50% 50% Corporation X (E&P) Plan Distribute ______ ______ pro rata to each owner, §305(a) Redeem some _______ ________ from estate, §303 Issue Is the stock distribution nontaxable given that some shares will be redeemed immediately afterwards as part of a plan?

68 Rev. Rul. 87-132 Conclusion Rationale Stock distribution is ________
Shareholder issues Gain or loss recognized Death taxes and expenses Rev. Rul Owns 150 shares voting common Owns 150 shares voting common A Estate Unrelated Conclusion Stock distribution is ________ Redemption is a §303 _________ 50% 50% Corporation X (E&P) Rationale Sec. 305 applies _________ §303 even though two steps part of one _____ Sec. 303(c) treats stock with ________ basis same as original stock and, thus, was enacted with this transaction in mind

69 Shareholder issues Basis of property received Section 301(d) (d) Basis. The basis of property received in a distribution to which subsection (a) applies shall be the fair market value of such property. Shareholders Stock Property Corporation

70 Section 1223(2) For purposes of this subtitle--
Shareholder issues Holding period of property received Section 1223(2) For purposes of this subtitle-- (2) In determining the period for which the taxpayer has held property however acquired there shall be included the period for which such property was held by any other person, if under this chapter such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person. Shareholders Stock Property Corporation

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

72 Section 1059(a) (a) General rule.
Shareholder issues Basis of redeemed shares Section 1059(a) (a) General rule. If any corporation receives any extraordinary dividend with respect to any share of stock and such corporation has not held such stock for more than 2 years before the dividend announcement date-- (1) Reduction in basis. The basis of such corporation in such stock shall be reduced (but not below zero) by the nontaxed portion of such dividends. Shareholders Stock Property Corporation

73 Section 311(b) (b) Distributions of appreciated property.
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), Shareholders then gain shall be recognized to the distributing corporation as if such property were sold to the distributee at its fair market price. Stock Property Corporation

74 Corporate issues E&P impact 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. Shareholders Stock Property Corporation

75 Corporate issues E&P impact Watch E&P For redemptions treated as ______ _______, E&P decreases by greater of FMV or adjusted basis, §312(a)(3), (b)(2). For redemptions treated as exchanges, the decrease in E&P equals lesser of: Greater of ____ or adjusted basis or ____ _____ portion of E&P, §312(n)(7) Shareholders Stock Property Corporation

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 Attribution via options

78 Attribution from Family §318(a)(1)
Constructive ownership Attribution from Family §318(a)(1) Individuals constructively own stock owned directly or indirectly by: _______, Parents, Children, and ____________. No re-attribution to another family member

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

80 Example: Family Business
Constructive ownership Example: Family Business a. How much does Ron own? b. How much does Nancy own? Ron 40% Maureen (Ron’s daughter by prior marriage) Nancy (Ron’s Wife) 10% C 30% 20% c. How much does Jack own? Jack (Ron’s Dad) d. How much does Maureen own?

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

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

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

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

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

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

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

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

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

90 Attribution to Corporation §318(a)(3)(C)
Constructive ownership Attribution to Corporation §318(a)(3)(C) _____ attribution if SH owns ≥ ___% No re-attribution via “attribution ____” rules Shareholder C1 C2

91 Examples: Attribution to Rules
Constructive ownership Examples: Attribution to Rules Partner Shareholder Partner 10% 5% 10% 5% 40% 50% PS PS C C1 C2 C Shareholder Partner Shareholder 50% 5% 50% 5% 60% 90% PS C1 C2 C C1 C2

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

93 Attribution via Options §318(a)(4)
Constructive ownership Attribution via Options §318(a)(4) Any person with an option to buy stock is treated as directly owning the stock. Many planning opportunities Can increase __________ shares Issuing stock options to one shareholder can make it easier for another shareholder to receive a substantially _______________ distribution

94 (5 of adopted son’s shares)
Lind et al., p. 213 Problem 1 Grandfather (25 shares) Grandmother (0 shares) Wham Corporation (100 shares) Mother (20 shares) Option to Buy (5 of adopted son’s shares) Mother’s Cousin (0 shares) 50% beneficiary 50% beneficiary Daughter (15 shares) Adopted Son (10 shares) Grandmother’s Estate (30 shares) How much Wham stock does Grandfather own?

95 (5 of adopted son’s shares)
Lind et al., p Problem 1 Grandfather (25 shares) Grandmother (0 shares) Wham Corporation (100 shares) Mother (20 shares) Option to Buy (5 of adopted son’s shares) Mother’s Cousin (0 shares) 50% beneficiary 50% beneficiary Daughter (15 shares) Adopted Son (10 shares) Grandmother’s Estate (30 shares) How much Wham stock does Mother’s Daughter own?

96 (5 of adopted son’s shares)
Lind et al., p Problem 1 Grandfather (25 shares) Grandmother (0 shares) Wham Corporation (100 shares) Mother (20 shares) Option to Buy (5 of adopted son’s shares) Mother’s Cousin (0 shares) 50% beneficiary 50% beneficiary Daughter (15 shares) Adopted Son (10 shares) Grandmother’s Estate (30 shares) 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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