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Stock Redemptions Tx 8120

Stock Redemptions Tx 8120. Goals to Achieve. Distinguish between stock redemptions and other ______________, Describe consequences of redemptions to _________ and __________, and Apply _________ ownership rules in analyzing redemptions. You should be able to:. Non-Liquidating Distributions.

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Stock Redemptions Tx 8120

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  1. Stock RedemptionsTx 8120

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

  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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 78-401 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. 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?

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

  23. Shareholder issues Gain or loss recognized Not equivalent to dividend Rev. Rul. 76-364 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. 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. 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. 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. 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. 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. 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? SharesPercentageRedeemedSharesPercentageRedeemedSharesPercentage A 1,466 72.18% 902 564 564 B 210 210 210 0 C 200 200 200 D 155 155 155 2,031 1,129 919

  31. Shareholder issues Gain or loss recognized Substantially disproportionate 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 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. SharesPercentageRedeemedSharesPercentageRedeemedSharesPercentage A 1,466 72.18% 902 564 564 B 210 210 210 0 C 200 200 200 D 155 155 155 2,031 1,129 919

  32. Lind et al., p. 217Problem 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. 217Problem 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. 217Problem 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. 217Problem 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. 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. SharesPercentage Redemption Shares Percentage A’s Voting Common 6 60% 3 3 43% Other Voting Common 4 4 A’s Nonvoting Common 30 100% 27 3 100% • 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?

  37. Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul. 87-88(continued) SharesPercentage Redemption Shares Percentage A’s Voting Common 6 60% 43% Other Voting Common 4 A’s Nonvoting Common 30 100% 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. 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 ______. #2 #1 100% • 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. Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul. 75-447(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. Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul. 75-447(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. Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul. 75-447(Situation 1 continued) Focus on Transfer #2 Focus on Overall Result BeforeAfter A 50 shares 40% B 50 shares 40% C 25 shares 20% BeforeAfter A 50 shares 50% B 50 shares 50% C

  42. Shareholder issues Gain or loss recognized Substantially disproportionate Rev. Rul. 75-447(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 BeforeAfter A 35 shares 35% B 35 shares 35% C 30 shares 30% BeforeAfter A 50 shares 50% B 50 shares 50% C

  43. 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. 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. 77-293 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. Shareholder issues Gain or loss recognized Termination Rev. Rul. 77-293(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. 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. 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.

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