Z

1
Problem 249 -1(a)
Z Corp
Redeem 7 Shrs
D
C
B
A
28 Shrs
25 Shrs
23 Shrs
24 Shrs

• (a) Z redeems 7 of As shares. Prior to
  redemption, A could control with any other single
  shareholder. After, A owns 21 of 93 shares and
  could no longer control with just one. Good case
  for (b)(1). Rev. Rule 76-364 (OK under similar
  facts.)

2
Problem 249 -1(b)
Z Corp
Redeem 5 Shrs
D
C
B
A
28 Shrs
25 Shrs
23 Shrs
24 Shrs
Mother / Daughter

• (b) Z redeems 5 shares from A A and D are
  mother daughter. Before with attribution, A
  owned 52 (52 / 100). After, A own 49.4 (47 /
  95). This loss of control probably enough to get
  under (b)(1) where balance of stock owned only be
  a few (no big dispersion). Rev. Rule 95-502.

LLM Corporate Tax Instructor
Dwight Drake
3
Problem 249 -1(c), (d)
Z Corp
Redeem 5 Shrs
D
C
B
A
28 Shrs
25 Shrs
23 Shrs
24 Shrs
Mother / Daughter

• Z redeems 5 shares from A A and B mother
  daughter. 53 before (53 / 100) and 50.5 after
  (48 / 90), with attribution. No hope under
  (b)(1).
• (d) Same as (c), but A and B not spoken since B
  married outside of faith. Issue Does hostile
  family situation negate family attribution of
  318? IRS has said no. Rev. Rule 80-26. First
  Circuit once allowed, but most have held no. Even
  if attribution negated, still have (b)(1) issue.
  Before redemption, A had 29 shares and could
  control with any one of other three. After
  redemption of 5 shares, could control only with
  B, who she doesnt talk to. Should family
  hostility be issue for (b)(1) purposes? Tax
  Court in Cerone v. Comm, 87 T.C. 1 (1986) said
  yes.

LLM Corporate Tax Instructor
Dwight Drake
4
Problem 249 -2(a), (b)
Y Corp
Redeem 5 Pref
D
C
B
A
E
0 Com, 20 Pref.
15 Com, 15 Pref.
25 Com, 10 Pref.
20 Com, 55 Pref.
40 Com, 0 Pref.

• (a) Y redeems 5 preferred shared from E. (b)(1)
  qualified because E never had any control. Reg.
  1.302-2(a) Rev. Rule 77-426.
• (b) Y redeems all preferred stock. Each
  shareholder analyzed. E qualifies under (b)(3)
  complete redemption. Others technically all fail
  because no change in voting control thus no hope
  under (b)(2) or (b)(1). But is this right as to
  B, who has taken big hit in economic interest
  from 37.5 of all shares to 10?

LLM Corporate Tax Instructor
Dwight Drake
5
Problem 249- 3

• Basic Facts A owns 10 shares common, basis 15k.
• - What is basis impact if 5 shares are redeemed
  in transaction treated as dividend? Basis of
  remaining 5 shares is 15k. Reg 1.302-2(c).
• - What basis impact if all 10 shares redeemed in
  transaction treated as dividend? Would happen
  where (b)(3) not available because family
  attribution waiver not available. Here, basis is
  transferred to shares belonging to others that
  were attributed to A and killed (b)(3). Reg.
  1.302-2(c), Ex 2.

6
302(b)(4) Partial Liquidation Exception
Applies - Only to noncorporate shareholders
- Even thought distribution pro rata and
otherwise flunks (b)(1) (b)(3). - Based on
impact at corporate level not shareholder
level. - Stock held by partnership, estate or
trust deemed help proportional by partners and
beneficiaries. Requirements 302(e) - Not
essentially equivalent to dividend (determined at
corporate level) - Distribution pursuant to a
plan - Distribution occurs in taxable year
plan adopted or following year.
7
Partial Liquidation Not Essentially Equivalent
to Dividend
Safe Harbor - Distribution attributable to
ceasing to conduct qualified trade or business
operated for 5 years and not acquired during 5
yr period in transaction that recognized gain or
loss. - After distribution, corp still
involved in active conduct of qualified trade
or business. Non- Safe Harbor Scenarios -
Tough must show serious contraction of
business. - Example Fire destruction
corporate cutback and all insurance proceeds
distributed. - Bona fide business reason
unrelated to desire to bail out liquid assets -
No hope if plan is to bail out accumulated
investment assets
8
Problem 253-(a)
A Corp Books Cram
Beta
100
Books distributed / Redeem 50 Shrs from each
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (a) A distributes Books (more than 5 yrs owned,
  as is Cram) to shareholders in equal shares and
  redeems 50 shares from each.
• - For M P, qualifies for exchange as
  partial liquidation if pursuant to plan, done
  within year of plan or next year. A Corp must
  continue to operate Cram. Both held 5 yrs. Same
  result if no actual share surrender (just
  reallocate basis to stock). Makes no difference
  if pro rata under (b)(4) partial liquidation
  provision.
• - Partial liquidation provision not
  available to corp shareholder. So I Corp stuck
  with dividend under 301 (pro rata kills any hope
  of other three 302(b) provisions). 243 dividend
  deduction of 70 available, but any redemption
  that is part of partial liquidation requires
  stock basis reduction under 1059.

LLM Corporate Tax Instructor
Dwight Drake
9
Problem 253-(b)
A Corp Books Cram
Beta
100
Books distributed / Redeem 50 Shrs from each
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (b) What impact if Books bought 3 yrs ago for
  cash? Not qualified business because not held 5
  years. All shareholders have 301 dividend.
  Concern is bailing liquid cash through partial
  liquidation. Hence, 5 yr rule. If bought in
  tax-free reorg, would have used stock and could
  qualify if business ran for 5 yrs. No liquid
  asset bailout.

LLM Corporate Tax Instructor
Dwight Drake
10
Problem 253-(c)
A Corp Books Cram
Beta
100
Books destroyed / Half proceeds used in prorata
redemption
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (c) Books destroyed by fire, 1/2 insurance
  proceeds distributed pro rata and other half used
  to scale down book business. I Corp still
  dividend. For P M, not qualify under 302(e)(2)
  because not ceasing business or distributing all
  assets. Could be not essentially equivalent to
  dividend under (e)(1) but need more facts to see
  if it corporate contraction. For ruling
  purposes, IRS requires 20 cut in revenues, FMV
  and employees. Rev. Proc. 2002-3.

LLM Corporate Tax Instructor
Dwight Drake
11
Problem 253-(d)
A Corp Books Cram
Beta
100
Books distributed to M for all stock
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (d) Books distributed to Michael in redemption of
  all his stock. Valid partial liquidation -
  exchange treatment allowed. Also may qualify
  under (b)(3) (family attribution waived) and
  maybe (b)(1) (attribution interest reduced from
  67 to 50).

LLM Corporate Tax Instructor
Dwight Drake
12
Problem 253-(e)
A Corp Books Cram
Beta
100
Books distributed to I Corp for all stock
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (e) Books distributed to I Corp in redemption of
  all stock. Although cant qualify under partial
  liquidation provision, qualifies under (b)(3) as
  termination of complete interest. Exchange
  treatment allowed.

LLM Corporate Tax Instructor
Dwight Drake
13
Problem 253-(f), (g), (h)
A Corp Books Cram
Beta
100
M
P
I Corp
1/3 Com
1/3 Com
1/3 Com

• (f) Securities portfolio distributed pro rata in
  redemption. No hope. Not partial liquidation or
  corporate contraction. 301 dividend to all
  shareholders.
• (g) A sells stock in B Corp and distributes
  proceeds pro rata. Sub corp stock cant qualify
  as partial liquidation per Rev. Rule 79-184.
  Hence, 301 dividend to all shareholders.
• (h) A liquidates B Corp (operated for more than 5
  yrs) and distributes assets in pro rata
  redemption. If liquidated in non-taxable
  transaction under 332 (discussed later in
  course), A picks up all B Corp attributes and may
  qualify as partial liquidation per Rev. Rule
  75-223.

LLM Corporate Tax Instructor
Dwight Drake
14
Redemption Impact on Corp
Three issues - Gain or loss to corp on
distribution of property other than cash. 311
governs the same as it does for non-liquidating
distributions. Gain is always recognized by
corporation, but losses not recognized. - EP
impact. EP reduced by amount of distribution,
but per 312(n)(7) reduction can not exceed
ratable share of EP attributable to redeemed
stock. So if 1/3 stock redeemed, EP before
redemption can not be reduced more than 1/3. -
Stock acquisition expenses paid by corp
(brokerage commissions, legal fees, etc) are not
deductible per Section 162(k). They are treated
as non-amortizable capital expenditures. Amounts
paid that have no nexus to redemption (employment
agreement amount) are deductible and loan costs
and fees involved in redemption may be amortized
over term of loan.
15
Problem 260
100k Acc. EP 100k Cur. EP
X Corp
250k for all As stock
A
B
100 Com 100k Basis
100 Com 100k Basis

• A shares redeemed for 250k cash. Since
  cash, X recognizes no gain or loss on exchange.
  Since half of shares redeemed, 312(n)(7) permits
  half reduction in EP. Thus, EP reduced 100k
  and remaining EP 100k.

LLM Corporate Tax Instructor
Dwight Drake
16
Zenz Bootstrap Acquisitions
Three scenarios all part of common plan
Scenario 1 Shareholder sells some stock and
then has corporation redeem balance of shares.
Qualifies under 302(b)(3) even though corporate E
P distributed to help facilitate acquisition.
Zenz case/ Scenario 2 Corporation sells new
shares to new shareholder and then redeem shares
from existing shareholder. Percentages before
and after both transactions control whether
(b)(2) substantially disproportionate tests
met. Scenario 3 Existing shareholder sell
some shares to new shareholder and then have
corporation redeem shares from existing
shareholder. Percentages before and after both
transactions control whether (b)(2)
substantially disproportionate tests met. Rev.
Rule 75-447
17
Problem 265
T Corp
100k for 20 of Ss stock
Sale 80 for 400k
S
B
100 Com

• Can qualify for exchange treatment as
  complete (b)(3) redemption under Zenz case so
  long as all part of the same plan. Do we care if
  capital gains and dividend rates the same? If
  Ss stock basis over 400k, (b)(3) treatment will
  result is less income. With dividend scenario,
  have 100k dividend and capital loss
• EP implications? If exchange, T Corp EP
  reduced 20, but not over 100k amount distributed
  in redemption. If 301 dividend, EP reduced
  100k. Thus, if EP less than 500k before, may
  get bigger EP reduction (a good thing) with
  dividend.

LLM Corporate Tax Instructor
Dwight Drake
18
Corporate Buy-Sell Agreements

• Most important document in many privately-owned
  businesses
• Determines value and exit opportunities for
  shareholders
• Contain buy-out triggers death, disability,
  bankruptcy, expulsion, etc.
• Many tax issues, including estate tax valuation.
• Often rely on (b)(3) exception for family
  businesses
• Constructive dividend trap
• - Co-shareholders become obligated under
  agreement to buy out a departing shareholder.
  Cross-purchase structure.
• - Corporation then discharges obligation
  of co-shareholders by redeeming stock.
• - Result is constructive dividend to
  co-sharholders.
• - Often screwed-up through bad life
  insurance structuring.

19
Corporate Buy-Sell
C Corp
Cash or Property
Constructive dividend
Sells Stock
Shareholder A
Shareholder B
Cross-Purchase Buy-Sell Agreement
20
Problem 271

• Basic Facts A, B C unrelated equal
  shareholders of Y Corp with cross purchase
  buy-sell. Y Corp owns polices on each
  shareholder. B dies, Y Corp collects policy and
  pays proceeds to redeem B stock.
• Premium payments by Y Corp not deductible per
  264(a)(1).
• Premium payments by Y not dividend to any
  shareholders because Y Corp own policy.
• Insurance proceeds received by Y Corp tax free
  per 101(a). Likely AMT tax trigger.
• Y Corp EP increased by excess of insurance
  proceeds over aggregate premiums paid on policy.
• On payment of insurance proceeds in redemption of
  B stock, A C have constructive dividend
  distribution because their obligation to buy
  shares being satisfied by Y Corp. Defective
  buy-sell planning. 301 dividend to extent of
  EP.

21
Insurance Cross-Purchase
C Corp 15 Million
20
80
Shareholder A 3 mill policy on B
Shareholder B 12 mill policy on A
Cross-Purchase Agreement
22
Insurance Cross-Purschase
A dies - B sells business for 15 million A
family return Payment from B
12 million
Estate Taxes
5 million Net return
7 million
Bs Return Sales Proceeds
15 million
Income Tax
.6 million Net return
14.4 million
A Goes Ballistic!


23
Restructured Insurance Program
C Corp 15 Million
20
80
Shareholder A 3 mill policy on B
Shareholder B
One Leg Cross-Purchase Agreement
Life Ins. Trust 12 mill policy
24
Restructured Insurance Program
A dies - B sells business for 15 million A
family return Payment on sale
12 million
Estate Taxes
5 million Net return on sale
7 million
Tax Free Insurance
12 million Total yield
19
million Bs Return Sales Proceeds
3
million Income Tax
.6 million Net
return
2.4 million