The previous lesson considered redemptions not
equivalent to dividends, and disproportionate redemptions.
This lesson continues the examination of section 302,
by covering the final three types of
qualifying redemptions: complete termination redemptions,
redemptions in partial liquidation,
and redemptions by regulated investment companies.
After learning the concepts,
you will apply them to Sunchaser Shakery.
Under Section 302 b3,
a stock redemption qualifies for sale or exchange treatment,
if it is in complete redemption of all of
the stock of the corporation owned by the shareholder.
In other words, the shareholder's entire interests in the corporation is terminated.
Not surprisingly, the stock attribution rules
play an important role in this type of redemption.
For instance, if shares are owned by the redeeming shareholder spouse,
then the redemption does not likely qualify as a complete termination redemption.
However, section 302 c1,
provides that if two conditions are satisfied,
then the family stock attribution rules do not apply to complete termination redemptions.
First, the shareholder does not hold or acquire any interest other than that
of a creditor in the corporation for at least 10 years after the redemption.
This means that the redeeming shareholder cannot be an officer,
director, or employee, et cetera,
for at least 10 years.
Second, the shareholder agrees to notify
the treasury department of any prohibited interest acquired within
the 10-year post redemption period and to retain
all necessary records pertaining to the redemption during this time period.
Such agreement is attached to the tax return
of the shareholder in the year of redemption.
The fourth type of qualifying redemption is a redemption in partial liquidation.
This redemption differs from the others in part
because it is evaluated at the corporate level,
rather than at the shareholder level.
Section 302 b4 stipulates a sale or exchange treatment applies for redemptions of stock,
held by non-corporate shareholders,
if the distribution qualifies as a partial liquidation.
Section 302 e1, defines
a partial liquidation as a distribution that is pursuant to a plan,
occurs within the tax year in which the plan is adopted or the next year,
and is not essentially equivalent to a dividend.
The not essentially equivalent to a dividend requirement is the same concept as before,
except it is determined at the corporate level in this situation.
Thus, any redemption that legitimately
results in a contraction of the corporation's business,
may qualify for sale or exchange treatment as a partial liquidation,
if the redemption is made to a shareholder other than a corporation.
However, determining whether a redemption results in
a corporate contraction or not is highly subjective.
Thus, section 302 e2 provides a safe harbor provision which assures
partial liquidation status if the distribution
consists of the assets of a qualified trader business,
or is attributed to the termination of such trader business.
And immediately after the distribution,
the corporation continues to conduct another qualified trader business.
For purposes of this action,
a trader business is qualified if it has been actively
conducted throughout the five-year period ending on the date of the distribution,
and must not have been acquired by
the distributing corporation in a taxable transaction during that period.
The active trader business that the corporation continues
to conduct must also have a five-year history.
The final type of qualifying stock redemption is
a redemption by certain regulated investment companies.
Section 302 b5 states that sale or
exchange tax treatment shall apply to any distribution and redemption of
stock of a publicly offered regulated investment company
such as a mutual fund or real estate investment trust,
if such redemption satisfies two requirements.
First, the redemption is upon the demand of the shareholder,
and second, the company issues stock which is
only redeemable upon the demand of the shareholder.
While important, we will focus our attention on the other four types of
qualifying redemptions as they are more broadly applicable in practice.
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
