Problem 247-1

1
Problem 247-1

• Basic Facts Z Corp 100 shares common. All
  parties unrelated. Issue (b)(1).
• A - 28 shares
• B - 25 shares
• C - 23 Shares
• D 24 Shares
• Z redeems 7 of As shares. Prior to redemption,
  A could control with any other single
  shareholder. After, A own 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.)
• 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.
• 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).

2
Problem 247-1

• Basic Facts Z Corp 100 shares common. All
  parties unrelated. Issue (b)(1).
• A - 28 shares
• B - 25 shares
• C - 23 Shares
• D 24 Shares
• 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.

3
Problem 247- 2
Basic Facts Y Corp 100 shares common 100
shares nonvoting preferred, not convertible and
not 306 (no tax avoidance potential) . All
parties unrelated.
Common Preferred
A 40
0 B
20
55 C
25 10
D 15
15 E
0
20 (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?
4
Problem 247- 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.

5
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.
6
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
7
Problem 252

• Basic Facts A Corp has publishing business
  (Books) , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• 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.

8
Problem 252

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• What impact in (a) 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. Here, no
  liquid asset bailout.
• 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.

9
Problem 252

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• Same as (a) but 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).
• Same as (a) but Books distributed to I Corp in
  redemption of all stock. Although cant qualify
  under be partial liquidation provision, qualifies
  under (b)(3) as termination of complete interest.
  Exchange treatment allowed.
• Securities portfolio distributed pro rata in
  redemption. No hope. Not partial liquidation or
  corporate contraction. 301 dividend to all
  shareholders.

10
Problem 252

• Basic Facts A Corp has publishing business
  (Books , bar review course division (Cram),
  all stock of B Corp (beta processing), and
  securities portfolio. A Corp stock owned equal
  shares by M P (H W) and I Corp (unrelated).
• 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.
• 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.

11
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.
12
Problem 255

• Basic Facts X Corp shareholders A B 100
  shares each with 100k basis. X EP 100k
  accumulated from prior years, 50k current year.
  Assume exchange treatment. Consequences to X
  Corp?
• A shares redeemed for land, 250 FMV, 200k basis.
  X has 50k gain on sale, which takes EP to 200k
  (100k 50k 50k). Since half shares redeemed,
  312(n)(7) permits half reduction in EP. Thus,
  remaining EP 100k.
• Same, except adjusted basis in land 300k. Net
  loss of 50k to X, which is not recognized under
  311(a). EP still 150k, half of which is reduced
  per 312(n)(7) because half of stock redeemed.
  Hence 75k EP remains after redemption.

13
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
14
Problem 260
Basic Facts S sole shareholder of T Corp., to
be sold to B where B pay 400k for 80 of stock
and Zenz redemption for 20 _at_ 100k. - 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 Consider 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 for B) with
dividend.
15
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.

16
Corporate Buy-Sell
C Corp
Cash or Property
Constructive dividend
Sells Stock
Shareholder A
Shareholder B
Cross-Purchase Buy-Sell Agreement
17
Problem 266

• 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.

18
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
19
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!


20
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
21
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