Category: Corporate Subject: Redemptions Title: Corporate Redemptions, retention of control, escrow arrangements IRC Sections: 302(b)(3) Filename: x1001.html Date produced: 12/96 Copyright 1998, The Tax Resource Group. All rights reserved.
TP wishes to have his stock redeemed in a transaction intended to qualify as a complete redemption of this interest under IRC Section 302(b)(3). The redemption will be accomplished by means of an 8-year installment note. During the first four years of the note, TP will remain employee, officer, and director of X Corporation. During the remaining four years, TP will cease to be an employee but a deferred compensation arrangement as well as a consulting agreement will remain in place. All the parties involved are residents of the state of Michigan. As I understand it, Michigan is not a community property state. The wife of S (i.e., the TP's daughter) has no direct ownership in X. It seems to me that TP's continuing interest in the X would not disturb his ability to utilize IRC Section 302(b)(3). Revenue Ruling 76-524 speaks directly to this issue. It holds that Sec. 302(b)(3) applies to a taxpayer who remained as president and chairman of the board after all his stock (as well as all the stock of parties related to the individual) was redeemed. Such continuing involvement with the affairs of the redeeming corporation would not be permissible if it were necessary to rely on the waiver of the family attribution rules pursuant to IRC Section 302(c)(2). It is my view that the circumstances at hand do not require waiver of the attribution rules. It is true that the constructive ownership rules of Section 318 apply for purposes of applying the redemption rules of Section 302. It is also true that generally one is considered to constructively own stock actually owned by one's family. In this case, the issue is whether TP constructively owns the stock actually owned by S, the son-in-law. It is clear that S's wife (TP's daughter) constructively owns the stock actually owned by her husband (S). The question is then whether this constructively owned stock is then attributed to TP, her father. The answer is no. IRC Section 318(a)(5) provides that stock owned constructively by virtue of the family attribution rule is not considered actually owned for purposes of creating another constructive owner via the family attribution rules. Given that TP will not constructively own any of S's stock, the redemption of TP's entire stock interest completely terminates his stock ownership in X and Section 302(b)(3) applies to the transaction. Collateral Issue I believe you stated that TP's stock will be held in some kind of escrow pending payment of the installment note. Section 3.01(16) of Rev. Proc. 96-3 states the Service will not rule on redemptions in which there is possibility of the taxpayer reacquiring his redeemed stock upon default by the corporation. I wonder, does TP have any rights with respect to the stock while it is in escrow (e.g., the right to vote the stock)? Notwithstanding the IRS no-ruling policy, there are a number of favorable cases. See Lisle v. Comr., 35 T.C.M. 627 (1976) (stock escrowed to secure payment); Lynch v. Comr., 83 T.C. 597 (1984), rev'd on other grounds, 801 F.2d 1176 (9th Cir. 1986) (note secured by pledge of remaining shareholder's stock); Mathis Est. v. Comr., 47 T.C. 248 (1966) acq., 1967-1 C.B. 2 (stock held in escrow); Hoffman v. Comr., 47 T.C. 218 (1966), aff'd per curiam, 391 F.2d 930 (5th Cir. 1968) (pledge of stock as security). |
