Corporate stock redemption: not always black & white.
A common and important transaction in the area of corporate tax practice is the redemption of stock. Such a transaction is entered to either terminate a shareholder's stock interest or to substantially reduce a shareholder's corporate ownership interest. Such a redemption may occur in order to shift control of the corporation or to buy out the interest of one of the shareholders.
Stock redemptions are the reacquisition of stock by the issuing corporation. Thus stock redemptions differ drastically dras·tic
1. Severe or radical in nature; extreme: the drastic measure of amputating the entire leg; drastic social change brought about by the French Revolution.
2. from the normal arm's length arm's length adj. the description of an agreement made by two parties freely and independently of each other, and without some special relationship, such as being a relative, having another deal on the side or one party having complete control of the other. sale of stock by a shareholder. In a normal sale of stock, the shareholder need only look to the stock's basis and the holding period to determine the nature of the income that must be reported. In contrast to the relative ease of determining the tax status of a sale of stock, a redemption of all or part of a shareholder's stock can involve an exceedingly ex·ceed·ing·ly
To an advanced or unusual degree; extremely.
Adv. 1. complex analysis. Many times a redemption can result in the entire proceeds being taxed as dividend income, ordinary income, without regard to the basis of the surrender shares. This treatment should generally be avoided.
The basic rules governing gov·ern
v. gov·erned, gov·ern·ing, gov·erns
1. To make and administer the public policy and affairs of; exercise sovereign authority in.
2. distributions of cash or other property by a corporation to its shareholders are set forth in Section 301 of the Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq. .(1) It states that distributions with respect to stock are taxed as ordinary dividend income to the extent of current and post- post- word element [L.], after; behind.
1. After; later: postpartum.
2. Behind; posterior to: postaxial. 1913 Earnings and Profits. Statutory exceptions are found in Section 302. Four types of redemptions are indicated that will qualify the transaction as a sale, allowing consideration of the stock's basis and permitting capital asset treatment.(2) Three of these four exceptions are applicable if it can be shown that substantial change has occurred in the redeemed re·deem
tr.v. re·deemed, re·deem·ing, re·deems
1. To recover ownership of by paying a specified sum.
2. To pay off (a promissory note, for example).
3. shareholder's ownership interest in the corporation. The application of these three available exceptions is greatly complicated by the constructive ownership rules which come into play in the determination of the shareholder's interest in the corporation both before and after the redemption. It is not sufficient to look at a particular shareholder's ownership interest before and after a redemption to determine whether an exception is met in order to qualify the transaction for exchange treatment.
Attribution Rules Attribution Rules
A set of rules created by Canada Customs and Revenue Agency (CCRA) that prevents investors from transferring assets between family members with the intention of avoiding taxes.
The constructive ownership rules were first added to the Internal Revenue Code in 1954 as Section 318. Prior to their enactment, case law was the only authority that the Internal Revenue Service had to police the area of stock redemptions where abuses were believed to be taking place. A typical transaction which the Service sought to disallow To exclude; reject; deny the force or validity of.
The term disallow is applied to such things as an insurance company's refusal to pay a claim. was the occasional attempt by a taxpayer to avoid dividend treatment by channeling redemptions through related parties or controlled entities. To end this abuse, Congress added the attribution rules to the Code.
Generally, these rules require that shares of stock held by an individual taxpayer are deemed to be constructively owned by a second taxpayer. This type of attribution at·tri·bu·tion
1. The act of attributing, especially the act of establishing a particular person as the creator of a work of art.
2. or constructive ownership is commonly referred to as primary attribution. These rules are also applied where the ownership interest attributed to a second taxpayer is attributed to a third taxpayer.
The primary attribution rules of Section 318 include five categories of relationships. They are: 1. Members of a family 2. Partners and partnerships 3. Estates and beneficiaries 4. Trusts and beneficiaries 5. Corporations and shareholders
Section 318 first considers attribution among family members. Section 318(a)(1) states an individual shall be considered as owning the stock owned, directly or indirectly, by or for his: 1. Spouse spouse A legal marriage partner as defined by state law ; 2. Children; 3. Grandchildren GRANDCHILDREN, domestic relations. The children of one's children. Sometimes these may claim bequests given in a will to children, though in general they can make no such claim. 6 Co. 16. ; or 4. Parents.
In applying Section 318, there will no attribution between spouses who are legally separated under a decree decree, in law, decision of a suit in a court of equity. It is the counterpart in equity of the judgment in a court of law, although in those jurisdictions where law and equity have merged, judgment is sometimes used to include both. of divorce or a separate maintenance agreement.(3) The definition of children of a taxpayer includes those children who have been legally adopted.(4) An important consideration in light of the frequency of divorce, stepchildren are not viewed as children of the stepparent step·par·ent
A stepfather or stepmother.
Noun 1. stepparent - the spouse of your parent by a subsequent marriage for purposes of Section 318. Thus, there is no attribution from a stepchild step·child
1. A child of one's spouse by a previous union.
2. Something that does not receive appropriate care, respect, or attention: "Demography has a reputation for being the stepchild of . . . to a stepparent, from a child to a grand-stepparent or from a parent to a stepchild. If a stepchild is legally adopted, then Section 318 apply.
Under the family attribution rules, the same shares of stock can be attributed to more than one family member for purposes of determining whether the exceptions of Section 302(b)(1) through (3) apply. Application of this can be found in an example contained in the regulations.(5)
Example. Four individuals actually own shares of stock in a corporation as follows:
Shares actually Individuals owned H 25 W (H's wife) 25 S (H's son) 25 G (H's grandson) 25
After applying the family attribution rules, H, W and S are each deemed to own 100 shares, while G is only considered as owning 50 shares (his own and that of his father).
This example illustrates that, despite the attribution of stock from an individual's grandchild to the individual, the opposite (due to a lack of statutory authorization The right or permission to use a system resource; the process of granting access. See access control. ) is not true. Attribution from or to an individual's brothers, sisters, uncles, aunts, nephews, nieces, cousins or more distant relatives is also not authorized au·thor·ize
tr.v. au·thor·ized, au·thor·iz·ing, au·thor·iz·es
1. To grant authority or power to.
2. To give permission for; sanction: by Section 318. The lack of attribution between particular family members is extremely important when attempting to qualify for the exceptions of Section 302(b)(2).
Application of the family attribution rules can generate adverse and unusual results. By applying these rules, it is possible for a minority shareholder to have his entire holdings redeemed and, immediately after the redemption, be deemed to own the entire 100% of the stock of the corporation.(6) In some circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or , attribution and reattribution of stock is limited by Section 318(a)(5)(C); yet, in other circumstances, the family attribution rules are waived by Section 302(c)(2)(A).
Stock which is considered to be constructively owned by a family member by action of the family attribution rules cannot be reattributed to another family member.(7) If stock is deemed to be owned under another attribution rule, however, the ownership can be reattributed to another family member.(8) In such situations, the stock constructively owned by one family member is considered to be actually owned for purposes of further attribution.
Partners and Partnership
In considering the attribution of stock owned by either a partner or a partnership, the Code considers stock owned, directly or indirectly, by or for a partner to be owned by the partnership;(9) and such stock owned, directly or indirectly, by or for a partnership to be owned by the partners.(10) Attribution between a partner and a partnership operates in a somewhat different manner. A partner is attributed only his proportionate pro·por·tion·ate
Being in due proportion; proportional.
tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates
To make proportionate. share of the stock owned by the partnership. Partnerships, however, are deemed to own 100% of the stock actually or constructively owned by the partners.
Under this two-way attribution, it would seem that a partner could be deemed to own a portion of the stock actually owned by the other partners in the partnership. This was indeed the case when Section 318 was first enacted; however, this sidewise side·wise
adv. & adj.
Adv. 1. sidewise - toward one side; "the car slipped sideways into the ditch"; "leaning sideways"; "a figure moving sidewise in the shadows"
2. attribution or back attribution has been limited. Effective August 31, 1964, Section 318(a)(5)(C) was added to the Code which stated that stock constructively owned by an entity under Section 318(a)(3) shall not be considered as owned under the provisions of Section 318(a)(2).(11) This limitation on sidewise attribution applies to attribution from all entities such as partnerships, estates, trusts and corporations.
Prior to the enactment of this limitation, application of sidewise attribution could be quite harsh.(12) It was necessary for a taxpayer, who was an owner or beneficiary beneficiary
Person or entity (e.g., a charity or estate) that receives a benefit from something (e.g., a trust, life-insurance policy, or contract). A primary beneficiary receives proceeds from a trust or insurance policy before any other. of an entity, to determine whether the other taxpayers involved with the entity owned any stock of the corporation before knowing what the tax effects of a redemption would be. Both primary and sidewise stock attribution can occur even if the partnership is inactive in·ac·tive
1. Not active or tending to be active.
a. Not functioning or operating; out of use: inactive machinery.
b. .(13) The concept of business activity being required prior to application of the attribution rules is not contained in the statute. Mere existence of a partnership relation is sufficient to require sidewise attribution.
In considering attribution from a partnership, the proportionate interest of the partner is the major factor. Although this may be easy to ascertain for most partnerships, complex partnership agreements could cause some problems. Currently, neither the Code nor the regulations have set forth any procedures for this determination. In situations where the profit sharing profit sharing, arrangement by which employees receive, in addition to their wages, a share of the net profits of a business. The purpose is to give them an incentive to increase their output through enhanced morale, less wasteful use of materials, better care of ratios change in accordance Accordance is Bible Study Software for Macintosh developed by OakTree Software, Inc.
As well as a standalone program, it is the base software packaged by Zondervan in their Bible Study suites for Macintosh. to some predetermined pre·de·ter·mine
v. pre·de·ter·mined, pre·de·ter·min·ing, pre·de·ter·mines
1. To determine, decide, or establish in advance: increase in profitability and where losses are shared equally, courts have held that the loss ratio represents the true ownership percent of the partners and such percentage is to be used in attributing stock.(14)
Estate and Beneficiaries
Much like a partnership, stock owned directly or indirectly, by or for an estate is deemed to be owned proportionally pro·por·tion·al
1. Forming a relationship with other parts or quantities; being in proportion.
2. Properly related in size, degree, or other measurable characteristics; corresponding: by the estate's beneficiaries;(15) and such stock owned directly or indirectly, by or for an estate's beneficiaries is considered to be owned by the estate.(16) In this area of attribution, consideration must be given to defining who is a beneficiary of an estate and in determining their respective proportionate interests. The statutes do not define the term beneficiary; however, the regulations define the term beneficiary as any person entitled en·ti·tle
tr.v. en·ti·tled, en·ti·tling, en·ti·tles
1. To give a name or title to.
2. To furnish with a right or claim to something: to receive property from a decedent An individual who has died. The term literally means "one who is dying," but it is commonly used in the law to denote one who has died, particularly someone who has recently passed away. pursuant to a will or the laws of decedent and distribution. The regulations do not consider an individual to be a beneficiary of an estate for purposes of Section 318(a) unless the individual has a direct present interest in the property held by the estate or in the income that is produced by it. If a person has only a remainder interest in an estate, which would entitle en·ti·tle
tr.v. en·ti·tled, en·ti·tling, en·ti·tles
1. To give a name or title to.
2. To furnish with a right or claim to something: him to the property after the death of a life tenant, that person is not considered to be a beneficiary for purposes of Section 318(a) since he has no direct present interest.(17)
Status as a beneficiary of an estate terminates once the property to which he is entitled has been received and when any claims due to having been a beneficiary no longer exist. In addition, there must be only a slight possibility that the estate would need to seek payment or return of property by the beneficiary to satisfy the claims against the estate or administration expenses. Once an individual is no longer considered to be a beneficiary, the stock owned by the individual will not thereafter be considered owned by the estate and, conversely con·verse 1
intr.v. con·versed, con·vers·ing, con·vers·es
1. To engage in a spoken exchange of thoughts, ideas, or feelings; talk. See Synonyms at speak.
2. , the stock owned by the estate will not be considered owned by him.(18)
A specific legatee's beneficiary status terminates when all of his share of the estate's assets are distributed to him. A residuary LEGACY, RESIDUARY. That which is of the remainder of an estate after the payment of all the debts and other legacies. Madd. Ch. P. 284. legatee's status as a beneficiary does not terminate until the estate terminates.(19) This differentiation is based on the residuary legatee RESIDUARY LEGATEE. He to whom the residuum of the estate is devised or bequeathed by will. Roper on Leg. Index, h.t.; Powell Mortg. Index, h.t.; 8 Com. Dig. 444. being entitled only to the remaining assets after the payment of debts, estate and inheritance taxes inheritance tax, assessment made on the portion of an estate received by an individual; it differs from an
estate tax, which is a tax levied on an entire estate before it is distributed to individuals. , administration expenses and the distributions to the specific legatees. The entitlement An individual's right to receive a value or benefit provided by law.
Commonly recognized entitlements are benefits, such as those provided by Social Security or Workers' Compensation. of a residuary legatee cannot be determined until all prior claims have been satisfied.
A residuary interest in an estate is quite different from a remainder interest after a life estate. The residuary interest has a claim to the property left after all of the other claims have been satisfied while a person holding a remainder interest, generally, has a claim only after another beneficiary's life estate has passed. It is exceedingly difficult for the redemption of corporate stock by an estate to qualify for exchange treatment when a residuary beneficiary is a shareholder with any degree of control. Only the formal closing of the estate will terminate his beneficiary status, which many times, is too late to effect the desired redemption.
When a partial distribution of a beneficiary's share of an estate occurs, the beneficiary's interest in an estate is required to be adjusted with each partial distribution.(20) Ownership interest fluctuates with each partial distribution. In the case of redemptions during the administration of an estate, the date of the redemption should be used to determine the proportionate interests of the beneficiaries which exists at that time. Timing of a redemption can easily make the difference between a desired sale treatment and the undesired dividend treatment when the attribution among an estate and its beneficiaries is necessary.
For purposes of applying Section 318(a) to estates, property of a decedent shall be considered owned by his estate if such property is subject to administration for the purpose of paying claims against the estate and expenses of administration not withstanding that, under local law, legal title to such property vests in the decedent's heirs, legatees or devices immediately upon death.(21) For instance, corporate stock owned by an estate would not be attributed to a beneficiary of a life insurance policy on the decedent's life since the insurance proceeds are not subject to administration by the executor executor n. the person appointed to administer the estate of a person who has died leaving a will which nominates that person. Unless there is a valid objection, the judge will appoint the person named in the will to be executor. . The results would be different if, under state law, the executor were entitled to recover a portion of federal estate tax from the life insurance beneficiary.
Some of the adverse consequences of estate and beneficiary attribution have been eliminated by the 1964 amendment to the attribution rules. This Amendment eliminated the attribution from a beneficiary to a trust and then to other beneficiaries. Prior to its enactment, two unrelated individuals could suddenly find themselves constructively owning the share of another merely by both being beneficiaries of a given estate. Again, this potentially disastrous possibility has been eliminated.
Trusts and Beneficiaries
Attribution of stock when trusts and beneficiaries are involved is somewhat different than the constructive ownership rules previously discussed. There are three significant differences.
First, the attribution from a trust is not based simply on one's proportionate interest in a trust, but on one's proportionate actuarial ac·tu·ar·y
n. pl. ac·tu·ar·ies
A statistician who computes insurance risks and premiums.
Second, when dealing with trusts there is attribution to a holder of a remainder interest. This is different from the estate attribution where there is no attribution to someone holding only a residuary interest.
Third, there is no attribution from a beneficiary to a trust if the beneficiary's interest is considered both remote and contingent.(22)
Basically, the attribution from a beneficiary to a trust is the same as a partner's attribution to a partnership or a beneficiary attribution to an estate. The stock owned directly or indirectly by a beneficiary is considered to be owned by the trust.(23) However, if the beneficiary's interest in the trust is considered to be both remote and contingent no attribution will be required from the beneficiary to the trust.
A remote interest is defined by statute which states that a contingent interest contingent interest n. an interest in real property which, according to the deed (or a will or trust), a party will receive only if a certain event occurs or certain circumstances happen. of a beneficiary in a trust shall be considered to be remote if, under the maximum exercise of discretion by the trustee in favor of upon the side of; favorable to; for the advantage of.
See also: favor such beneficiary, the value of such interest, computed actuarially, is 5% or less of the value of the trust property.(24) The term "contingent" is, however, not so clearly defined. The Service has ruled that, for the sole purpose of Section 318(a)(3)(B)(i), a beneficiary's interest in a trust is contingent if it is conditioned on survivorship survivorship n. the right to receive full title or ownership due to having survived another person. Survivorship is particularly applied to persons owning real property or other assets, such as bank accounts or stocks, in "joint tenancy. without regard to whether survivorship is a condition precedent condition precedent n. 1) in a contract, an event which must take place before a party to a contract must perform or do their part. 2) in a deed to real property, an event which has to occur before the title (or other right) to the property will actually be in the or subsequent.(25)
When a life tenant of a trust has the power of appointment over the trust's assets, it is not clear who the remainder beneficiaries will be. The Service has ruled on this issue only in the case of a family trust. Where a surviving spouse is the income beneficiary Income beneficiary
One who receives income from a trust. of a trust and also holds a power of appointment over the corpus of the trust which would pass to the children of the surviving spouse if the power of appointment is not exercised, attribution will be determined as if the surviving spouse exercised the power in favor of the children. Thus, the children will be considered beneficiaries in the absence of evidence that the power has been differently exercised.(26) Despite this ruling, it is not clear how the attribution rules would operate given different circumstances.
Concerning grantor trusts Grantor trust
A mechanism of issuing MBS wherein the mortgages' collateral is deposited with a trustee under a custodial or trust agreement. , the Code states that a grantor An individual who conveys or transfers ownership of property.
In real property law, an individual who sells land is known as the grantor.
grantor n. who is taxed on trust income because he is considered the owner of part of a trust will be considered as owning the stock of the trust in proportion to his considered ownership. Attribution from the grantor to the trust is spelled out in the Code. The stock owned by the grantor will be attributed to the trust. (Since the grantor is required to recognize part of the trust income, he is considered as owning part of the trust.(27))
An additional consideration in the attribution rules applying to trusts and beneficiaries is that a beneficiary can effectively renounce TO RENOUNCE. To give up a right; for example, an executor may renounce the right of administering the estate of the testator; a widow the right to administer to her intestate husband's estate.
2. his interest in a trust. If a renunciation The Abandonment of a right; repudiation; rejection.
The renunciation of a right, power, or privilege involves a total divestment thereof; the right, power, or privilege cannot be transferred to anyone else. is effective, attribution between the trust and the beneficiary will be not be required. In order to be an effective renunciation, the beneficiary must be of the entire interest in a trust which is irrevocable Unable to cancel or recall; that which is unalterable or irreversible.
IRREVOCABLE. That which cannot be revoked.
2. A will may at all times be revoked by the same person who made it, he having a disposing mind; but the moment the testator is ; and valid and binding under local law.(28)
Corporations and Shareholders
Attribution between a corporation and its shareholders is restrictive. Before any attribution will occur a 50% or more ownership test must be satisfied. If satisfied, then the proportionate ownership rules apply. The stock which will be attributed to a shareholder is any stock owned, directly or indirectly, by or for such corporation. Such attribution will be in that proportion of the value of the stock the shareholder bears to the value of all the stock in corporation.(29) Attribution from shareholders to the corporation is necessary if 50% or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person; such corporation is considered as owning the stock owned, directly or indirectly, by or for such person.(30) The 50% test is based on value, not the number of shares owned.
Use of the value of the stock has created many more problems than the number of shares restriction. For instance, a corporation with different classes of stock can have different voting rights Voting rights
The right to vote on matters that are put to a vote of security holders. For example the right to vote for directors.
The type of voting and the amount of control held by the owners of a class of stock. for each class, different dividend rights for each class and even different liquidation rights Liquidation rights
The rights of a firm's securityholders in the event the firm liquidates. for each class of stock which pose unique valuation problems. Even a corporation with only one class of stock can generate problems using this valuation concept if some of the stock has special restrictions placed upon it.(31) Such restrictions may have a major depressing effect on the value of the stock if it reduces the ability to sell freely the stock.
Other questions have developed in the attribution of stock between a corporation and its shareholders. First, it would seem possible that a corporation could be deemed to own its own stock due to the attribution rules. This result is eliminated by regulation.(32) A second question which may arise is how to handle a situation where the corporation has an option to purchase its own stock. Again, the Service has ruled that the corporation will not be considered the owner of its own stock.(33) The Service held that, since the corporation does not acquire voting or other rights as a shareholder by acquiring its own stock through exercise of an option, it is not considered, under Section 318(a)(4), to be the owner of the stock.
S Corporations and Their
Prior to 1984, the attributions required between an S corporation and its shareholders were exactly the same as the C corporation rules. After the passage of the Tax Reform Act of 1984, the attribution of stock to or from an S corporation and its shareholders would apply in the same manner as if the S corporation and shareholders were a partnership and partners. Thus, attribution will occur to and from shareholders owning less than 50% of the corporation's stock.(34)
Options to Acquire Stock
Section 318(a)(4) requires that if a person has an option to acquire stock, such stock shall be considered as owned by such person. Under this provision, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire stock.
There has been some disagreement in this area, primarily whether the option attribution rule should be applied only to options on stock that is issued and outstanding or also to options to acquire unissued treasury stock. The Tax Court ruled that unissued treasury stock was to be considered for purposes of option attribution.(35) This position was not universally accepted. In Bloch Bloch , Konrad Emil 1912-2000.
German-born American biochemist. He shared a 1964 Nobel Prize for research on cholesterol and fatty acid metabolism. , the court was reluctant to follow the Sorem decision since it seemed that it is highly questionable that treasury stock might be issued.(36)
A third court held that the option attribution rule should apply only to the options held by the shareholders who are actually redeeming re·deem
tr.v. re·deemed, re·deem·ing, re·deems
1. To recover ownership of by paying a specified sum.
2. To pay off (a promissory note, for example).
3. their shares.(37) The Service stated their agreement with the Friend decision in Revenue Ruling 68-601.(38) In this ruling, the Service held that stock should be considered issued for redemption purposes on a shareholder by shareholder basis without regard to the rights of unrelated shareholders to acquire unissued stock unissued stock n. a corporation's shares of stock which are authorized by its articles of incorporation, but have never been issued (sold) to anyone. They differ from "treasury stock," which is stock that was issued and then reacquired by the corporation. . In addition, the Service held that it would not follow the Sorem decision in this matter.
Problems have arisen in the area of defining what the term option includes. Neither the Internal Revenue Code nor the Regulations actually define the term. The Service has issued a number of rulings, which help define this term. Warrants and convertible debentures Convertible Debenture
Any type of debenture that can be converted into some other security.
For example, a convertible bond can be converted into stock. are to be considered options when the holder of such instruments have the right to obtain the stock at his election. In such circumstances, warrants and convertible debentures are not realistically different from options as referred to in Section 318(a)(4).(39)
In each instance, stock may be acquired at the election of the shareholder if no contingencies Contingencies (ISSN 1048-9851) is the bimonthly magazine of the American Academy of Actuaries, providing a large and diverse readership with general interest and technical articles on a wide range of issues related to the actuarial profession. exist with respect to such election. A delay in the right to exercise an option does not prevent the option from constituting an option for purposes of Section 318(a)(4) since the taxpayer can eventually convert the option to stock.(40) This ruling clarifies the phase "at the election of the shareholder" to distinguish between situations where the option holder has a unilateral unilateral /uni·lat·er·al/ (-lat´er-al) affecting only one side.
On, having, or confined to only one side. right to acquire stock from those where there is a bilateral contract An agreement formed by an exchange of a promise in which the promise of one party is consideration supporting the promise of the other party.
A bilateral contract is distinguishable from a unilateral contract, a promise made by one party in exchange for the performance of .
Thus, the right to obtain stock at the shareholder's election without contingencies appears to be the controlling factor. Where the option holder has a right to obtain stock which is contingent only on the passage of time, such an option will be considered an option. At the same time, the Service has ruled that holders of warrants to acquire corporate stock, which are exercisable only if the corporation issues additional stock, are not considered to own the stock represented by the warrants.(41)
Similarly, the Service held that when a shareholder wishes to sell his stock, the shareholder was required to offer first to the corporation and then to the non-selling shareholders; then only, does the agreement not constitute a stock option.(42) Since the issuing corporation had the right of first refusal Right of First Refusal
In general, the right of a person or company to purchase something before the offering is made available to others.
For example, a football team may have the right of first refusal on a player's contract. , the Service found that the purchasing shareholder could not by election cause the sale of stock.
Although these letter rulings do not have the the force of the Revenue Rulings preceding them, the letter rulings do illustrate that the logic used by the Service to make these determinations is consistent. The power to acquire the stock must be at the shareholder's discretion and not subject to any contingencies.
Interaction of Primary
Stock that is deemed to be held by a taxpayer is often reattributed from the constructive owner to a third party. This reattribution is commonly called secondary attribution. In effect, secondary attribution links together two or more primary attribution rules. For reattribution to occur, the stock constructively owned by a taxpayer must be considered as actually being owned by the taxpayer. Under this assumption, the attribution - reattribution cycle is potentially endless. Important exceptions to this cycle are provided by Section 318(a)(5)(B) and (C).
Under Section 318(a)(5)(B), the stock constructively owned by an individual by reason of the application of the family attribution rules is not be considered as owned by him in order to make another individual the constructive owner of the stock. When considering the family attribution rules, it is important to note that the option rule has priority. Operationally, Code Section 318(a)(5)(D) states that when a stock can be owned either by means of the option rule or the family attribution rule, the option rule will control. Thus, stock considered owned by action of the option rules can then be reattributed to other family members.
Example. Three individuals own the following shares of stock:
Individual Shares Actually Owned F 25 (F also holds an option to acquire S's 75 shares) S (F's Son) 75 D (F's Daughter) 0 GD (D's Daughter) 0
After applying the attribution rules, F is deemed to own the stock that he has option to acquire and is therefore deemed to own S's 75 shares. Although these 75 shares could be attributed from S to F under the family attribution rules, the attribution occurs under the option rules.
The family attribution rules follow by attributing F's 25 shares to S and D. The shares of S deemed to be owned by F can also be reattributed to D under the family rules, and D is deemed to own an additional 75 shares actually owned by S. The 100 shares deemed to be owned by D cannot be reattributed from her to her daughter. This would involve a double family attribution from F to D to her child, in effect treating the granddaughter as owning the grandfather's shares.
In the case where a complete termination of an individual's interest would be accomplished by means of a redemption in the absence of the family attribution rules, these rules will not be applied under Section 302(c)(2)(A). In order for the family attribution rules to be waived, the individual must not have an interest in a corporation as an officer, director, employee, or otherwise, except for an interest as a creditor An individual to whom an obligation is owed because he or she has given something of value in exchange. One who may legally demand and receive money, either through the fulfillment of a contract or due to injury sustained as a result of another's Negligence immediately after the redemption. Such an interest may not be acquired any such interest during the ten year period after the redemption.
Sidewise attribution is limited by Section 318(a)(5)(C). It provides that stock constructively owned by a partnership, estate or trust by attribution from a partner, beneficiary or shareholder is not considered as owned by the entity for purposes of attributing the stock to another partner, beneficiary or shareholder. In addition, a corporation will not be considered the owner of its own stock.(43) Thus, no reattribution of such stock can occur.
Section 318 has greatly complicated stock redemptions, but it has greatly reduced the abuse of stock redemptions. Under Section 318, the required computations of ownership percentages both before and after a redemption can be quite complex. Yet such computations must be made in order to determine the tax consequences of the stock redemption. In making the computations both primary and secondary attribution must be considered. A complete analysis of the shareholder's and his family's interests in partnerships, estates, trusts and corporations and these entities' stock ownership must be undertaken before a redemption is recommended, for the potential adverse tax consequences can be very disastrous.
(1) All section references are to the Internal Revenue Code sections unless otherwise noted. (2) While the Tax Reform Act of 1986 removed the preferential pref·er·en·tial
1. Of, relating to, or giving advantage or preference: preferential treatment.
2. tax treatment previously given to long-term capital gains Long-term capital gain
A profit on the sale of a security or mutual fund share that has been held for more than one year. , there are still situations in which it is preferable to generate long-term capital gains instead of ordinary income. (3) Section 318(a)(l)(A)(i). (4) Section 318(a)(l)(B). (5) Regulation Section 1.318-2(b). (6) See, Levin lev·in
[Middle English levene, levin; see leuk- in Indo-European roots.] v. Commissioner, 385 F.2d 521 (2nd Cir., 1967), aff g 47 TC 258 (1966). (7) Section 318(a)(5)(B) and Regulation Section 1.318-2. (8) Section 318(a)(5)(B); and see Lewis v. Commissioner, 35 TC 71 (1960). (9) Section 318(a)(3)(A). (10) Section 318(a)(2)(A). (11) Public Law 88-554, Section 5(a)., 78 Stat. 762 (Aug. 31, 1964). (12) See, Baker Commodities, Inc. v. Commissioner, 415 F.2d 519 (2d Cir., 1969), aff g 48 TC 374 (1968), cert (Computer Emergency Response Team) A group of people in an organization who coordinate their response to breaches of security or other computer emergencies such as breakdowns and disasters. . den. 397 U.S. 988 (1970). This case involved a redemption that occurred prior to 1964. The taxpayers, however, claimed that the 1964 amendment illustrated the "true" intent of Congress not to require sidewise attribution. The courts found that since the transaction occurred prior to the amendment and Congress made the amendment prospective, attribution was required. (13) See, Sorem v. Commissioner, 40 TC 206 (1963), rev'd on other grounds, 334 F.2d 275 (10th Cir., 1964). (14) For example, see Bloch v. U.S., 386 F.2d (5th Cir., 1968), aff g per curiam [Latin, By the court.] A phrase used to distinguish an opinion of the whole court from an opinion written by any one judge.
Sometimes per curiam signifies an opinion written by the chief justice or presiding judge; it can also refer to a brief oral announcement 261 F. Supp. 597 (D.C. Tex., 1967). (15) Section 318(a)(2)(A). (16) Section 318(a)(3)(A). (17) Regulation Section 1.318-3(a). The origin of this interpretation appears to be Steuben Securities Corporation v. Commissioner, 1 TC 395 (1943). (18) Regulation Section 1.318-3(a); and pertaining per·tain
intr.v. per·tained, per·tain·ing, per·tains
1. To have reference; relate: evidence that pertains to the accident.
2. to the remote possibility of seeking payment for expenses has been the subject of litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute.
When a person begins a civil lawsuit, the person enters into a process called litigation. , for example, see Weber Weber, river, United States
Weber (wē`bər), river, c.125 mi (200 km) long, rising in the Uinta Mts., N central Utah, and flowing north and northwest to join the Ogden River at Ogden. The combined stream flows to the Great Salt Lake. v. U.S., 404 F.2d 411 (6th Cir., 1968), aff g 263 F. Supp. 703 (D.C.-Ky, 1967). A different result was reached in Wieskopf v. Commissioner, 77 TC 135 (1981) since the beneficiaries had a court approved tax apportionment The process by which legislative seats are distributed among units entitled to representation; determination of the number of representatives that a state, county, or other subdivision may send to a legislative body. The U.S. agreement which fixed their share of the death taxes. (19) Revenue Ruling 60-18, 1960-1 C.B. 58. (20) Revenue Ruling 58-111, 1958-1 C.B. 173. (21) Regulation Section 1.318-3(a). (22) Section 318(a)(3)(B). (23) Section 318(a)(3)(B)(i). (24) Section 318(a)(3)(B)(i). (25) Revenue Ruling 76-213, 1976-1 C.B. 92. (26) Revenue Procedure 77-37, 1977-2 C.B. 568. (27) Section 318(a)(3)(B)(ii). (28) Revenue Ruling 71-211, 1971-1 C.B. 173. (29) Section 318(a)(2)(C). (30) Section 318(a)(3)(C). (31) U.S. v. Parker, 367 F.2d 402 (5th Cir., 1967), aff g 242 F. Supp.117 (DC-LA, 1965). (32) Regulation Section 1.318-1(b)(1). (33) Revenue Ruling 69-562, 1969-2 C.B. 47. (34) Section 318(a)(5)(E). (35) Sorem v. Commissioner, 40 TC 206 (1963), rev'd on other grounds, 334 F.2d 275 (10th Cir., 1964). See also Patterson Patterson, family of American journalists.
Robert Wilson Patterson, 1850–1910, b. Chicago, grad. Williams, 1871, became (1871) a reporter on the Chicago Times and after 1873 was attached to the Chicago Tribune. v. U.S. 729 F.2d 1089 (6th Cir., 1984). (36) Supra A relational DBMS from Cincom Systems, Inc., Cincinnati, OH (www.cincom.com) that runs on IBM mainframes and VAXs. It includes a query language and a program that automates the database design process. , note 14. (37) Friend v. U.S., 345 F.2d 761 (1st Cir., (1965), aff g 226 F. Supp. 814 (DC-MASS., 1964). (38) Revenue Ruling 68-601, 1968-2 C.B. 124. (39) Revenue Ruling 68-601, Supra note 38. (40) Revenue Ruling 89-64, 1989-1 C.B., 91. (41) Private Letter Ruling 8936016. (42) Private Letter Ruling 8106008. (43) Supra, note 33.
Robert M. Kozub, DBA, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , is an associate professor of taxation in the School of Business Administration at the University of Wisconsin-Milwaukee. He has authored more than 50 articles on accounting and taxation in numerous professional accounting journals.
Jill M. West is a graduate student in the Masters of Science in Taxation Program in the School of Business Administration at the University of Wisconsin-Milwaukee.