Practical tax planning for sec. 303 stock redemptions.Sec. 303, which permits redemptions of stock owned by estates or beneficiaries to receive capital gain, rather than dividend, treatment, is much more liberal a provision than it initially appears. Sec. 303 actually allows an infusion of cash into an estate or to a 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. and therefore offers a number of planning opportunities. These opportunities and the basic workings of Sec. 303 are addressed in this article's many examples. When should a taxpayer take advantage of the benefits provided by Sec. 303? Sec. 303, distributions in redemption of stock to pay death taxes, allows an estate that owns stock or beneficiaries who inherit To receive property according to the state laws of intestate succession from a decedent who has failed to execute a valid will, or, where the term is applied in a more general sense, to receive the property of a decedent by will. inherit v. stock to redeem redeem v. to buy back, as when an owner who had mortgaged his/her real property pays off the debt. The term also refers to paying the amount due and all charges after a foreclosure (due to failure to make payments when due) has begun. shares with minimal (if any) income tax ramifications ramifications npl → Auswirkungen pl ; such a transaction may be necessary to generate cash to pay certain death taxes and estate expenses. The underlying purpose of Sec. 303 is to help mitigate mit·i·gate v. To moderate in force or intensity. mit  i·ga tion n. the potential cash-flow shortage often associated with estates comprised largely of stock in a closely held A phrase used to describe the ownership, management, and operation of a corporation by a small group of people.In a closely held corporation, the same people often act as shareholders, directors, and officers, and no outside investors exist. or family owned business.(1) Example 1: D's estate consists of $100,000 cash and $750,000 of I corporation stock, while death taxes and estate expenses are $250,000. D's 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. can use Sec. 303 to have the I stock 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. to generate the cash necessary to meet the estate's dosing expenses without significant adverse income tax consequences. In most cases, the cash generated by such a redemption, although limited to the total death taxes and funeral and administration expenses, need not be spent in actual payment of such items. Sec. 303 grants a redemption sale or exchange treatment; thus, any recognized gain Recognized Gain The amount of gain reported for income tax purposes. Notes: You can defer recognizing some gains until the following year(s). See also: Capital Gain, Capital Loss, Deferred Income Tax, Drought Sale, Exempt Income, Exemption, Gain, Recognized Loss or loss is capital rather than ordinary.(2) In addition, under Sec. 1014, because most assets owned by a shareholder at death receive a step up (or step down) in basis to fair market value (FMV FMV - full-motion video ),(3) the redemption will frequently result in no gain or loss to the owner. Example 2: The facts are the same as in Example 1. If $250,000 of I stock is redeemed shortly after D's death at its FMV, the estate realizes no gain or loss ($250,000 amount realized-$250,000 adjusted basis).(4) Individuals often seek to have a stock redemption receive sale or exchange treatment, a preference arising from the basis offset and applicability of the capital gains rate. If an estate owns stock that is not redeemed, it will ultimately be held by the beneficiaries; any subsequent stock redemption not qualifying under Sec. 303 could produce (relatively harsher) dividend treatment. Assuming the beneficiaries could benefit from the receipt of cash, the better result is for the estate to redeem the stock under Sec. 303 (even if the cash is not needed) and distribute it to the beneficiaries. Alternatively, in certain cases, a beneficiary could redeem stock under Sec. 303 after receiving it from the estate. Thus, even though Sec. 303 is designed to help meet an estate's cash-flow needs, the estate need not actually require additional cash for Sec. 303 to be available. Indeed, because of the beneficial results, it can be argued that Sec. 303 should be used even if additional cash is not required in closing the estate. Although Sec. 303 offers a very attractive way for an estate or beneficiaries to receive desired cash with little or no negative income tax effects, three major conditions must be met for Sec. 303 to apply. This article discusses these conditions(5) and considers some important tax planning Tax planning Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. aspects. Sec. 303 Requirements For an estate or beneficiary to use Sec. 303, three conditions must be met: 1. The qualifying redemption cannot exceed the total of certain taxes and expenses incurred by the estate in the normal course of closing its affairs and distributing its assets to the beneficiaries (Sec. 303(a)). 2. The value of the stock subject to the redemption owned by the estate must exceed 35% of the adjusted gross estate (AGE) (Sec. 303(b)(2)(A)). 3. The redemption must occur within one of three specific time frames (Sec. 303(b)(1)). Dollar Limit Under Sec. 303(a), a qualifying redemption cannot exceed the total of certain death taxes and funeral and administration expenses deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). under Sec. 2053(6) As mentioned earlier, the redemption proceeds do not have to be used to pay such taxes and expenses, but instead can be distributed to the beneficiaries. While Sec. 303 is designed to mitigate cash-flow constraints CONSTRAINTS - A language for solving constraints using value inference. ["CONSTRAINTS: A Language for Expressing Almost-Hierarchical Descriptions", G.J. Sussman et al, Artif Intell 14(1):1-39 (Aug 1980)]. typically characteristic of estates holding large blocks of closely held stock, the estate is not required to show that it otherwise could not meet its cash-flow requirements. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. Sec. 303(a)(1), "taxes" include any estate, inheritance inheritance, in law inheritance, in law: see heir. inheritance, in biology inheritance, in biology: see heredity. inheritance Devolution of property on an heir or heirs upon the death of its owner. , legacy and succession taxes paid or to be paid by the estate net of any appropriate credits or discounts. Interest costs are also included to the extent collected as a part of the taxes. Under Regs. Secs. 20.2053-2 and -3, the funeral and administration expenses permitted to be deducted de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. under Sec. 2053 encompass reasonable funeral expenses, executor's commissions, attorney's fees attorney's fee n. the payment for legal services. It can take several forms: 1) hourly charge, 2) flat fee for the performance of a particular service (like $250 to write a will), 3) contingent fee (such as one-third of the gross recovery, and nothing if there is no and other miscellaneous expenses (including court costs court costs n. fees for expenses that the courts pass on to attorneys, who then pass them on to their clients or, in some kinds of cases, to the losing party. , accountant's and appraiser's fees and other expenses related to disposition of the estate's assets). Redemption proceeds exceeding the qualifying taxes and funeral and administration expenses are taxed under Sec. 302.(7) Example 3: Q's AGE includes stock in corporation X with an FMV of $200,000; estate taxes are $100,000 and funeral and administration expenses are $50,000. The maximum redemption qualifying under Sec.303 is $150,000 ($100,000 + $50,000). If the remaining $50,000 of stock is also redeemed, the proceeds are taxed under Sec.302.(8) Ownership Requirements Under Sec. 303(b)(2)(A), the value of the stock subject to redemption owned by the estate must exceed 35% of the AGE: the gross estate less the sum of the amounts allowable as a deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. under Sec. 2053 or 2054. Example 4: Z's AGE is 51,000,000 and includes stock in corporation M valued at $400,000. Because the value of the M stock is 40% of the AGE ($400,000 $1,000,000), qualifying amounts of M stock may be redeemed under Sec. 303. Sec. 303(b)(2)(B) provides that if the gross estate includes stock in two or more corporations, those corporations are deemed a single corporation for purposes of the 35% test if the estate owns at least 20% of the value of each corporation's outstanding stock. For purposes of the 20% threshold, under Sec. 303(b)(2)(B), any stock owned by the surviving spouse spouse A legal marriage partner as defined by state law as community property, joint tenants, tenants by the entirety The whole, in contradistinction to a moiety or part only. When land is conveyed to Husband and Wife, they do not take by moieties, but both are seised of the entirety. , or tenants in common is treated as being included in the decedent's gross estate. Example 5: V's AGE is $1,000,000, including stock in corporations A and B valued at $300,000 and $100,000, respectively; I "s holdings represent 25% of the value of the outstanding stock of each corporation. This exceeds the Sec. 303(b)(2)(B) 20% ownership requirement; thus, the value of the A and B stock can be aggregated for purposes of the Sec. 303(b)(2)(A) 35% test (($300,000 + $100,000) / $1,000,000 = 40%). Because more than 35% of the value of the AGE consists of A and B stock, Sec. 303 applies to redemptions of such stock by V's estate. Example 6: The facts are the same as in Example 5, except that the FMV of the A stock is $200,000 (which represents 25% of the out standing A stock). The 20% ownership test is still met, allowing the value of the A stock to be aggregated with the value of the B stock in calculating the 35% test. However, the total value of the stock in both corporations is only $300,000 ($200,000 (A) + $100,000 (B)), which fails the 35% test ($300,000 / $1,000,000). Because less than 35% of the AGE consists of A and B stock, the redemption of either stock will not qualify under Sec.303. In Examples 5 and 6, the assumption is chat the corporate stock is easily capable of valuation for estate and income tax purposes. Sec. 303 was conceived with closely held and family owned corporations in mind, so that valuation may not be easy The executor should retain a qualified appraiser A person selected or appointed by a competent authority or an interested party to evaluate the financial worth of property. Appraisers are frequently appointed in probate and condemnation proceedings and are also used by banks and real estate concerns to determine the market to value the stock; the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. provides guidance in valuing the corporation by specifying certain factors to be considered by the appraiser(9): * The nature of the business and the history of the enterprise from its inception. * The economic outlook in general and the condition and outlook of the specific industry in particular. * The book value of the stock and the financial condition of the business. * The earning capacity of the company. * The dividend-paying capacity. * Whether or not the enterprise has goodwill or other intangible value. * Sales of the stock and the size of the block of stock to be valued. * The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter. Time Limits Sec. 303 imposes a time limit on the redemption. According to Sec. 303(b)(1)(A), a qualifying redemption must occur within three years and 90 days after the estate tax return is filed. Typically, this deadline occurs approximately four years following the decedent's death, because the estate tax return is due within nine months after death, under Sec. 6075(a). However, if the estate files a Tax Court petition for redetermination Noun 1. redetermination - determining again determination, finding - the act of determining the properties of something, usually by research or calculation; "the determination of molecular structures" of an estate tax deficiency, Sec. 303(b)(1)(B) requires the redemption to take place within 60 days of that court's final decision.(10) Example 7: R's $1,000,000 A(;E includes $400,000 of G stock. The estate tax return was filed on duly 1, 1993. A property valuation dispute between R's executors and the IRS is taken to Tax Court, which renders a final decision on Sept. 15, 1997. A qualifying redemption can occur at any point while the case is in Tax Court and up to Nov. 14, 1997 (60 days after the decision). Sec. 303(b)(1)(C) specifies that if the estate elects to pay Federal estate taxes in Sec. 6166 installments, the redemption (or series of redemptions) may take place within the time determined under Sec. 6166 (i.e., up to 15 years). If the estate elects to use this installment method installment method The accounting method of treating revenue from the sale of an asset on installments such that profits are recognized in proportion to the percentage of the sale price collected in a given accounting period. and the series of payments extends beyond the time restrictions in Sec. 303(b)(1)(B), it can have the stock redeemed over a 15-year period.(11) Late Distribution Limit Finally, Sec. 303(b)(4) mandates that the maximum amount of proceeds of any stock redemption occurring more than four years after the decedent's death that will qualify for Sec. 303 treatment is the lesser of (1) the total unpaid death taxes and funeral and administration expenses immediately before the redemption or (2) the total death taxes and funeral and administration expenses paid in the one-year adj. 1. completing its life cycle within a year. Adj. 1. one-year - completing its life cycle within a year; "a border of annual flowering plants" annual phytology, botany - the branch of biology that studies plants period beginning on the date of the redemption. Example 8: P died on duly 1,1993; his estate holds stock in corporation J and incurs $150,000 in death taxes and funeral and administration expenses. There was a $75,000 Sec. 303 redemption in June June: see month. 1994. On July 1,1997, $50,000 of unpaid death taxes and funeral and administration expenses remain. If a portion of the) stock is redeemed by the estate after July 1, 1997, the qualifying redemption is limited to the $50,000 of unpaid death taxes and funeral and administration expenses, even though the total taxes and expenses were $150,000 and only $75,000 of stock had previously been redeemed under Sec. 303. Therefore, this limitation can reduce the qualifying Sec. 303 redemption to an amount ($125,000) smaller than would otherwise be available under the general rules ($150,000). Tax advisers should plan around this limit. Tax Planning Issues Sec. 303's inherent complexity makes it imperative for an executor to be aware of some important issues. While Sec. 303 provides beneficial tax consequences, various nontax considerations exist in assessing whether to pursue a stock redemption. Redemptions by Beneficiaries Although most Sec. 303 redemptions are generally by estates, beneficiaries may also receive Sec. 303 distributions. Under Regs. Sec. 1.303-2(f), a corporation can redeem stock from an heir, legatee A person who receives Personal Property through a will. The term legatee is often used to denote those who inherit under a will without any distinction between real property and personal property, but technically, a devisee , donee The recipient of a gift. An individual to whom a power of appointment is conveyed. donee n. a person or entity receiving an outright gift or donation. DONEE. , surviving joint tenant, surviving spouse, appointee APPOINTEE. A person who is appointed or selected for a particular purpose; as the appointee under a power, is the person who is to receive the benefit of the trust or power. , taker tak·er n. One that takes or takes up something, such as a wager or purchase: There were no takers on the bets. taker Noun in default of appointment or a trustee of a trust established by the 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. (provided that the stock was not transferred to the beneficiary in satisfaction of a specific monetary bequest bequest: see legacy. ). Sec. 303(b)(3) provides that a redemption from a beneficiary qualifies only to the extent the shareholder's interest in the estate's assets is reduced (either directly or through a binding obligation to contribute) by the payment for death taxes and funeral and administration expenses. If there is no decrease in the shareholder's interest in the estate's residual assets Residual assets Assets that remain after sufficient assets are dedicated to meet all senior debtholders' claims in full. , Sec. 303 does not apply. Under Sec. 303(b)(3), when a beneficiary redeems stock received from the estate, only the value of stock equal to his share of the death taxes and funeral and administration expenses receives Sec. 303 treatment; this restriction is consistent with comparable restrictions placed on estates. If the stock had been redeemed from the estate, the qualifying amount would have been limited to the sum of the death taxes and funeral and administration expenses. Thus, if the stock is redeemed from the beneficiary, the qualifying redemption proceeds should not exceed the proceeds had the redemption been made from the estate. Example 9: O's AGE includes stock that qualifies for a Sec. 303 redemption. O's only beneficiary is his surviving spouse, S. If O's will releases S's marital Pertaining to the relationship of Husband and Wife; having to do with marriage. Marital agreements are contracts that are entered into by individuals who are about to be married, are already married, or are in the process of ending a marriage. share of the estate assets from any obligation to pay death taxes or funeral and administration expenses, Sec. 303 will not be available to S under Sec. 303(b)(3), because S does not have direct responsibility for such taxes or expenses. Given O's wish to shield S from such obligation, it may be prudent for the executor to affect a Sec. 303 redemption, then distribute the redemption proceeds to S to the extent not needed to meet the estate's obligations. Example 10: H's $1,000,000 AGF AGF Assurances Générales de France AGF Army Ground Forces AGF American Growth Fund (mutual fund) AGF American General Finance AGF Arbeitsgemeinschaft der Grossforschungseinrichtungen AGF Anatomic Gift Foundation AGF Assume Good Faith includes $400,000 of corporation F stock; death taxes and funeral and administration expenses are $250,000. H's estate has two equal beneficiaries, S and P, neither of whom is a debtor One who owes a debt or the performance of an obligation to another, who is called the creditor; one who may be compelled to pay a claim or demand; anyone liable on a claim, whether due or to become due. of the estate. If S elects to have his $200,000 share of the F stock redeemed after receipt from the estate and after the estate's payment of the taxes and funeral and administration expenses, $125,000 of the redemption will qualify under Sec. 303 because S's residual interest Residual Interest A type of interest payment received by investors in a real estate mortgage investment conduit (REMIC). Notes: Investors receive interest payments after all required regular interest has been paid to investors within higher priority tranches. in the estate's assets was reduced by his share of the $250,000 in taxes and expenses; in addition, the balance of the redemption ($75,000) could qualify for sale or exchange treatment under Sec. 302(b)(3). Example 11: The facts are the same as in Example 10. After the first redemption, P has $100,000 of F stock redeemed; only $50,000 qualifies for Sec. 303 ($250,000 - $200,000 previously redeemed and receiving sale or exchange treatment); the remaining $50,000 will be tested under Sec. 302 to determine the appropriate tax Control of the Corporation Another factor in deciding whether to use Sec. 303 is whether the loss of control of the corporation that accompanies a stock redemption is tolerable tol·er·a·ble adj. 1. Capable of being tolerated; endurable. 2. Fairly good; passable. See Synonyms at average. tol to the estate or beneficiaries. This nontax issue may not be as critical in a family owned business as in a closely held corporation Noun 1. closely held corporation - stock is publicly traded but most is held by a few shareholders who have no plans to sell corp, corporation - a business firm whose articles of incorporation have been approved in some state with unrelated shareholders; nevertheless, a redemption of a portion of the decedent's shares might directly affect the relative voting power of the stock in the beneficiaries' hands. To mitigate this situation, a closely held corporation can issue preferred or nonvoting common stock after the decedent's death as a nontaxable stock dividend, allowing the corporation to later redeem such stock under Sec. 303 without affecting the various shareholders' 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. voting rights The type of voting and the amount of control held by the owners of a class of stock. and relative control. Example 12: After a decedent shareholder's death, a closely held corporation with two equal shareholders (the estate and an unrelated individual) issues a second class of nonvoting stock Nonvoting stock A security that does not entitle the holder to vote on the corporation's resolutions or elections. nonvoting stock equally to each as a Sec. 305 tax-free distribution. Simultaneously, the corporation redeems from the estate the portion of the nonvoting stock covering the allowable taxes and expenses. This enables the estate to extract cash from the corporation tax free and without altering the corporation's ownership.(12) According to Regs. Sec. 1.303-2(d), this type of transaction meets the Sec. 303(c) substituted basis definition(13) and avoids Sec. 306 problems. Stock in Related Corporations Another alternative exists if the decedent owned stock in more than one corporation and a redemption by one of those corporations is not desired even though cash is needed by the estate. If the decedent owned a controlling interest controlling interest The ownership of a quantity of outstanding corporate stock sufficient to control the actions of the firm. Controlling interest often involves ownership of significantly less than 51% of a firm's outstanding stock because many owners fail in the stock of related corporations, one corporation could buy the stock of the other and receive capital gain treatment under Sec. 304(a)(1) and (2) as long as the Sec. 303 requirements are met. Example 13: (14) K's estate owns 40% of the outstanding stock of corporation W and 50% of the outstanding stock of corporation B; the remainder of the Wand B stock is owned equally by K's two sons (his sole beneficiaries). The stock of Wand B accounts for 20% and 40% of the value of K's AGE, respectively K's will provides that if any of the W or B stock has to be sold by his executor, the W stock should be sold first, with W having the first, and B the second, option to purchase. To meet expenses, K's executor decides to sell all of the W stock. W does not exercise its option to purchase due to a lack of liquid assets Cash, or property immediately convertible to cash, such as Securities, notes, life insurance policies with cash surrender values, U.S. savings bonds, or an account receivable. ; B elects to purchase the W stock under its option. Sec. 304(a)(1) provides that, for Sec. 303 purposes, if one or more persons control two corporations and one corporation acquires the stock of the other from such controlling person(s) in return for property, the transaction is a redemption of the stock of the acquiring corporation. Sec. 304(c)(2) provides that Sec. 318 (relating to relating to relate prep → concernant relating to relate prep → bezüglich +gen, mit Bezug auf +acc constructive ownership) applies in determining the ownership of the stock for purposes of Sec. 304(a)(1). Sec. 318(a)(3)(A) provides that stock owned (directly or indirectly) by or for a beneficiary is deemed owned by the estate. Thus, under Sec. 318(a)(3)(A), the estate owns all of the stock of W and B. The acquisition by B of the W stock from the estate is a deemed redemption of the stock of B, the acquiring corporation under Sec. 304(a)(1); the B stock is thus tested under Sec. 303b(b)(2)(A). Accordingly because the value of the B stock has been included in K's gross estate within the amounts specified in Sec. 303(b)(2)(A) and the sales proceeds do not exceed the death taxes and administration expenses, Sec. 303 applies.(15) Thus, the estate receives sale or exchange treatment on the disposition. Corporate Financial Condition Although the benefits of a Sec. 303 redemption are evident, in some cases the 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. corporation may be jeopardizing its financial position by redeeming the stock. To mitigate this problem, the corporation could make a series of redemptions over time. Under regs. Sec. 1.303-2(g), if a redemption plan is adopted, the serial distributions will be applied to the total death taxes and funeral and administration expenses in the order in which redemptions are made. Example 14: T's estate includes stock in corporation J valued at $400,000; estate taxes and funeral and administration expenses are $200,000. J redeems $150,000 of its stock from the estate in the first year of estate administration and the remaining $250,000 in the second year. The first ($150,000) distribution qualifies for Sec. 303 treatment because it is less than the total taxes and expenses. Only $50,000 of the second redemption Second Redemption refers to the period following the election of 1968 characterized by more conservatism, and a retreat from governmental and judicial activism on issues of civil rights. qualifies under Sec. 303; the remaining $200,000 is taxed under other Code provisions.(16) Deathbed Transfers Under Sec. 2035(d)(3)(A), gifts made by the decedent within three years of death are included in his AGE when calculating the 35% threshold. Example 15:(17) Z died on Jan. 1, 1997. During 1994, 1995 and 1996, Z had made various gifts of corporation E stock to A, his sole beneficiary. At death, Z owned no E stock; however, if the E stock given to A by Z since 1994 were included in Z's gross estate for Federal estate tax purposes, it would have constituted 40% of the AGE. Z's death taxes and funeral and administration expenses were $450,000. On July 15, 1997, E redeemed from A for $450,000 stock that Z had given A. The value of all the E stock given to A by Z was included in Z's gross estate under Sec. 2035(a) and (d)(3)(A) in determining whether the estate satisfied the Sec. 303(b)(2)(A) percentage requirements. However, because the E stock surrendered by A in the redemption was not included in Z's gross estate except by operation of Sec. 2035(d)(3)(A), Sec. 303 does not apply to the redemption. Example 16: The facts are the same as in Example 15, except that the E stock surrendered by A for redemption had actually been owned by Z at death and received by A as part of a residual distribution. If the E stock given to A by Z in Example 15 were included in Z's gross estate for Federal estate tax purposes, such stock, when combined with the E stock actually owned by Z at death, would have constituted 40% of Z's AGE. The E stock actually owned by Z at death constituted only 15% of his AGE. Under Sec. 2035(a) and (d)(3)(A), because the value of the E stock given to A by Z was combined with the value of the E stock actually owned by Z at death, the percentage requirements of Sec. 303(b)(2)(A) were satisfied. In addition, Sec. 303(b)(3) is satisfied because, as sole beneficiary, A's interest in the estate is directly reduced by the payment of the death taxes and funeral and administration expenses. Accordingly, because the amount distributed to A was in redemption of E stock actually owned by Z at death and included in his gross estate and did not exceed the Sec. 303(a) limits, the distribution is in full payment in exchange for the stock redeemed (assuming the redemption occurs within the appropriate time frame). Without this provision, deathbed transfers would be used to decrease the value of the estate and increase the likelihood that the 35% threshold would be met. Example 17: As a part of a review of his estate plan, K notes that if he were to die currently, his AGE would be $1,100,000, including corporation C stock valued at $350,000. K recognizes that, under Sec. 303(b)(2)(A), his estate would not be able to have any of its C stock redeemed under Sec. 303 because the value of the stock would comprise only 31.8% of his AGE ($350,000 / $1,100,000), less than the 35% statutory requirement. In an attempt to safeguard the option of his estate's use of Sec. 303, K contemplates making a $200,000 cash gift to his children in the belief that his AGE would be reduced to $900,000, increasing the value of the C stock in his estate to 38.9% ($350,000 / $900,000), thus enabling use of Sec. 303. This plan will not work if K dies within three years of the gift, because Sec. 2035(d)(3)(A) will pull back into his AGE the $200,000 gift for purposes of testing the 35% threshold. K's plan will be successful only if he outlives the gift by three years. Conclusion This article has described the requirements and benefits 1 associated with Sec. 303 redemptions. If the statutory requirements are met and no overwhelming negative nontax considerations are present, a Sec. 303 redemption is an excellent way to get cash out of the corporation and into the estate while incurring in·cur tr.v. in·curred, in·cur·ring, in·curs 1. To acquire or come into (something usually undesirable); sustain: incurred substantial losses during the stock market crash. 2. little (if any) Federal income taxes. If the estate decides not to use Sec. 303, the beneficiaries may still be able to benefit from it. (1) The benefits of Sec. 303 are not limited to taxpayers owning interests in closely held corporations, but could also be used when the stock is widely held and publicly traded. However, Sec. 303 is primarily intended to assist taxpayers whose stock interests are not readily marketable Marketable are securities that can be easily converted into cash. Such securities will generally have highly liquid markets allowing the security to be sold at a reasonable price very quickly. , so that the most likely buyer is the issuing corporation. (2) Redemptions not qualifying under Sec. 303 are granted sale or exchange treatment only if they pass one of the Sec. 302(b) tests; otherwise, these transactions are treated as other nonliquidating distributions (i.e., dividend income to the recipient to the extent of available earnings and profits); see Secs. 302(d) and 301. (3) If the executor elects Sec. 2032 alternate valuation, the stock is valued on the earlier of (1) six months after the date of death or (2) the date of disposition. (4) Gain or loss would be recognized only if the stock is redeemed for an amount that differs from the value used for estate tax purposes (e.g., when market conditions following the death cause the corporation's value to rise or fall). As with all nonliquidating corporate distributions, the corporation recognizes gain if it distributes appreciated property; see Sec. 311 (b). However, if cash is distributed in exchange for the stock (which likely would be the case when the estate or beneficiary needs cash to pay expenses), no corporate-level gain occurs. (5) Sec. 303(d), special rules for generation-skipping transfers, is outside of the scope of this article, because it differs from the fundamental purpose of Sec. 303 and applies to relatively few taxpayers. (6) Deductions allowable under Sec. 2053 include funeral expenses, administration expenses: claims against the estate: and unpaid mortgages on (or any debt in respect of) property when the value of the decedent s interest therein (undiminished by such mortgage or debt) is included in the value of the gross estate. However, Sec. 303 is available only to the extent of death taxes, funeral expenses and administration expenses. (7) Sec. 302(a) provides sale or exchange treatment if the distribution is (1) not essentially equivalent to a dividend (Sec. 302(b)(1)), (2) a substantially disproportionate dis·pro·por·tion·ate adj. Out of proportion, as in size, shape, or amount. dis pro·por redemption with respect to the shareholder (Sec. 302(b)(2)), (3) in complete termination of the shareholder's interest (Sec. 302(b)(3)), or (4) from a noncorporate shareholder in partial liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts.A type of proceeding pursuant to federal Bankruptcy (Sec. 302(b)(4)). (8) Sec. 302(b)(3) could provide sale or exchange treatment on receipt of the final $50,000 if the conditions regarding complete termination are met. (9) Rev Rul REV RUL Revenue Rule . 59-60, 1959-1 CB 237 (10) The flexibility associated with this limit is not available if the deficiency is pursued in one of the other Federal courts of original jurisdiction (e.g., district court). (11) Sec.6166(a)(1) allows the estate to pay its taxes in two to 10 equal annual installments Sec. 6166(a)(3) allows deferral deferral - Waiting for quiet on the Ethernet. of payment of the first installment for up to five years; the provision is particularly beneficial if an estate is experiencing acute cash-flow problems and cannot pay the tax within the normal time frame. Its effect is to permit the estate to make tax payments over time without having to sell off assets to generate the required cash (i.e., ideally, the required cash can be generated through the continuing operations continuing operations Parts of a business that are expected to be maintained as an ongoing segment of an overall business operation. Income and losses from continuing operations are reported separately if any segments have been discontinued during the of the closely held corporation held by the estate). If the estate elects Sec. 6166 installments, only a portion of the estate tax can be deferred under that provision, based on the ratio of the value of the stock in the closely held corporation to the AGE. For this purpose, AGE is defined by Sec. 6166(b)(6) as the value of the gross estate reduced by the amounts allowable as deductions under Secs. 2053 and 2054; this sum is determined on the basis of the facts and 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 on the due date (including extensions) of the estate tax return. (12) See Rev Rul. 87-132, 1987-2 CB 82. (13) Stock received in a tax-free transaction (e.g., stock dividends) whose basis is determined by reference to the old stock can qualify for Sec. 303 treatment; see Sec. 303(c). (14) This example has has been adapted from Rev. Rul. 71-527, 1971-2 CB 174. (15) Not only must the dollar limit and the ownership requirements of Sec. 303 be met, it is assumed that the sale occurs within the Sec. 303(b)(1) time limits. (16) The remaining distribution may receive sale or exchange treatment under Sec. 302(b)(3), because there is a complete termination of the estate s interest in J. (17) Examples 15 and 16 have been adapted from Rev. Rul. 84-76, 1984-1 CB 91. RELATED ARTICLE: EXECUTIVE SUMMARY * The benefits of a Sec. 303 redemption include capital gain or loss treatment and an infusion of cash to the estate or beneficiary. * While the amount of the redemption subject to capital gains rates is capped at the total death taxes, funeral and administration expenses, the estate or beneficiary need not actually use the redemption proceeds to pay those bills. * Redemptions can be made in a lump sum Lump sum A large one-time payment of money. or in installment payments Installment payments Distribution of plan assets to beneficiaries based upon a regular schedule. . John W. Howard Price Waterhouse LLP LLP - Lower Layer Protocol Norfolk, Va. David M. Maloney, Ph. D., 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. McIntire School of Commerce The McIntire School of Commerce is the University of Virginia's undergraduate business school. It was founded in 1921 through a gift by Paul Goodloe McIntire. The two-year McIntire program offers students B.S. University of Virginia Virginia, state, United States Virginia, state of the south-central United States. It is bordered by the Atlantic Ocean (E), North Carolina and Tennessee (S), Kentucky and West Virginia (W), and Maryland and the District of Columbia (N and NE). Charlottesville, Va. |
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