Cerone v. Commissioner

United States Tax Court · 1986 · Corporations

CorporationsStock redemptionsConstructive ownershipDividend equivalencysection 302section 318section 301stock redemption

Facts

Michael Cerone and his son each owned 50 percent of Stockade Cafe, Inc., but increasing hostility led them to arrange for the corporation to redeem all of Michael's stock for $125,000 payable partly down and partly over time. Around January 16, 1975, Michael gave up his stock, resigned as officer and director, and relinquished managerial and check-signing authority. After the redemption, however, he continued to work for the corporation for several years as an employee handling the cash register and received salary, although he had no managerial role or control over corporate decisions. Michael reported the principal-designated payments as installment sale capital gain, and the corporation deducted the interest-designated amounts as interest expense.

Issue

Whether the corporation's redemption of Michael Cerone's stock qualified for exchange treatment under section 302(a) because it was either not essentially equivalent to a dividend under section 302(b)(1) or a complete redemption under section 302(b)(3). Relatedly, whether family hostility could prevent application of section 318 family attribution rules, and whether Michael's continued employment prevented waiver of attribution under section 302(c)(2).

Rule

Family hostility does not nullify the section 318(a)(1) family attribution rules in determining whether a redemption satisfies section 302(b)(1) or section 302(b)(3). Under section 302(b)(1), attribution is applied first; if the shareholder is treated as owning the same proportionate shareholder interest before and after the redemption, the redemption is essentially equivalent to a dividend. Under section 302(c)(2), family attribution may be waived for a section 302(b)(3) complete redemption only if, immediately after the distribution, the distributee has no prohibited interest in the corporation, including as an employee other than as a creditor.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Des Moines, Owen Patel and his adult daughter, Mira Patel, each own 50% of Prairie Lantern Foods, Inc. After years of bitter personal conflict, the corporation redeems all of Owen's shares, and he resigns as director and officer; Mira remains the only actual shareholder.

If Owen argues the redemption should receive exchange treatment because the family feud makes attribution unrealistic, which result is most consistent with the governing rule?

Explanation. Under the majority rule, section 318 family attribution applies despite hostility within the family. In determining whether a redemption is essentially equivalent to a dividend under section 302(b)(1), attribution is applied first. A feud between parent and child does not create an exception to attribution.