Lynch v. Commissioner

United States Court of Appeals for the Ninth Circuit · 1986 · Corporations

CorporationsStock redemptionTaxationI.R.C. § 302I.R.C. § 301I.R.C. § 318stock redemptionfamily attribution

Facts

William Lynch originally owned all the stock of W.M. Lynch Co. In December 1975, he sold 50 shares to his son Gilbert, and later that month the corporation redeemed all 2,300 of William's remaining shares in exchange for property and a promissory note; Gilbert's 50 shares were pledged as security, and William could vote or sell them on default. On the date of redemption, William also entered into a consulting agreement under which the corporation paid him monthly and reimbursed certain expenses, and he continued to come to the office regularly and received some medical-insurance-related benefits. If family attribution applied, William would be deemed to own Gilbert's shares and the redemption would not qualify as a complete redemption under § 302(b)(3).

Issue

Does a former shareholder who performs post-redemption services for the corporation as an independent contractor retain a prohibited interest under I.R.C. § 302(c)(2)(A)(i), thereby preventing waiver of family attribution and defeating complete-redemption treatment under § 302(b)(3)?

Rule

Section 302(c)(2)(A)(i) operates mechanically: to avoid family attribution in a purported complete redemption under § 302(b)(3), the redeemed shareholder must sever all interests in the corporation other than a creditor's interest. A shareholder who provides post-redemption services to the corporation, whether as an employee or independent contractor, holds a prohibited noncreditor interest because he is more than merely a creditor.

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

In Phoenix, Nora Velasquez owned all but 40 shares of Desert Span Fabrication, which were owned by her daughter. The corporation redeemed all of Nora's shares for cash and a fixed promissory note, and on the same day Nora signed a one-year agreement to train the shop manager for a flat monthly fee as an outside consultant.

How should Nora's post-redemption consulting relationship affect the availability of the family-attribution waiver for complete-redemption treatment under § 302(b)(3)?

Explanation. The majority adopted a mechanical rule: to avoid family attribution under § 302(c)(2)(A)(i), the redeemed shareholder must retain no interest other than as a creditor. A post-redemption service relationship is a prohibited noncreditor interest whether the person serves as an employee or independent contractor. The court rejected a facts-and-circumstances inquiry based on control or financial stake.