Seda v. Commissioner

United States Tax Court · 1984 · Corporations

CorporationsStock redemptionConstructive ownershipDividend versus sale treatmentsection 302(b)(3)section 302(c)(2)(A)(i)section 318(a)(1)family attribution

Facts

Petitioners owned all stock of B & B Supply Co. and, due to declining health, entered into a June 30, 1979 redemption agreement under which the corporation redeemed all of their stock for $299,000 while issuing 1,000 shares to their son James, who became sole shareholder. Petitioners resigned as officers and directors on the redemption date, but Mr. Seda continued working for the corporation for almost two years and received $1,000 per month in salary until June 1981. The corporation had never paid a dividend and had retained earnings of $202,455 as of June 30, 1978. Petitioners reported the redemption as long-term capital gain and later argued that $18,000 paid after the redemption was part of the stock purchase price.

Issue

Whether the redemption of all petitioners' stock qualified for sale or exchange treatment as a complete termination under section 302(b)(3), or instead was taxable as a dividend because their son's stock was attributable to them under section 318(a)(1). Also, whether the $18,000 Mr. Seda received after the redemption was compensation for services or partial payment for his redeemed stock.

Rule

Under section 302(b)(3), a redemption is treated as a sale or exchange only if it completely terminates the shareholder's interest. Family attribution under section 318(a)(1) applies unless the shareholder satisfies section 302(c)(2)(A), including the requirement in section 302(c)(2)(A)(i) that immediately after the distribution the distributee have no interest in the corporation, including an interest as officer, director, or employee, other than as a creditor. Where the redeemed shareholder continues post-redemption employment at a level that gives him a financial stake and continued involvement, the waiver does not apply and the redemption is taxed as a dividend to the extent of earnings and profits.

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

Nina and Omar Patel owned all the shares of Front Range Valve Supply, a closely held corporation in Colorado Springs. The corporation redeemed all of their stock, and on the same day their daughter Mira bought all newly issued shares and became sole shareholder; Omar resigned as officer and director but stayed on for 20 months as a paid operations employee earning a monthly salary.

How should the redemption most likely be treated for federal tax purposes?

Explanation. Under the majority opinion, a redemption does not qualify under section 302(b)(3) if family attribution remains in place. Family attribution from a child can be waived only if the distributee has no interest immediately after the distribution, including as officer, director, or employee, other than as a creditor. Continued paid employment for an extended period gave the redeemed shareholder a financial stake and suggested continued involvement, so the daughter's stock would still be attributed and the redemption would be taxed as a dividend to the extent of earnings and profits.