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Redemptions and Partial Liquidation I. II.
III. Section 302(d): redemption treated as dividend unless subsections of 302(b) apply (then treated as sale, capital gain). Section 302: redemption treated as sale (SH therefore recognizes capital gain or loss) if: a. 302(b)(1)-(3): a sufficient reduction in the SH's ownership interest in the corporation to justify treating the redemption as an exchange, or b. 302(b)(4): on a corporate level, distribution that qualifies as a "partial liquidation" under 302(e) is treated as exchange c. 302(b)(5): redemption by mutual fund or real estate investment trust generally will be treated as an exchange Exchange (or sale)/ Dividend - Consequences a. If a redemption is treated as sale, the basis of the redeemed stock is taken into account in determining the SH's gain or loss b. If a redemption is treated as a dividend, basis shift to the SH's other retained share.
302(b)(2): Substantially disproportionate redemptions IV. V.
VI. 13-3 302(b)(2): substantially disproportionate redemption safe harbor: if a SH's reduction in voting stock as a result of a redemption satisfies three mechanical requirements, the redemption will be treated as sale: (example: A owns 70 out of a total of 100 outstanding, A redeems 50) a. Immediately after the redemption, the SH must own (actually and constructively) less than 50% of the total combined voting power of all classes of stock entitled to vote i. (70-50)/(100-50)<50%
b. The % of total outstanding voting stock owned by the shareholder immediately after the redemption must be less than 80% of the percentage of total voting stock owned by the SH immediately before the redemption, and i. (70-50)/(100-50)<80%*70%
c. The SH's percentage ownership of common stock (voting or not voting) after the redemption also must be less than 80% of the percentage of common stock owned before the redemption. Step transaction: a. 302(b)(2)(D) requires the application of step transaction principles in the case of a "plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substantially disproportionate" b. Rev. Rul. 85-14 indicates that a plan can exist solely in mind, without agreement c. Does this only apply to the 80% test?
i. Yes: the language of 302(b)(2)(D) suggests that it only applies for the purpose of the "substantially disproportionate" test.
1. Also the 302(b)(2)(D) preempts the common law step transaction doctrine, so common law step transaction should not apply to the 50% test. ii. No: it also applies to the 50% test. Even if the language of 302(b)(2)(D) suggests it only applies to the 80% test, we can use the common law step transaction doctrine with respect to the 50% test. VII.
VIII. Example: a. A and B each own 50% of X, how can A and B satisfy the three tests?
b. First, can sell any share to have <50% of total voting power c. Second, must satisfy the 80% test, must go under 80%*50%=40%
i. Magic number x: sell at least x shares (must round up) ii. a = # of shares owned by A; b= total # shares outstanding; looking for X such that
1. (a-x)/(b-x)<80%*a/b, then x>ab(5b-4a) Problem p204: Y has 200 preferred non-voting stock, 100 voting shares. A owns: 80 voting, 100 preferred; C owns: 20 voting, 100 preferred a. Y redeems 75 of A's preferred share. i. No treatment of sale because no voting power share redeemed. And has 80% of voting power b. Same as (a) above, except Y also redeems 60 shares of A's voting stock i. No treatment of sale because must get below 50%, now she has exactly 20/(20+20)=50%
c. Same as (a) above, except Y also redeems 70 shares of A's voting stock i. 10/30< 50%
ii. For the 80% test, you should go below 80%*80%=64% of total voting power after the sale, and 10/30<64%
d. Same as (c), later in the year, Y redeems 10 shares of C. i. Consequences for A?
1. step transaction principles apply to the two 80% test, treated as part of the same plan as the A's redemption
2. step transaction does not apply to the 50%
3. For the 50% test, do not take into account of C's later redemption, 10/(10+20)<50%
4. For the 80% test, take into account of C's later redemption a. A still goes below 64%: 10/(100-7010)=50%
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