LLM - Corporate Tax Instructor: Dwight Drake Problem Basic Facts: Z Corp 100 shares common. All parties unrelated. Issue: (b)(1). A - 28 shares B - 25 shares C - 23 Shares D – 24 Shares (a)Z redeems 7 of A’s shares. Prior to redemption, A could control with any other single shareholder. After, A own 21 of 93 shares and could no longer control with just one. Good case for (b)(1). Rev. Rule (OK under similar facts.) (b)Z redeems 5 shares from A; A and D are mother – daughter. Before with attribution, A owned 52% (52 / 100). After, A own 49.4% (47 / 95). This loss of control probably enough to get under (b)(1) where balance of stock owned only be a few (no big dispersion). Rev. Rule (c)Z redeems 5 shares from A; A and B mother – daughter. 53% before (53 / 100) and 50.5% after (48 / 90), with attribution. No hope under (b)(1).

LLM - Corporate Tax Instructor: Dwight Drake Problem Basic Facts: Z Corp 100 shares common. All parties unrelated. Issue: (b)(1). A - 28 shares B - 25 shares C - 23 Shares D – 24 Shares (d)Same as (c), but A and B not spoken since B married outside of faith. Issue: Does hostile family situation negate family attribution of 318? IRS has said “no.” Rev. Rule First Circuit once allowed, but most have held no. Even if attribution negated, still have (b)(1) issue. Before redemption, A had 29 shares and could control with any one of other three. After redemption of 5 shares, could control only with B, who she doesn’t talk to. Should family hostility be issue for (b)(1) purposes? Tax Court in Cerone v. Comm, 87 T.C. 1 (1986) said “yes”.

LLM - Corporate Tax Instructor: Dwight Drake Problem Basic Facts: Y Corp 100 shares common; 100 shares nonvoting preferred, not convertible and not 306 (no tax avoidance potential). All parties unrelated. Common Preferred A 40 0 B C D E 0 20 (a) Y redeems 5 preferred shared from E. (b)(1) qualified because E never had any control. Reg (a); Rev. Rule (b) Y redeems all preferred stock. Each shareholder analyzed. E qualifies under (b)(3) – complete redemption. Others technically all fail because no change in voting control; thus no hope under (b)(2) or (b)(1). But is this right as to B, who has taken big hit in economic interest – from 37.5% of all shares to 10%?

LLM - Corporate Tax Instructor: Dwight Drake Problem Basic Facts: A owns 10 shares common, basis 15k. - What is basis impact if 5 shares are redeemed in transaction treated as dividend? Basis of remaining 5 shares is 15k. Reg (c). - What basis impact if all 10 shares redeemed in transaction treated as dividend? Would happen where (b)(3) not available because family attribution waiver not available. Here, basis is transferred to shares belonging to others that were attributed to A and killed (b)(3). Reg (c), Ex 2.

LLM - Corporate Tax Instructor: Dwight Drake 302(b)(4) – Partial Liquidation Exception Applies: - Only to noncorporate shareholders - Even thought distribution pro rata and otherwise flunks (b)(1) – (b)(3). - Based on impact at corporate level – not shareholder level. - Stock held by partnership, estate or trust deemed help proportional by partners and beneficiaries. Requirements: 302(e) - Not essentially equivalent to dividend (determined at corporate level) - Distribution pursuant to a plan - Distribution occurs in taxable year plan adopted or following year.

LLM - Corporate Tax Instructor: Dwight Drake Partial Liquidation – Not Essentially Equivalent to Dividend Safe Harbor: - Distribution attributable to ceasing to conduct “qualified trade or business” – operated for 5 years and not acquired during 5 yr period in transaction that recognized gain or loss. - After distribution, corp still involved in active conduct of “qualified trade or business.” Non- Safe Harbor Scenarios - Tough – must show serious contraction of business. - Example: Fire destruction; corporate cutback and all insurance proceeds distributed. - Bona fide business reason unrelated to desire to bail out liquid assets - No hope if plan is to bail out accumulated investment assets

LLM - Corporate Tax Instructor: Dwight Drake Problem 252 Basic Facts: A Corp has publishing business (“Books”), bar review course division (“Cram”), all stock of B Corp (beta processing), and securities portfolio. A Corp stock owned equal shares by M & P (H & W) and I Corp (unrelated). (a)A distributes Books (more than 5 yrs owned, as is Cram) to shareholders in equal shares and redeems 50 shares from each. - For M &P, qualifies for exchange as partial liquidation if pursuant to “plan”, done within year of plan or next year. A Corp must continue to operate Cram. Both held 5 yrs. Same result if no actual share surrender (just reallocate basis to stock). Makes no difference if pro rata under (b)(4) partial liquidation provision. - Partial liquidation provision not available to corp shareholder. So I Corp stuck with dividend under 301 (pro rata kills any hope of other three 302(b) provisions). 243 dividend deduction of 70% available, but any redemption that is part of partial liquidation requires stock basis reduction under 1059.

LLM - Corporate Tax Instructor: Dwight Drake Problem 252 Basic Facts: A Corp has publishing business (“Books”, bar review course division (“Cram”), all stock of B Corp (beta processing), and securities portfolio. A Corp stock owned equal shares by M & P (H & W) and I Corp (unrelated). (b)What impact in (a) if books bought 3 yrs ago for cash? Not qualified business because not held 5 years. All shareholders have 301 dividend. Concern is bailing liquid cash through partial liquidation. Hence, 5 yr rule. If bought in tax-free reorg, would have used stock and could qualify if business ran for 5 yrs. Here, no liquid asset bailout. (c)Books destroyed by fire, 1/2 insurance proceeds distributed pro rata and other half used to scale down book business. I Corp still dividend. For P & M, not qualify under 302(e)(2) because not ceasing business or distributing all assets. Could be “not essentially equivalent to dividend” under (e)(1) but need more facts to see if it corporate contraction. For ruling purposes, IRS requires 20% cut in revenues, FMV and employees. Rev. Proc

LLM - Corporate Tax Instructor: Dwight Drake Problem 252 Basic Facts: A Corp has publishing business (“Books”, bar review course division (“Cram”), all stock of B Corp (beta processing), and securities portfolio. A Corp stock owned equal shares by M & P (H & W) and I Corp (unrelated). (d)Same as (a) but Books distributed to Michael in redemption of all his stock. Valid partial liquidation - exchange treatment allowed. Also may qualify under (b)(3) (family attribution waived) and maybe (b)(1) (attribution interest reduced from 67% to 50%). (e)Same as (a) but Books distributed to I Corp in redemption of all stock. Although can’t qualify under be partial liquidation provision, qualifies under (b)(3) as termination of complete interest. Exchange treatment allowed. (f)Securities portfolio distributed pro rata in redemption. No hope. Not partial liquidation or corporate contraction. 301 dividend to all shareholders.

LLM - Corporate Tax Instructor: Dwight Drake Problem 252 Basic Facts: A Corp has publishing business (“Books”, bar review course division (“Cram”), all stock of B Corp (beta processing), and securities portfolio. A Corp stock owned equal shares by M & P (H & W) and I Corp (unrelated). (g)A sells stock in B Corp and distributes proceeds pro rata. Sub corp stock can’t qualify as partial liquidation per Rev. Rule Hence, 301 dividend to all shareholders. (h)A liquidates B Corp (operated for more than 5 yrs) and distributes assets in pro rata redemption. If liquidated in non-taxable transaction under 332 (discussed later in course), A picks up all B Corp attributes and may qualify as partial liquidation per Rev. Rule

LLM - Corporate Tax Instructor: Dwight Drake Redemption Impact on Corp Three issues: - Gain or loss to corp on distribution of property other than cash. 311 governs the same as it does for non-liquidating distributions. Gain is always recognized by corporation, but losses not recognized. - E&P impact. E&P reduced by amount of distribution, but per 312(n)(7) reduction can not exceed ratable share of E&P attributable to redeemed stock. So if 1/3 stock redeemed, E&P before redemption can not be reduced more than 1/3. - Stock acquisition expenses paid by corp (brokerage commissions, legal fees, etc) are not deductible per Section 162(k). They are treated as non- amortizable capital expenditures. Amounts paid that have no nexus to redemption (employment agreement amount) are deductible and loan costs and fees involved in redemption may be amortized over term of loan.

LLM - Corporate Tax Instructor: Dwight Drake Problem 255 Basic Facts: X Corp shareholders A & B: 100 shares each with 100k basis. X E&P 100k accumulated from prior years, 50k current year. Assume exchange treatment. Consequences to X Corp? (a)A shares redeemed for land, 250 FMV, 200k basis. X has 50k gain on sale, which takes E&P to 200k (100k + 50k +50k). Since half shares redeemed, 312(n)(7) permits half reduction in E&P. Thus, remaining E&P 100k. (b)Same, except adjusted basis in land 300k. Net loss of 50k to X, which is not recognized under 311(a). E&P still 150k, half of which is reduced per 312(n)(7) because half of stock redeemed. Hence 75k E&P remains after redemption.

LLM - Corporate Tax Instructor: Dwight Drake Zenz Bootstrap Acquisitions Three scenarios all part of common plan: Scenario 1: Shareholder sells some stock and then has corporation redeem balance of shares. Qualifies under 302(b)(3) even though corporate E & P distributed to help facilitate acquisition. Zenz case/ Scenario 2: Corporation sells new shares to new shareholder and then redeem shares from existing shareholder. Percentages before and after both transactions control whether (b)(2) “substantially disproportionate” tests met. Scenario 3: Existing shareholder sell some shares to new shareholder and then have corporation redeem shares from existing shareholder. Percentages before and after both transactions control whether (b)(2) “substantially disproportionate” tests met. Rev. Rule

LLM - Corporate Tax Instructor: Dwight Drake Problem 260 Basic Facts: S sole shareholder of T Corp., to be sold to B where B pay 400k for 80% of stock and Zenz redemption for 100k. - Can qualify for exchange treatment as complete (b)(3) redemption under Zenz case so long as all part of the same plan. Do we care if capital gains and dividend rates the same? If S’s stock basis over 400k, (b)(3) treatment will result is less income. With dividend scenario, have 100k dividend and capital loss Consider E&P implications. If exchange, T Corp E&P reduced 20%, but not over 100k amount distributed in redemption. If 301 dividend, E&P reduced 100k. Thus, if E&P less than 500k before, may get bigger E&P reduction (a good thing for B) with dividend.

LLM - Corporate Tax Instructor: Dwight Drake Corporate Buy-Sell Agreements -Most important document in many privately-owned businesses -Determines value and exit opportunities for shareholders -Contain buy-out triggers: death, disability, bankruptcy, expulsion, etc. -Many tax issues, including estate tax valuation. -Often rely on (b)(3) exception for family businesses -Constructive dividend trap - Co-shareholders become obligated under agreement to buy out a departing shareholder. Cross-purchase structure. - Corporation then discharges obligation of co-shareholders by redeeming stock. - Result is constructive dividend to co-sharholders. - Often screwed-up through bad life insurance structuring.

LLM - Corporate Tax Instructor: Dwight Drake Corporate Buy-Sell C Corp Shareholder A Shareholder B Cross-Purchase Buy-Sell Agreement Sells Stock Cash or Property Constructive dividend

LLM - Corporate Tax Instructor: Dwight Drake Problem 266 Basic Facts: A, B & C unrelated equal shareholders of Y Corp with cross purchase buy-sell. Y Corp owns polices on each shareholder. B dies, Y Corp collects policy and pays proceeds to redeem B stock. -Premium payments by Y Corp not deductible per 264(a)(1). -Premium payments by Y not dividend to any shareholders because Y Corp own policy. -Insurance proceeds received by Y Corp tax free per 101(a). Likely AMT tax trigger. -Y Corp E&P increased by excess of insurance proceeds over aggregate premiums paid on policy. -On payment of insurance proceeds in redemption of B stock, A & C have constructive dividend distribution because their obligation to buy shares being satisfied by Y Corp. Defective buy-sell planning. 301 dividend to extent of E&P.

LLM - Corporate Tax Instructor: Dwight Drake Insurance Cross-Purchase C Corp 15 Million Shareholder A 3 mill policy on B Shareholder B 12 mill policy on A 80% 20% Cross-Purchase Agreement

LLM - Corporate Tax Instructor: Dwight Drake Insurance Cross-Purschase A dies - B sells business for 15 million A family return: Payment from B 12 million Estate Taxes 5 million Net return 7 million B’s Return Sales Proceeds 15 million Income Tax.6 million Net return 14.4 million A Goes Ballistic!

LLM - Corporate Tax Instructor: Dwight Drake Restructured Insurance Program C Corp 15 Million Shareholder A 3 mill policy on B Shareholder B 80% 20% One Leg Cross-Purchase Agreement Life Ins. Trust 12 mill policy

LLM - Corporate Tax Instructor: Dwight Drake Restructured Insurance Program A dies - B sells business for 15 million A family return: Payment on sale 12 million Estate Taxes 5 million Net return on sale 7 million Tax Free Insurance 12 million Total yield 19 million B’s Return Sales Proceeds 3 million Income Tax.6 million Net return 2.4 million