1. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 IRC Section 303 allows a corporation to make a distribution in redemption of a portion of the stock of a decedent that will not be taxed as a dividend A Section 303 partial redemption can provide cash and/or other property from the corporation without resulting in dividend treatment –This permits a decedent shareholder’s executor to pay death taxes and other expenses What Is Section 303?

2. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 When the decedent shareholder’s family desires to keep control of a closely-held or family corporation after his/her death Corporation stock is a major estate asset and there exists a threat of a forced sale or liquidation of the business in order to pay death taxes and other costs Tax-favored withdrawal of funds from the corporation at the death of the stockholder would be useful Redemption of IRC Section 306 stock is desirable When Is Use Of A Section 303 Redemption Appropriate?

3. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 The redeemed stock must be included in the decedent’s gross estate for federal estate tax purposes The value for federal estate tax purposes of all stock of the corporation that is included in determining the value of the decedent’s gross estate must be –More than 35% of the excess of The value of the gross estate over The sum allowable as a deduction under IRC Sections 2053 (estate expense, indebtedness, and taxes) and 2054 (losses) What Are The Requirements?

4. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Only an amount equal to the total of –All estate, inheritance, legacy and succession taxes (including GST taxes) and interest imposed thereon by reason of decedent’s death –Funeral and administration expenses (whether or not claimed as a deduction on the federal estate tax return) –Can be redeemed and receive favorable income tax treatment Any excess –Will be taxed under Section 302 rules as a dividend to the seller (executor or heir from whom stock is being redeemed), or –May qualify for favorable tax treatment under Section 302 (no taxable gain due to step-up in basis at decedent’s death) What Are The Requirements?

5. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 A redemption under Section 303 will qualify for favorable tax treatment only to the extent that –Interest of a shareholder whose stock is redeemed is reduced either –Directly or indirectly through a binding obligation to contribute toward the payment of the decedent’s administration expenses and death taxes Example –Gross estate $1,250,000; admin. and funeral costs $250,000; no other deductible expenses –To qualify for a Section 303 redemption the value of the stock must exceed $350,000 {35% of ($1,250,000 - $250,000)} What Are The Requirements?

6. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 Example: –Aaron, a widower who dies in 2010, owns 75% of a corporation –His son Joshua owns the remaining 25% –Aaron’s stock is valued at $6,000,000 –His gross estate less allowable deductions equals $10,000,000 –There is minimal estate liquidity –Assuming Aaron’s estate and inheritance taxes and other death-related expenses are projected to be about $4,000,000, the corporation would purchase $4,000,000 of insurance on Aaron’s life How Is It Done?

7. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 How Is It Done?

8. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Example Steps: 1)At Aaron’s death his stock will pass to his estate 2)The corporation receives the insurance proceeds on Aaron’s life 3)The corporation uses the proceeds to pay Aaron’s estate for the stock qualifying for the Section 303 redemption 4)The estate transfers stock with a value equal to the money it receives to the corporation 5)Aaron’s estate uses the cash to pay federal and state death taxes, admin. and funeral expenses How Is It Done?

9. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 The amount paid by the estate should not be treated as a dividend distribution –It will be treated as the “exchange price” for the stock and will result in no gain being recognized by the estate, if –The basis of the stock has been stepped-up by reason of being included in the shareholder’s estate, unless –The stock was a gift to the decedent within one year of his death and the property passes from the decedent back to the donor or the donor’s spouse Tax Implications

10. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 To the extent the price paid to the estate exceeds the estate’s basis, the estate will pay a tax on any such gain Under the step-up in basis rules, a Section 303 redemption typically results in no adverse income tax consequences to the shareholder (executor of the estate) from whom the corporation made the redemption Tax Implications

11. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Insurance premiums paid on the life of the insured stockholder are not income tax deductible by the corporation Proceeds of a key person life insurance paid to the corporation are federal income tax free, but may be subject to corporate AMT tax Section 303 redemptions are specifically exempt from attribution (constructive ownership) problems, –Helping to make redemptions from family corporations possible without the threat of dividend treatment Tax Implications

12. Section 303 Stock Redemption Chapter 41 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 To qualify an aggregate ownership interest in two or more corporations for purposes of meeting the “more than 35% of adjusted gross estate” test, there must be –At least 20% in value of each corporation included in decedent’s estate In determining the 20% stock ownership interest by the decedent, –The surviving spouse’s half of the stock constituting community property may be included by treating it as if it had been included in determining the value of the gross estate of the decedent Issues In Community Property States