1. 1 CORPORATE TAXATION I Today Today Review Section 305 – Stock DividendsReview Section 305 – Stock Dividends Problems on Page 308Problems on Page 308 Chamberlin v. CommissionerChamberlin v. Commissioner S Corp EligibilityS Corp Eligibility Problems on Page 690Problems on Page 690 Problems on Page 695Problems on Page 695

2. 2 Section 305 – Stock Distributions Is a distribution of Stock a taxable event? Is a distribution of Stock a taxable event? Is this just increasing the number of “certificates” without a meaningful change in ownership percentage? Eisner v. MacomberIs this just increasing the number of “certificates” without a meaningful change in ownership percentage? Eisner v. Macomber General Rule is NO! [§ 305(a)]General Rule is NO! [§ 305(a)] Exceptions Exceptions

3. 3 Section 305 – Stock Distributions General Rule is NO! [§ 305(a)] General Rule is NO! [§ 305(a)] Exceptions:Exceptions: Stock dividends where any shareholder may elect to receive either cash or property instead of the stock [§ 305(b)(1)] Stock dividends where any shareholder may elect to receive either cash or property instead of the stock [§ 305(b)(1)] Stock dividends that have the effect of increasing the stock of some shareholders and property of others [§ 305(b)(2)] Stock dividends that have the effect of increasing the stock of some shareholders and property of others [§ 305(b)(2)] Stock dividends that result in some shareholders getting preferred an some getting common stock[§ 305(b)(3)] Stock dividends that result in some shareholders getting preferred an some getting common stock[§ 305(b)(3)] Any distribution as to preferred stock [§ 305(b)(4)] Any distribution as to preferred stock [§ 305(b)(4)] Other than an increase to compensate for a stock splitOther than an increase to compensate for a stock split Distribution of convertible preferred stock that is convertible [§ 305(b)(5)] Distribution of convertible preferred stock that is convertible [§ 305(b)(5)] Unless no disproportionate result (company’s burden)Unless no disproportionate result (company’s burden)

4. 4 Problems on Page 308, Problem 1 Hill Corporation Frank 100 Class A Fay 50 Class B Joyce 50 Class B

5. 5 Problems on Page 308 1(a) – Distribution of Convertible stock pro-rata 1(a) – Distribution of Convertible stock pro-rata NO PROBLEMNO PROBLEM 1(b) – Pro rata distribution, but option to take cash in lieu of the stock 1(b) – Pro rata distribution, but option to take cash in lieu of the stock Violates § 305(b)(1)Violates § 305(b)(1) 1(c) – Distribution of A on A and Cash on B 1(c) – Distribution of A on A and Cash on B Violates § 305(b)(2)Violates § 305(b)(2) 1(d) – Distribution of preferred stock to Class A holders 1(d) – Distribution of preferred stock to Class A holders Violates § 305(b)(2) – it has the effect of increasing Class A shareholders’ ownership of Hill E&P and AssetsViolates § 305(b)(2) – it has the effect of increasing Class A shareholders’ ownership of Hill E&P and Assets

6. 6 Problems on Page 308 1(e) – Distribution of preferred stock to Class A holders that is subordinated to Class B shareholders 1(e) – Distribution of preferred stock to Class A holders that is subordinated to Class B shareholders NO PROBLEM, since it does not affect Class B shareholdersNO PROBLEM, since it does not affect Class B shareholders 1(f) – Stock split without an adjustment of the conversion ration of the preferred shareholders 1(f) – Stock split without an adjustment of the conversion ration of the preferred shareholders Violates § 305(b)(2)Violates § 305(b)(2) 1(g) – Stock split with an adjustment of the conversion ration of the preferred shareholders 1(g) – Stock split with an adjustment of the conversion ration of the preferred shareholders NO PROBLEM, it falls within the exception to § 305(b)(4)NO PROBLEM, it falls within the exception to § 305(b)(4) 1(h) – Distribution of Class A on Class A and non- convertible preferred on Class B. 1(h) – Distribution of Class A on Class A and non- convertible preferred on Class B. Violates § 305(b)(3)Violates § 305(b)(3)

7. 7 Problems on Page 308 1(i) – Distribution of Class A on Class A and convertible (any time over the next 20 years at today’s prices) preferred on Class B. 1(i) – Distribution of Class A on Class A and convertible (any time over the next 20 years at today’s prices) preferred on Class B. Issue is whether the company can establish to the Commissioner that the preferred will be converted § 305(b)(5)Issue is whether the company can establish to the Commissioner that the preferred will be converted § 305(b)(5) 20-years 20-years Current Prices Current Prices Probably OK!Probably OK!

8. 8 Problems on Page 308, Problem 2 Z Corporation A 500 Shares (50%) B 300 Shares (30%) C 200 Shares (20%)

9. 9 Problems on Page 308, Problem 2 Z Corporation A 450 Shares (50% -> 47%) B 300 Shares (30% -> 32%) C 200 Shares (20% -> 21%) Does the Redemption of the 50 shares qualify for exchange treatment under § 302(b)? If not, would it cause any problems for B & C under § 305(c) 50 Shares

10. 10 Problems on Page 308, Problem 2 Z Corporation A 400 Shares (47% -> 44%) B 300 Shares (32% -> 33%) C 200 Shares (21% -> 22%) Does the Redemption of the 50 shares qualify for exchange treatment under § 302(b)? If not, would it cause any problems for B & C under § 305(c) 50 Shares

11. 11 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock

12. 12 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock Preferred Stock

13. 13 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock Preferred Stock Insurance Company $$$

14. 14 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock Preferred Stock Insurance Company

15. 15 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock Preferred Stock Insurance Company $$$$

16. 16 Chamberlin v. Commissioner The “Preferred Stock Bailout” Metal Moulding Corporation Chamberlin Family Common Stock $$$ NET RESULT: Preferred Stock Bailout

17. 17 S Corp Eligibility Small Business Corporations ONLY Small Business Corporations ONLY No more than 100 shareholdersNo more than 100 shareholders For Nominee, Guardians, Custodians, or Agents each beneficiary is counted toward the 100 shareholder limitation For Nominee, Guardians, Custodians, or Agents each beneficiary is counted toward the 100 shareholder limitation Only shareholders who are individuals, estates, certain types of trusts, and tax exempt organizationsOnly shareholders who are individuals, estates, certain types of trusts, and tax exempt organizations No corporate, partnership, ineligible trusts, or nonresident alien shareholdersNo corporate, partnership, ineligible trusts, or nonresident alien shareholders No more than ONE class of stockNo more than ONE class of stock S Corporations may NOW have subsidiaries S Corporations may NOW have subsidiaries For S subsidiaries, the Parent must make a Q-Sub Election (Qualified Subchapter S Subsidiary Election)For S subsidiaries, the Parent must make a Q-Sub Election (Qualified Subchapter S Subsidiary Election)

18. 18 Problems on Page 690 1(a) – 99 Shareholders plus A and his brother, B 1(a) – 99 Shareholders plus A and his brother, B If a family election is made then the corporation has not violated the 100 shareholder limitationIf a family election is made then the corporation has not violated the 100 shareholder limitation 1(b) – 99 Shareholders plus A and his wife, B (some of the shares are held as separate property) 1(b) – 99 Shareholders plus A and his wife, B (some of the shares are held as separate property) Husband and wife are a single shareholder for purposes of the 100 shareholder limitation regardless of how the shares are heldHusband and wife are a single shareholder for purposes of the 100 shareholder limitation regardless of how the shares are held 1(c) – Same as (b) above, except that B leaves the shares when she dies to her friend, F 1(c) – Same as (b) above, except that B leaves the shares when she dies to her friend, F OK, until F actually takes ownership of the sharesOK, until F actually takes ownership of the shares

19. 19 Problems on Page 690 1(d) – 99 Shareholders plus a voting trust with three beneficial owners. 1(d) – 99 Shareholders plus a voting trust with three beneficial owners. Each beneficial owner is counted toward the 100 shareholder limitation; therefore, this would blow the electionEach beneficial owner is counted toward the 100 shareholder limitation; therefore, this would blow the election 1(e) – 99 Shareholders plus a revocable, grantor trust. 1(e) – 99 Shareholders plus a revocable, grantor trust. revocable, grantor trust is deemed to be owned by the grantor only. He still must be a “qualified” individual (citizen or resident alien)revocable, grantor trust is deemed to be owned by the grantor only. He still must be a “qualified” individual (citizen or resident alien)

20. 20 Problems on Page 690 1(f) –99 Shareholders plus a “qualifies subchapter S trust” 1(f) –99 Shareholders plus a “qualifies subchapter S trust” Ok provided that it meets the definitions of § 1361(d)(3)Ok provided that it meets the definitions of § 1361(d)(3) Only one income beneficiary during the life of the current income beneficiary Only one income beneficiary during the life of the current income beneficiary Any corpus distributed during the life of the beneficiary may only be distributed to the beneficiary Any corpus distributed during the life of the beneficiary may only be distributed to the beneficiary Income beneficiary’s interest will terminate on death or termination of the trust Income beneficiary’s interest will terminate on death or termination of the trust If terminated during the life of the income beneficiary, all assets must be distributed to the income beneficiary If terminated during the life of the income beneficiary, all assets must be distributed to the income beneficiary

21. 21 Problems on Page 690 1(g) – 100 Shareholders and the S corporation forms a partnership with other 100 shareholder S corporations. 1(g) – 100 Shareholders and the S corporation forms a partnership with other 100 shareholder S corporations. The partnership does not blow the electionThe partnership does not blow the election 1(h) – 2 classes of common stock outstanding with the same financial rights, but different voting rights. A 3 rd class of stock with different financial rights that is unissued. 1(h) – 2 classes of common stock outstanding with the same financial rights, but different voting rights. A 3 rd class of stock with different financial rights that is unissued. Only concerned with outstanding shares. The different voting rights to NOT create a second “class” of stock for purposes of § 1361(c)(4)Only concerned with outstanding shares. The different voting rights to NOT create a second “class” of stock for purposes of § 1361(c)(4)

22. 22 Problems on Page 690 1(i) – 2 classes of common stock outstanding with the same financial rights, except that they are intended to compensate for different tax rates. 1(i) – 2 classes of common stock outstanding with the same financial rights, except that they are intended to compensate for different tax rates. The different financial rights (i.e. they are not identical) to DO create a second “class” of stock for purposes of § 1361(c)(4)The different financial rights (i.e. they are not identical) to DO create a second “class” of stock for purposes of § 1361(c)(4) 1(j) – 4 shareholders who each own a bond from the corporation in proportionate amounts that pay fixed interest. 1(j) – 4 shareholders who each own a bond from the corporation in proportionate amounts that pay fixed interest. Although the bonds are probably going to be viewed as “equity”, they do not create a 2 nd class of stock.Although the bonds are probably going to be viewed as “equity”, they do not create a 2 nd class of stock.