26 C.F.R. § 1.302-4

Termination of shareholder's interest

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Section 302(b)(3) provides that a distribution in redemption of all of the stock of the corporation owned by a shareholder shall be treated as a distribution in part or full payment in exchange for the stock of such shareholder. In determining whether all of the stock of the shareholder has been redeemed, the general rule of section 302(c)(1) requires that the rules of constructive ownership provided in section 318(a) shall apply. Section 302(c)(2), however, provides that section 318(a)(1) (relating to constructive ownership of stock owned by members of a family) shall not apply where the specific requirements of section 302(c)(2) are met. The following rules shall be applicable in determining whether the specific requirements of section 302(c)(2) are met:

(a) Statement. The agreement specified in section 302(c)(2)(A)(iii) shall be in the form of a statement entitled, “STATEMENT PURSUANT TO SECTION 302(c)(2)(A)(iii) BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER OR RELATED PERSON, AS THE CASE MAY BE], A DISTRIBUTEE (OR RELATED PERSON) OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF DISTRIBUTING CORPORATION].” The distributee must include such statement on or with the distributee's first return for the taxable year in which the distribution described in section 302(b)(3) occurs. If the distributee is a controlled foreign corporation (within the meaning of section 957), each United States shareholder (within the meaning of section 951(b)) with respect thereto must include this statement on or with its return. The distributee must represent in the statement—

(1) THE DISTRIBUTEE (OR RELATED PERSON) HAS NOT ACQUIRED, OTHER THAN BY BEQUEST OR INHERITANCE, ANY INTEREST IN THE CORPORATION (AS DESCRIBED IN SECTION 302(c)(2)(A)(i)) SINCE THE DISTRIBUTION; and

(2) THE DISTRIBUTEE (OR RELATED PERSON) WILL NOTIFY THE INTERNAL REVENUE SERVICE OF ANY ACQUISITION, OTHER THAN BY BEQUEST OR INHERITANCE, OF SUCH AN INTEREST IN THE CORPORATION WITHIN 30 DAYS AFTER THE ACQUISITION, IF THE ACQUISITION OCCURS WITHIN 10 YEARS FROM THE DATE OF THE DISTRIBUTION.

(b) Substantiation information. The distributee who files an agreement under section 302(c)(2)(A)(iii) shall retain copies of income tax returns and any other records indicating fully the amount of tax which would have been payable had the redemption been treated as a distribution subject to section 301.

(c) Stock of parent, subsidiary or successor corporation redeemed. If stock of a parent corporation is redeemed, section 302(c)(2)(A), relating to acquisition of an interest in the corporation within 10 years after termination shall be applied with reference to an interest both in the parent corporation and any subsidiary of such parent corporation. If stock of a parent corporation is sold to a subsidiary in a transaction described in section 304, section 302(c)(2)(A) shall be applicable to the acquisition of an interest in such subsidiary corporation or in the parent corporation. If stock of a subsidiary corporation is redeemed, section 302(c)(2)(A) shall be applied with reference to an interest both in such subsidiary corporation and its parent. Section 302(c)(2)(A) shall also be applied with respect to an interest in a corporation which is a successor corporation to the corporation the interest in which has been terminated.

(d) Redeemed shareholder as creditor. For the purpose of section 302(c)(2)(A)(i), a person will be considered to be a creditor only if the rights of such person with respect to the corporation are not greater or broader in scope than necessary for the enforcement of his claim. Such claim must not in any sense be proprietary and must not be subordinate to the claims of general creditors. An obligation in the form of a debt may thus constitute a proprietary interest. For example, if under the terms of the instrument the corporation may discharge the principal amount of its obligation to a person by payments, the amount or certainty of which are dependent upon the earnings of the corporation, such a person is not a creditor of the corporation. Furthermore, if under the terms of the instrument the rate of purported interest is dependent upon earnings, the holder of such instrument may not, in some cases, be a creditor.

(e) Acquisition of assets pursuant to creditor's rights. In the case of a distributee to whom section 302(b)(3) is applicable, who is a creditor after such transaction, the acquisition of the assets of the corporation in the enforcement of the rights of such creditor shall not be considered an acquisition of an interest in the corporation for purposes of section 302(c)(2) unless stock of the corporation, its parent corporation, or, in the case of a redemption of stock of a parent corporation, of a subsidiary of such corporation is acquired.

(f) Constructive ownership rules applicable. In determining whether an entire interest in the corporation has been terminated under section 302(b)(3), under all circumstances paragraphs (2), (3), (4), and (5) of section 318(a) (relating to constructive ownership of stock) shall be applicable.

(g) Avoidance of Federal income tax. Section 302(c)(2)(B) provides that section 302(c)(2)(A) shall not apply—

(1) If any portion of the stock redeemed was acquired directly or indirectly within the 10-year period ending on the date of the distribution by the distributee from a person, the ownership of whose stock would (at the time of distribution) be attributable to the distributee under section 318(a), or

(2) If any person owns (at the time of the distribution) stock, the ownership of which is attributable to the distributee under section 318(a), such person acquired any stock in the corporation directly or indirectly from the distributee within the 10-year period ending on the date of the distribution, and such stock so acquired from the distributee is not redeemed in the same transaction,unless the acquisition (described in subparagraph (1) of this paragraph) or the disposition by the distributee (described in subparagraph (2) of this paragraph) did not have as one of its principal purposes the avoidance of Federal income tax. A transfer of stock by the transferor, within the 10-year period ending on the date of the distribution, to a person whose stock would be attributable to the transferor shall not be deemed to have as one of its principal purposes the avoidance of Federal income tax merely because the transferee is in a lower income tax bracket than the transferor.

(h) Effective/applicability date. Paragraph (a) of this section applies to any taxable year beginning on or after May 30, 2006. However, taxpayers may apply paragraph (a) of this section to any original Federal income tax return (including any amended return filed on or before the due date (including extensions) of such original return) timely filed on or after May 30, 2006. For taxable years beginning before May 30, 2006, see § 1.302-4 as contained in 26 CFR part 1 in effect on April 1, 2006.

(Sec. 302(c)(2)(A)(iii) (68A Stat. 87; 26 U.S.C. 302 (c)(2)(A)(iii))) [T.D. 7535, 43 FR 10686, Mar. 15, 1978, as amended by T.D. 9264, 71 FR 30594, 30607, May 30, 2006; T.D. 9329, 72 FR 32796, 32808, June 14, 2007]

Notes of Decisions

Cited in 13 cases, 1963–1987 · leading case: Dunn v. Comm'r, 70 T.C. 715 (Tax Ct. 1978).

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Dunn v. Comm'r, 70 T.C. 715 (Tax Ct. 1978). · cites it 8× “, which provides: (d) For the purpose of section 302(c)(2)(A)(i) , a person will be considered to be a creditor only if the rights of such person with respect to the corporation are not greater or broader in scope than necessary for the enforcement of his claim.”

Cary v. Comm'r, 41 T.C. 214 (Tax Ct. 1963). · cites it 6× “This amended return, with agreement attached, was received by the district director at Dallas on August 3, 1959.”

Lynch v. Comm'r, 83 T.C. 597 (Tax Ct. 1984). · cites it 10× “He bases his contention on the fact that subsequent to the redemption, the petitioner agreed to subordinate the note to enable the corporation to take advantage of an opportunity to expand and to gain a competitive advantage. The petitioners contend that under section 1.”

Metzger Trust v. Comm'r, 76 T.C. 42 (Tax Ct. 1981). · cites it 2× “In partial payment for the 600 shares redeemed from Cecelia, MDI executed a promissory note to her in the amount of $ 627,110.”

Herbert A. Dunn & Georgia E. Dunn v. Comm'r of Internal Revenue, 615 F.2d 578 (2d Cir. 1980). “The Commissioner argues that the Treasury regulation, 26 C.F.R. § 1.302-4 (d), defining the term creditor in the context of § 302(b)(3) stock redemptions, is decisive of the case when it is applied to the postponement of payment provision of the Agreement.”

Bennion v. Comm'r, 88 T.C. 684 (Tax Ct. 1987). · cites it 2× “] The regulations under section 302 , interpreting the "interest other than an interest as a creditor" language of that section, state that such other interests include interests that are proprietary in nature and interests that are subordinate to the claims of the corporation's…”

Haft Trust v. Comm'r, 62 T.C. 145 (Tax Ct. 1974). · cites it 2× “In the first place, we would have to decide whether the filing of the agreements after the decisions in a case have been entered constitutes substantial compliance with the requirement of section 302(c)(2)(A)(iii) .”

Est. of Lennard v. Comm'r, 61 T.C. 554 (Tax Ct. 1974). · cites it 4× “7. Sec. 1.302-4(d), Income Tax Regs. , provides as follows: Sec.”

Columbia Iron & Metal Co. v. Comm'r, 61 T.C. 5 (Tax Ct. 1973). · cites it 2× “The regulations require that such statement be filed with a timely return for the year in which the redemption occurred.”

David Metzger Trust v. Comm'r of Internal Revenue, 693 F.2d 459 (5th Cir. 1982). “On February 10, 1976, Jacob, as trustee of the David Metz-ger Trust, delivered to the IRS a waiver agreement, executed pursuant to 26 C.F.R. § 1.302-4 and purporting to waive any future interest the trust might have in the corporation.”

Niedermeyer v. Comm'r, 62 T.C. 280 (Tax Ct. 1974). · cites it 2× “It is clear that, if they are to meet the requirements of the test of section 302(b)(3), petitioners must show that they completely terminated their stock interest in AT&T and in so doing they must be able to effect a waiver of the family attribution rules of section 318(a)(1)…”

Fehrs Fin. Co. v. Comm'r, 58 T.C. 174 (Tax Ct. 1972). · cites it 2× “With respect to the agreement described in section 302(c)(2)(A) (iii) , the requirements are set out in greater detail in section 1.”

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