Question

19. Claude, a 50 percent shareholder in the Loget Corporation, dies. The remaining stock in the corporation is owned by Claude’s son, the sole beneficiary of Claude’s estate. More than one-half of the value of his adjusted gross estate consists of stock in the Longet Corporation. The attribution rules would cause Claude’s estate to have taxable dividend income in the event stock was redeemed to raise cash for payment of estate tax. Explain how code Sec 303 mitigates this situation.

Attach Internal Revenue Code Section

Answer 1

After the death of one of its shareholders, a closely held corporation often redeems shares from the descendants estate. In the abscense of Section 303, the estate would have been required to report such distribution as a dividend under section 301 after applying section 302 redemption analysis and incorporating the family attribution rules. This will cause hardships for many family businesses who will be forced to liquidate in order to pay estate and other death taxes.

So here section 303 comes to the foreplay which provides such redemption of shares on the event of death of one of the shareholder of closely held corporation to be treated as sale or exchange and not as dividend. Sale or exchange treatment will result in capital gain taxes but since the redemption occurs after death, there is also a step-up in basis, so there is no capital gains tax.

However to avail this benefit the following criteria shall be satisfied:

1. The stock to be redeemed must be in the taxable estate.

The value of all stock of the redeeming corporation, which is includable in the deceased businessowner's gross estate, must exceed 35% of the adjusted gross estate (gross estate less allowable deductions). Stock of two or more corporations will be treated as that of one corporation provided 20% or more of all the value of all the outstanding stock of each corporation is includable in the decedent's gross estate.

3. Redemption limited to sum of death taxes and funeral taxes and administration expense

4. Stock must be redeemed within certain windows of time.

5. Stock must be redeemed from the deceased shareholder's estate

This is how Section 303 helps to mitigate the situation in the above case. In the above case more than one-half of the value of Claude's adjusted gross estate consists of stock in the Longet Corporation which is more than 35% and assuming all the other conditions gets satisfied we can treat this redemption as sale or exchange which would otherwise have caused Claude’s estate to have taxable dividend income in the event stock was redeemed to raise cash for payment of estate tax.