Rev. Rul. 57-387

Advice has been requested whether a complete redemption by a corporation of all stock held by three adult sons can be considered a termination of interest under section 302(b)(3) of the Internal Revenue Code of 1954 where the distributees, who agreed to comply with the requirements of section 302(c)(2)(A), sold a portion of their stock originally acquired by gift from their parents to their father immediately before the redemption date.

A father, four sons, and the estate of the mother owned most of the common and preferred stock of a corporation. The father and the four sons were beneficiaries of the estate. The four sons acquired their stock by gifts from their parents during the period 1923 to 1951. These gifts of stock were made pursuant to their parents' long term plan to share the family enterprise with their children.

Three of the four sons were not officers, directors, or employees of the corporation and had no connection with the corporation except as shareholders. These three brothers desired to sell all of their stock in the corporation. Pursuant to a plan of severance between the interested parties and the corporation, the estate made distributions of property in complete discharge of the direct and indirect interests of the three brothers. These three individuals then disposed of all of the stock which they owned in the corporation by redemption or sale. It was the intention of these three individuals to completely terminate their interest in the corporation. Only the fourth brother was interested in remaining with their father in the enterprise.

As the first step, the executors of the estate distributed equally to each of the three sons shares of preferred stock of the corporation. Immediately after this distribution, the three sons sold a portion of their common and preferred stock to their father. The purchase price for such stock was paid with negotiable promissory notes to the respective sellers. Such notes bear interest, are not secured, and will mature in five years from the date of issue. The corporation then redeemed for cash the remaining shares of its stock held by the three brothers.

At issue is whether the redemption should be treated as payments in exchange for stock as provided by section 302(a) of the Internal Revenue Code of 1954. Inasmuch as the provisions of section 318 of the Code are applicable in determining the ownership of stock for the purposes of section 302, those persons whose stock were redeemed in the instant case are each considered to own all of the stock owned by their father. In view of this constructive ownership of stock, the redemptions can be treated as being in exchange for the stock only if each one equalifies under the provisions of section 302(b)(3) and (c)(2) of the code.

Section 302(c)(2)(A) provides that under certain conditions a shareholder is not considered to own the stock owned by his father so that a redemption (otherwise in order) may qualify as a termination of the shareholder's interest under section 302(b)(3). In the instant case, in view of the fact that the three sons acquired some of their stock from their father within the ten-year period specified in section 302(c)(2)(B), the provisions of section 302(c)(2)(A) are not applicable unless the acquisition and dispositions of the stock in each case did not have as one of its principal purposes the avoidance of Federal income tax.

In the instant case, all of the parties to the disposition of stock are adults. The only purpose of the sale of part of the distributees' stock to their father is to assure the termination of their interest in the corporation. The same tax result will obtain regardless of how their interest is terminated, so that tax avoidance is not considered to be one of the principal purposes of the disposition. The relatively small gifts of stock made years ago within the ten-year period were not in contemplation of the present redemption.

Accordingly, based solely upon the above facts, the Internal Revenue Service holds as follows:

(1) Neither the acquisition by the three sons of stock in the corporation from their father nor the disposition of part of their stock to their father had as one of its principal purposes the avoidance of Federal income tax within the meaning of section 302(c)(2)(B) of the Code.

(2) Provided that the three brothers each filed the agreement described in section 302(c)(2)(A)(iii) of the Code in accordance with the regulations prescribed for that section, then to the extent that the consideration received by them on the redemption of all the shares of stock of the corporation which they owned at that time was not greater than the fair market value of the shares so redeemed, such redemption should be treated in each case as a distribution in full payment for the stock in accordance with the provisions of section 302(a) and (b)(3) of the Code, but subject to the conditions stated in section 302(c)(2)(A) of the Code.

(3) As provided in section 1001 of the Code, gain or loss is realized by the three brothers in the amount of the difference between the adjusted basis of the stock of the corporation sold or redeemed and the consideration received therefor, to the extent that the consideration received was no greater than the fair market value of the stock at the date of sale or redemption. In accordance with section 1002 of such Code, the entire amount of the gain (if any) is recognized and constitutes capital gain, subject to the provisions of subchapter P of Chapter 1 of the Code. However, no loss on the sale or redemption of the stock is allowed as a deduction in computing taxable income in view of the provisions of section 267 of the Code.

In connection with the last sentence of the previous paragraph holding, in effect, that no loss on the redemption of the stock is allowable in view of the prohibition against allowing losses between related taxpayers under section 267 of the Code, consideration is given to Revenue Ruling 56-556, C.B. 1956-2, 177, which concerned both a sale and a redemption of stock between related taxpayers as defined in section 267. By inadvertence, the word `loss' was erroneously included in the ruling, and no mention was made of the effect of section 267 on losses between related taxpayers. Since a redemption under section 302(a) of the 1954 Code is no longer considered a distribution in liquidation as it was under sections 115(c) and (i) of the Internal Revenue Code of 1939 (see section 331(b) of the 1954 Code and the comments relative thereto on page 255 of Senate Report No. 1622, 83rd Congress, 2nd Session), no loss is allowable on redemptions qualifying under section 302(a) which involve related taxpayers within the purview of section 267 of the 1954 Code. In view of the foregoing, Revenue Ruling 56-556, supra , is hereby modified to the extent that losses between related taxpayers are disallowed.

The views expressed herein are not inconsistent with those expressed in Revenue Ruling 56-584, C.B. 1956-2, 179, in which the father and son owned less than 50 percent of the stock and the remainder was not attributable to them.