Rev. Rul. 79-67

ISSUE

Are the waiver of the attribution provisions of section 302(c)(2)(A) of the Internal Revenue Code of 1954 applicable to a redemption of stock under the circumstances described below?

FACTS

A son and his father's estate owned all the outstanding stock of X corporation. The son's mother was the sole beneficiary of the estate. The son was active and knowledgeable in the business of X. The mother never took any part in the affairs of X. The executor of the estate transferred the X stock owned by the father at his death to the mother. Thereafter, the estate remained in existence and the mother continued as beneficiary of the estate. Then, in order to allow the son to have complete ownership of X, the X stock held by the mother was redeemed by X for an amount of money equal to the fair market value of the stock. Section 303(a) of the Code was not applicable to the redemption because the value of the X stock included in the father's gross estate was less than the percentages specified in section 303(b)(2).

LAW AND ANALYSIS

The applicable sections of the Code and Income Tax Regulations thereunder are 302(a), 302(b)(3) and 1.302-4, relating to a redemption in complete termination of a shareholder's interest, and 302(c), 318, 1.302-4, and 1.318-1, relating to constructive ownership of stock.

The mother intended to treat the redemption as a termination of interest under section 302(b)(3) of the Code by complying with the provisions of section 302(c)(2)(A) so that her son's ownership of X stock would not be attributed to her under section 302(c)(1) and section 318(a)(1)(A)(ii). Thus, the redemption would be treated as an exchange under section 302(a). If not for the provisions of section 302(c)(2)(A), the mother would be considered to own all her son's X stock (which represented all the outstanding X stock after the redemption) before and after the redemption of all her X stock. Therefore, her redemption would not be treated as an exchange under section 302(a) but would be treated, pursuant to section 302(d), as a distribution subject to the provisions of section 301. United States v. Davis, 397 U.S. 301 (1970), rehearing denied, 397 U.S. 1071 (1970) [Ct. D. 1937], 1970-1 C.B. 62.

If the X stock had been redeemed directly from the estate, the redemption would not have qualified as an exchange under section 302(a) of the Code because an estate cannot waive the application of the attribution rules of section 318(a)(1). See Rev. Rul. 59-233, 1959-2 C.B. 106, and the nonacquiescence (1974-2 C.B. 5) in Crawford v. Commissioner, 59 T.C. 830 (1973). Therefore, the ownership of the remaining X stock held by the son would be attributed to the estate under section 318(a)(3)(A) by virtue of the mother's constructive ownership of that stock under section 318(a)(1)(A)(ii). Since the estate would be considered as owning all of the X stock after the redemption, the proceeds of the redemption would, pursuant to section 302(d), be treated as a distribution subject to section 301.

Section 302(c)(2)(A) of the Code provides that, if all the conditions specified are met, section 318(a)(1) will not apply in determining whether a redemption terminates a shareholder's interest within the meaning of section 302(b)(3). These conditions are that (i) immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee), other than an interest as a creditor, (ii) the distributee does not acquire any such interest (other than stock required by bequest or inheritance) within 10 years from the date of such distribution, and (iii) the distributee, at such time and in such manner as the Secretary by regulations prescribes, files an agreement to notify the Secretary of any acquisition described in clause (ii) and to retain such records as may be necessary. However, section 302(c)(2)(B)(i) provides that section 302(c)(2)(A) will not apply if any portion of the stock redeemed was acquired, directly or indirectly, within the 10-year period ending on the date of 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) and the acquisition had as one of its principal purposes the avoidance of federal income tax.

In the present case, the mother's acquisition of the X stock redeemed is described in section 302(c)(2)(B) of the Code. She acquired the stock within the 10-year period ending on the date of the redemption distribution from the estate whose ownership of stock would be attributed to her at the time of the distribution under section 318(a)(2)(A) since she had a beneficial interest in the estate at such time. Therefore, it is necessary to determine if the mother's acquisition of the X stock had as one of its principal purposes the avoidance of federal income tax within the meaning of section 302(c)(2)(B).

In the present case, neither the estate nor the mother will retain any control and/or economic interest in X after the redemption. The distribution of the X stock by the estate to the mother and the subsequent redemption of such stock by X from the mother was intended to enable the son to obtain complete control of X. Therefore, the avoidance of federal income tax will not be deemed to have been one of the principal purposes of the distribution of stock from the estate to the mother, notwithstanding the difference in tax treatment had the estate directly redeemed the stock.

HOLDING

The provisions of section 302(c)(2)(A) of the Code are applicable to the redemption of the mother's stock. Since the attribution rules of section 318(a)(1) will not be applicable to treat the mother as owning her son's X stock, she will have completely terminated her interest in X within the meaning of section 302(b)(3). Therefore, the redemption will be treated as an exchange under section 302(a), provided the mother files the agreement required under section 302(c)(2)(A)(iii).

EFFECT ON OTHER REVENUE RULINGS

In Rev. Rul. 68-388, 1968-2 C.B. 122, the transfer by an estate of all its stock of a corporation to its sole beneficiary, the mother of the only other corporate shareholder, in return for the cash received from a simultaneous redemption of the shares from the mother was considered transitory and without economic substance. The corporation was considered to have redeemed the stock from the estate which could not execute a valid waiver of the section 318(a)(1) attribution rules. Rev. Rul. 68-388 is distinguishable from this Revenue Ruling because here the mother transfers no assets to the estate in exchange for the stock. The substance of the transaction here is a redemption from the mother who continues to hold the proceeds of the redemption.

Rev. Rul. 68-388 is distinguished.