Rev. Rul. 54-458

Advice is requested whether the Internal Revenue Service will continue to litigate the issue involved in Fern R. Zenz v. Quinlivan , 213 Fed.(2d) 914. In that case the sole stockholder of a corporation, desiring to dispose of her interest therein, sold part of her stock to a competitor and shortly thereafter sold the remainder of her stock to the corporation for an amount corresponding to its earned surplus. The corporation had accumulated large profits and the issue presented was whether the redemption of the corporation's stock for an amount corresponding to its earned surplus was substantially equivalent to the distribution of a taxable dividend. The court held that the purchase of the stock by the corporation was not a dividend to the selling stockholder under the terms of section 115(g) of the Internal Revenue Code of 1939 and that the redemption was taxable under the provisions of sections 115(c) and (i) of the Internal Revenue Code of 1939 as a partial liquidation.

Section 39.115(g)-1 of Regulations 118 provides in part that the question whether a distribution in connection with a cancellation or redemption of stock is essentially equivalent to the distribution of a taxable dividend depends upon the circumstances of each case. A cancellation or redemption by a corporation of a portion of its stock pro rata among all the shareholders will generally be considered as effecting a distribution essentially equivalent to a dividend distribution to the extent of the earnings and profits accumulated after February 28, 1913. On the other hand, a cancellation or redemption by a corporation of all of the stock of a particular shareholder, so that the shareholder ceases to be interested in the affairs of the corporation, does not effect a distribution of a taxable dividend.

The Internal Revenue Service is in accord with the conclusion reached in the decision mentioned under the particular facts involved. However, every case in which a stockholder sells part of his stock to new or existing stockholders and thereafter transfers the remainder to the corporation for redemption will be closely scrutinized to determine whether the selling stockholder `ceases to be interested in the affairs of the corporation' immediately after the redemption. Every such case will also be examined to determine whether any payment by the corporation for stock has the effect of a dividend to the stockholders who remain interested in the corporation. Cf. H. F. Wall , v. United States , 164 Fed.(2d) 462. In considering these questions all the facts and circumstances involved will be taken into account.