11

CORPORATE TAXATION ICORPORATE TAXATION I

TodayToday• Review Section 305 – Stock DividendsReview Section 305 – Stock Dividends• Problems on Page 308Problems on Page 308• Chamberlin v. CommissionerChamberlin v. Commissioner• S Corp EligibilityS Corp Eligibility• Problems on Page 690Problems on Page 690• Problems on Page 695Problems on Page 695

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Section 305 – Stock DistributionsSection 305 – Stock Distributions

Is a distribution of Stock a taxable event?Is a distribution of Stock a taxable event?• Is this just increasing the number of Is this just increasing the number of

“certificates” without a meaningful “certificates” without a meaningful change in ownership percentage? change in ownership percentage? Eisner Eisner v. Macomberv. Macomber

• General Rule is NO! [§ 305(a)]General Rule is NO! [§ 305(a)] ExceptionsExceptions

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Section 305 – Stock DistributionsSection 305 – Stock Distributions General Rule is NO! [§ 305(a)]General Rule is NO! [§ 305(a)]

• Exceptions:Exceptions: Stock dividends where any shareholder may elect to receive Stock dividends where any shareholder may elect to receive

either cash or property instead of the stock [§ 305(b)(1)]either cash or property instead of the stock [§ 305(b)(1)] Stock dividends that have the effect of increasing the stock Stock dividends that have the effect of increasing the stock

of some shareholders and property of others [§ 305(b)(2)]of some shareholders and property of others [§ 305(b)(2)] Stock dividends that result in some shareholders getting Stock dividends that result in some shareholders getting

preferred an some getting common stock[§ 305(b)(3)]preferred an some getting common stock[§ 305(b)(3)] Any distribution as to preferred stock [§ 305(b)(4)]Any distribution as to preferred stock [§ 305(b)(4)]

• Other than an increase to compensate for a stock splitOther than an increase to compensate for a stock split Distribution of convertible preferred stock that is convertible Distribution of convertible preferred stock that is convertible

[§ 305(b)(5)][§ 305(b)(5)]• Unless no disproportionate result (company’s burden)Unless no disproportionate result (company’s burden)

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Problems on Page 308, Problem 1Problems on Page 308, Problem 1

Hill Corporation

Frank100 Class A

Fay50 Class B

Joyce50 Class B

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Problems on Page 308Problems on Page 308

1(a) – Distribution of Convertible stock pro-rata1(a) – Distribution of Convertible stock pro-rata• NO PROBLEMNO PROBLEM

1(b) – Pro rata distribution, but option to take cash 1(b) – Pro rata distribution, but option to take cash in lieu of the stockin lieu of the stock• Violates Violates § 305(b)(1)§ 305(b)(1)

1(c) – Distribution of A on A and Cash on B1(c) – Distribution of A on A and Cash on B• Violates Violates § 305(b)(2)§ 305(b)(2)

1(d) – Distribution of preferred stock to Class A 1(d) – Distribution of preferred stock to Class A holdersholders• Violates Violates § 305(b)(2) – it has the effect of increasing Class § 305(b)(2) – it has the effect of increasing Class

A shareholders’ ownership of Hill E&P and AssetsA shareholders’ ownership of Hill E&P and Assets

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Problems on Page 308Problems on Page 308 1(e) – Distribution of preferred stock to Class A 1(e) – Distribution of preferred stock to Class A

holders that is subordinated to Class B shareholdersholders that is subordinated to Class B shareholders• NO PROBLEM, since it does not affect Class B shareholdersNO PROBLEM, since it does not affect Class B shareholders

1(f) – Stock split without an adjustment of the 1(f) – Stock split without an adjustment of the conversion ration of the preferred shareholdersconversion ration of the preferred shareholders• Violates Violates § 305(b)(2)§ 305(b)(2)

1(g) – Stock split 1(g) – Stock split withwith an adjustment of the an adjustment of the conversion ration of the preferred shareholdersconversion ration of the preferred shareholders• NO PROBLEM, it falls within the exception to NO PROBLEM, it falls within the exception to § 305(b)(4)§ 305(b)(4)

1(h) – Distribution of Class A on Class A and non-1(h) – Distribution of Class A on Class A and non-convertible preferred on Class B.convertible preferred on Class B.• Violates Violates § 305(b)(3)§ 305(b)(3)

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Problems on Page 308Problems on Page 308

1(i) – Distribution of Class A on Class A and 1(i) – Distribution of Class A on Class A and convertible (any time over the next 20 years at convertible (any time over the next 20 years at today’s prices) preferred on Class B.today’s prices) preferred on Class B.• Issue is whether the company can establish to the Issue is whether the company can establish to the

Commissioner that the preferred will be converted Commissioner that the preferred will be converted § § 305(b)(5)305(b)(5)

20-years20-years Current PricesCurrent Prices

• Probably OK!Probably OK!

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Problems on Page 308, Problem 2Problems on Page 308, Problem 2

Z Corporation

A500 Shares

(50%)

B300 Shares

(30%)

C200 Shares

(20%)

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Problems on Page 308, Problem 2Problems on Page 308, Problem 2

Z Corporation

A450 Shares

(50% -> 47%)

B300 Shares

(30% -> 32%)

C200 Shares

(20% -> 21%)

Does the Redemption of the 50 shares qualify for exchange treatment under § 302(b)?

If not, would it cause any problems for B & C under § 305(c)

50 Shares

1010

Problems on Page 308, Problem 2Problems on Page 308, Problem 2

Z Corporation

A400 Shares

(47% -> 44%)

B300 Shares

(32% -> 33%)

C200 Shares

(21% -> 22%)

Does the Redemption of the 50 shares qualify for exchange treatment under § 302(b)?

If not, would it cause any problems for B & C under § 305(c)

50 Shares

1111

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

1212

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

Preferred Stock

1313

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

Preferred Stock

InsuranceCompany$$$

1414

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

Preferred Stock

InsuranceCompany

1515

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

Preferred Stock

InsuranceCompany

$$$$

1616

Chamberlin v. CommissionerChamberlin v. CommissionerThe “Preferred Stock Bailout”The “Preferred Stock Bailout”

Metal Moulding Corporation

Chamberlin Family

Common Stock

$$$NET RESULT:Preferred Stock Bailout

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S Corp EligibilityS Corp Eligibility Small Business Corporations ONLYSmall Business Corporations ONLY

• No more than 100 shareholdersNo more than 100 shareholders For Nominee, Guardians, Custodians, or Agents each For Nominee, Guardians, Custodians, or Agents each

beneficiary is counted toward the 100 shareholder beneficiary is counted toward the 100 shareholder limitationlimitation

• Only shareholders who are individuals, estates, certain Only shareholders who are individuals, estates, certain types of trusts, and tax exempt organizationstypes of trusts, and tax exempt organizations

• No corporate, partnership, ineligible trusts, or No corporate, partnership, ineligible trusts, or nonresident alien shareholdersnonresident alien shareholders

• No more than ONE class of stockNo more than ONE class of stock S Corporations may NOW have subsidiariesS Corporations may NOW have subsidiaries

• For S subsidiaries, the Parent must make a Q-Sub For S subsidiaries, the Parent must make a Q-Sub Election (Qualified Subchapter S Subsidiary Election)Election (Qualified Subchapter S Subsidiary Election)

1818

Problems on Page 690Problems on Page 690

1(a) – 99 Shareholders plus A and his brother, B1(a) – 99 Shareholders plus A and his brother, B• If a family election is made then the corporation has not If a family election is made then the corporation has not

violated the 100 shareholder limitationviolated the 100 shareholder limitation 1(b) – 99 Shareholders plus A and his wife, B 1(b) – 99 Shareholders plus A and his wife, B

(some of the shares are held as separate (some of the shares are held as separate property)property)• Husband and wife are a single shareholder for purposes Husband and wife are a single shareholder for purposes

of the 100 shareholder limitation regardless of how the of the 100 shareholder limitation regardless of how the shares are heldshares are held

1(c) – Same as (b) above, except that B leaves 1(c) – Same as (b) above, except that B leaves the shares when she dies to her friend, Fthe shares when she dies to her friend, F• OK, until F actually takes ownership of the sharesOK, until F actually takes ownership of the shares

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Problems on Page 690Problems on Page 690

1(d) – 99 Shareholders plus a voting trust with 1(d) – 99 Shareholders plus a voting trust with three beneficial owners.three beneficial owners.• Each beneficial owner is counted toward the 100 Each beneficial owner is counted toward the 100

shareholder limitation; therefore, this would blow the shareholder limitation; therefore, this would blow the electionelection

1(e) – 99 Shareholders plus a revocable, grantor 1(e) – 99 Shareholders plus a revocable, grantor trust.trust.• revocable, grantor trust is deemed to be owned by the revocable, grantor trust is deemed to be owned by the

grantor only. He still must be a “qualified” individual grantor only. He still must be a “qualified” individual (citizen or resident alien)(citizen or resident alien)

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Problems on Page 690Problems on Page 690

1(f) –99 Shareholders plus a “qualifies subchapter 1(f) –99 Shareholders plus a “qualifies subchapter S trust”S trust”• Ok provided that it meets the definitions of § 1361(d)(3)Ok provided that it meets the definitions of § 1361(d)(3)

Only one income beneficiary during the life of the Only one income beneficiary during the life of the current income beneficiarycurrent income beneficiary

Any corpus distributed during the life of the Any corpus distributed during the life of the beneficiary may only be distributed to the beneficiary beneficiary may only be distributed to the beneficiary

Income beneficiary’s interest will terminate on death Income beneficiary’s interest will terminate on death or termination of the trustor termination of the trust

If terminated during the life of the income If terminated during the life of the income beneficiary, all assets must be distributed to the beneficiary, all assets must be distributed to the income beneficiary income beneficiary

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Problems on Page 690Problems on Page 690

1(g) – 100 Shareholders and the S corporation 1(g) – 100 Shareholders and the S corporation forms a partnership with other 100 shareholder S forms a partnership with other 100 shareholder S corporations.corporations.• The partnership does not blow the electionThe partnership does not blow the election

1(h) – 2 classes of common stock outstanding 1(h) – 2 classes of common stock outstanding with the same financial rights, but different voting with the same financial rights, but different voting rights. A 3rights. A 3rdrd class of stock with different financial class of stock with different financial rights that is unissued.rights that is unissued.• Only concerned with outstanding shares. The different Only concerned with outstanding shares. The different

voting rights to NOT create a second “class” of stock for voting rights to NOT create a second “class” of stock for purposes of § 1361(c)(4)purposes of § 1361(c)(4)

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Problems on Page 690Problems on Page 690

1(i) – 2 classes of common stock outstanding with 1(i) – 2 classes of common stock outstanding with the same financial rights, except that they are the same financial rights, except that they are intended to compensate for different tax rates.intended to compensate for different tax rates.• The different financial rights (i.e. they are not identical) The different financial rights (i.e. they are not identical)

to DO create a second “class” of stock for purposes of § to DO create a second “class” of stock for purposes of § 1361(c)(4)1361(c)(4)

1(j) – 4 shareholders who each own a bond from 1(j) – 4 shareholders who each own a bond from the corporation in proportionate amounts that the corporation in proportionate amounts that pay fixed interest.pay fixed interest.• Although the bonds are probably going to be viewed as Although the bonds are probably going to be viewed as

“equity”, they do not create a 2“equity”, they do not create a 2ndnd class of stock. class of stock.