Taxes and Business Decisions 34195% of the control and can qualify for a stock redemption only by selling all his
shares to the corporation.
Complete Termination of Interest
Carried to its logical conclusion, even a complete redemption would not qual-
ify for favorable tax treatment, since Lisa and Victor ’s stock would still be at-
tributed to Morris, leaving him in control of 67% of the corporation’s stock.
Fortunately, however, Code Section 302(b)(3) provides for a distribution to be
treated as a redemption if the stockholder ’s interest in the corporation is com-
pletely terminated. The attribution rules still apply under this section, but they
may be waived if the stockholder files a written agreement with the IRS re-
questing such a waiver. In such an agreement, Morris would be required to di-
vest himself of any relationship with the corporation other than as a creditor
and agree not to acquire any interest in the corporation for a period of 10 years.
In addition to the two safe harbors described in Sections 302(b)(2) and
(3), the Code, in Section 302(b)(1), grants redemption treatment to distribu-
tions which are “not essentially equivalent to a dividend.” Unlike the previous
two sections, however, the Code does not spell out a mechanical test for this
concept, leaving it to the facts and circumstances of the case. Given the obvi-
ous purpose of this transaction to transfer corporate assets to a stockholder on
favorable terms, it is unlikely that the IRS under this section would recognize
any explanation other than that of a dividend.
Thus, Morris’s plan to turn in his stock and receive a tax-favored distribu-
tion for his retirement will not work out as planned unless he allows the re-
demption of all his stock; resigns as a director, officer, employee, consultant,
and so forth; and agrees to stay away for a period of 10 years. He may, however,
accept a promissory note for all or part of the redemption proceeds and
thereby become a creditor of the corporation. Worse yet, if Lisa obtained her
shares from Morris within the 10 years preceding his retirement, even this
plan will not work unless the IRS can be persuaded that her acquisition of the
shares was for reasons other than tax avoidance. It may be advisable to ensure
that she acquires her shares from the corporation rather than from Morris, al-
though one can expect, given the extent of Morris’s control over the corpora-
tion, that the IRS would fail to appreciate the difference.
Employee Stock Ownership Plans
Although Morris should be relatively happy with the knowledge that he may be
able to arrange a complete redemption of his stock to fund his retirement and
avoid being taxed as if he had received a dividend, he may still believe that the
tax and economic effects of such a redemption are not ideal. Following such a
plan to its logical conclusion, the corporation would borrow the money to pay
for Morris’s stock. Its repayments would be deductible only to the extent of the
interest. At the same time, Morris would be paying a substantial capital gain