Section 304: Stock Redemptions Through Related Brother-Sister Corporations

How Section 304 Works:

  1. The redemption of a small number of shares out of a relatively large number of shares will be treated as a dividend
  2. The sale of these same shares to an unrelated party will likely generate capital gain treatment
  3. What about when the sale of shares by the shareholder are sold to a related party? This is what Section 304 deals with.

Section 304 Creates the Potential for Dividend Treatment

  1. Two types of Section 304 transactions exist:
    1. Brother-Sister Sales
    2. Parent-Subsidiary Sales

Requirements of Brother-Sister Sales

  1. Shareholder (or shareholders) of Issuer “I” sell shares to Acquirer “A” in exchange for cash or property
  2. Shareholder(s) must be in control of both “I” and “A”
  3. Control is defined as owning 50% or more by vote or value (Section 304(c))
  4. For purpose of control, the attribution rules apply
    1. In terms of attribution rules, the 50% corporation-shareholder test is reduced to 5%

Section 304 Example of a Redemption through Related Corporations

  • John owns two corporations: ABC and DEF
  • John decides to sell 20% of ABC to DEF in exchange for $300,000
  • On the surface, this looks like a sale or exchange
  • But in reality, Chris still indirectly owns everything… he owns both corporations, whether or not DEF now owns 20% of ABC
  • It’s pretty clear that the $300,000 will be treated as a dividend in this situation

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