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Tax Planning

Tax Planning Case Study #1
FP 575

20 August, 2008
The issue presented is that fifteen years ago, Mr. and Mrs. Boyer created Brovo, a regular corporation, through which to operate a service business. The Boyers own all of Brovo’s 1,000 shares of stock with a $1.6 million aggregate tax basis. This makes it a privately held corporation under section 542(a) of Title 26 of the Internal Revenue Code. The corporate business has been extremely successful; at the beginning of the year, Brovo’s balance sheet reflected over $2 million retained earnings. According to a recent appraisal, its stock is worth $2.5 million. The Boyers want to withdraw $500,000 in exchange for 200 shares of their stock. The Boyers believe that they will recognize a $180,000 gain on this redemption, which will qualify as capital gain. The question is: are the Boyers correct in their analysis of the tax consequences of the redemption?
As a tax planner I’m going to assume that the Boyer’s are indeed paying appropriate dividends and that the computation of tax consequence on the above transaction does not fall into the category of a corporation that would be subject to a constructive dividend in this situation.
Title 26, Section 302 of the Internal Revenue Code (IRC) addresses distributions by corporations, specifically distributions in redemption of stock. It states that “If a corporation redeems its stock (within the meaning of section 317 (b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.” I believe that paragraph (1) applies because it states, “Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.” Thus, under section 302(d), the redemption is a distribution of property to which section 301 applies.
Section 301(a) states: Except as otherwise provided in this chapter, a distribution of property (as defined in section 317...