Stock Redemptions and Partial Liquidations Under the Internal Revenue Code of 1954

Abstract

When a shareholder transfers to a corporation its own stock in exchange for money or other property, the transaction may resemble either an ordinary sale of stock to an outsider in an arm s length bargain or the receipt by the shareholder of a dividend from the corporation. The "sale" analogy is appropriate, for example, when the owner of preferred stock instructs his broker to sell his stock and the broker by chance effects a sale to the corporation, which happens to be buying up its preferred stock at the time. The preferred shareholder ought to be able to treat the transaction like any other sale, reporting the difference between his adjusted basis and the sales price as capital gain or loss. On the other hand, when the owner of a one-man corporation having only common stock outstanding forgoes dividends for a period of years and then sells some of his shares to the corporation for cash, the transaction is more like a "dividend" than a "sale." Although the shareholder has surrendered some of his stock, his interest in the corporation's assets and his control of the corporation's fate are undisturbed. If the transaction were not taxed as a "dividend," moreover, the shareholder could enter upon a long-range program of intermittent transfers of stock to his corporation, employing tax-free stock dividends if necessary to replace his shares and to restore the corporation's stated capital for the benefit of nervous creditors. For shareholders who could adopt such a plan of intermittent "sales" of stock, the tax on dividend income would become a dead letter.