SCOTUS Reports

Tag: Section 304

  • Merrill Lynch & Co., Inc. & Subsidiaries v. Commissioner of Internal Revenue, 131 T.C. 293 (2008): Application of Section 304 in Corporate Stock Redemptions

    Merrill Lynch & Co. , Inc. & Subsidiaries v. Commissioner of Internal Revenue, 131 T. C. 293 (U. S. Tax Court 2008)

    In a significant ruling, the U. S. Tax Court clarified the tax treatment of cross-chain stock sales under Section 304 of the Internal Revenue Code. The court held that only the actual transferor of the stock must be considered for determining whether a redemption qualifies as a complete termination under Section 302(b)(3), rejecting Merrill Lynch’s argument that the parent company’s constructive ownership should be factored in. This decision impacts how corporations structure stock sales within affiliated groups to achieve desired tax outcomes.

    Parties

    Merrill Lynch & Co. , Inc. & Subsidiaries (Petitioner) filed a petition against the Commissioner of Internal Revenue (Respondent) in the U. S. Tax Court. The case was appealed to the Court of Appeals for the Second Circuit, which affirmed in part and remanded the case back to the Tax Court for further consideration.

    Facts

    Merrill Lynch & Co. , Inc. (Merrill Parent) was the parent corporation of an affiliated group that filed consolidated federal income tax returns. Merrill Parent owned Merrill Lynch Capital Resources, Inc. (ML Capital Resources), which was engaged in equipment leasing and owned subsidiaries involved in lending and financing. In 1987, Merrill Parent decided to sell ML Capital Resources but wanted to retain certain assets within the affiliated group. Before the sale, ML Capital Resources sold the stock of seven subsidiaries to other corporations within the affiliated group (MLRealty, ML Asset Management, and Merrill, Lynch, Pierce, Fenner & Smith, Inc. ) in cross-chain sales. These sales were treated as Section 304 transactions. Subsequently, ML Capital Resources was sold to GATX Leasing Corp. and BCE Development, Inc. (GATX/BCE) for $57,363,817. Merrill Lynch reported a long-term capital loss from this sale, treating the proceeds of the cross-chain sales as dividends that increased ML Capital Resources’ earnings and profits, thereby increasing the basis of its stock.

    Procedural History

    The Commissioner issued a notice of deficiency, decreasing the reported long-term capital loss by $328,826,143, asserting that the cross-chain sales should be treated as redemptions under Section 302(a) and (b)(3), not dividends under Section 301. The Tax Court initially held that the cross-chain sales, integrated with the later sale of ML Capital Resources, resulted in a complete termination of ML Capital Resources’ interest in the subsidiaries, thus requiring exchange treatment under Section 302(a). The Court of Appeals for the Second Circuit affirmed this decision but remanded the case for the Tax Court to consider Merrill Lynch’s new argument that Merrill Parent’s continuing constructive ownership should be considered under Section 302(b)(3).

    Issue(s)

    Whether, for purposes of determining if a redemption is in complete termination under Section 302(b)(3) as applied through Section 304(a)(1), the continuing constructive ownership interest of the parent corporation (Merrill Parent) in the issuing corporations must be taken into account?

    Rule(s) of Law

    Section 304(a)(1) of the Internal Revenue Code treats the proceeds of a stock sale between commonly controlled corporations as a distribution in redemption of the acquiring corporation’s stock, to be analyzed under Sections 301 and 302. Section 302(b)(3) provides that a redemption is treated as a distribution in exchange for stock if it is in complete redemption of all the stock of the corporation owned by the shareholder. Section 304(b)(1) specifies that determinations under Section 302(b) must be made by reference to the stock of the issuing corporation.

    Holding

    The Tax Court held that only the interest of ML Capital Resources, the actual transferor of the stock, must be considered under Section 302(b)(3) as applied through Section 304(a)(1). Since ML Capital Resources’ interest in the issuing corporations was completely terminated upon its sale outside the affiliated group, the redemption was properly treated as a distribution in exchange for stock under Section 302(a), rather than as a dividend under Section 301.

    Reasoning

    The court’s reasoning focused on the plain language and structure of Sections 304 and 302. It emphasized that Section 304(a)(1) requires the person in control to actually receive property in exchange for transferring stock to warrant redemption analysis under Section 302. The court rejected Merrill Lynch’s argument that the parent company’s constructive ownership interest should be considered, finding that such an interpretation would contradict the statutory requirement that only the actual transferor’s interest be tested. The court also relied on the regulations under Section 304, which support the application of Section 302(b) tests only to the person transferring stock in exchange for property. The court concluded that the language and structure of the statutes mandate that only ML Capital Resources’ interest be considered, and since its interest was completely terminated, the redemption must be treated as an exchange.

    Disposition

    The Tax Court entered a decision in accordance with the mandate of the Court of Appeals for the Second Circuit, affirming that the cross-chain sales must be treated as a distribution in exchange for stock under Section 302(a).

    Significance/Impact

    This case clarifies the application of Section 304 in the context of corporate stock redemptions within affiliated groups. It establishes that only the actual transferor’s interest is relevant for determining whether a redemption qualifies as a complete termination under Section 302(b)(3). This ruling impacts how corporations structure internal stock sales to achieve desired tax outcomes, emphasizing the importance of considering the actual transferor’s ownership interest rather than the constructive ownership of parent entities. The decision also underscores the Tax Court’s adherence to statutory language and legislative intent in interpreting tax provisions, setting a precedent for future cases involving similar transactions.

  • Hurst v. Comm’r, 124 T.C. 16 (2005): Termination Redemption and Section 304 Treatment in Corporate Stock Transactions

    Hurst v. Commissioner, 124 T. C. 16 (2005)

    In Hurst v. Commissioner, the U. S. Tax Court upheld the tax treatment of Richard and Mary Ann Hurst’s sale of their stock in Hurst Mechanical, Inc. (HMI) and R. H. , Inc. (RHI) as a termination redemption under Section 302(b)(3) of the Internal Revenue Code. The court rejected the Commissioner’s late attempt to apply Section 304 to the RHI sale, emphasizing the importance of timely raising issues. The decision clarifies the boundaries of family attribution rules and the tax implications of health insurance benefits for shareholders in S corporations.

    Parties

    Richard E. and Mary Ann Hurst (Petitioners) v. Commissioner of Internal Revenue (Respondent)

    Facts

    Richard Hurst founded Hurst Mechanical, Inc. (HMI), an S corporation, which he and his wife Mary Ann owned entirely until 1997. They also owned R. H. , Inc. (RHI), a smaller HVAC company, equally. In 1997, as part of their retirement plan, they sold RHI to HMI and HMI redeemed 90% of Mr. Hurst’s stock, with the remaining 10% sold to their son Todd Hurst and two other employees. The transactions included cross-default and cross-collateralization provisions across stock redemption, lease agreements, and Mrs. Hurst’s continued employment at HMI. The Hursts reported these transactions as installment sales of long-term capital assets on their 1997 tax return, which the Commissioner challenged, recharacterizing the income as dividends and immediate capital gains.

    Procedural History

    The Commissioner issued a notice of deficiency for the Hursts’ 1997 tax year, determining a deficiency of $538,114 and an accuracy-related penalty of $107,622. 80. The Hursts filed a petition with the United States Tax Court. At trial, the focus was primarily on the HMI stock redemption, with the Commissioner later attempting to apply Section 304 to the RHI sale in posttrial briefing. The court’s review was de novo.

    Issue(s)

    Whether the redemption of Richard Hurst’s HMI stock qualified as a termination redemption under Section 302(b)(3) of the Internal Revenue Code?

    Whether the sale of the Hursts’ RHI stock to HMI should be treated as a redemption under Section 304 of the Internal Revenue Code?

    Whether the cost of Mrs. Hurst’s health insurance provided by HMI was taxable to her under Section 1372 of the Internal Revenue Code?

    Rule(s) of Law

    A redemption of stock qualifies as a termination redemption under Section 302(b)(3) if it results in a complete termination of the shareholder’s interest in the corporation, except as a creditor. Section 302(c)(2) provides that family attribution rules do not apply if the shareholder elects to have no interest other than as a creditor for at least 10 years.

    Section 304 treats certain stock purchases between related corporations as redemptions under Section 302, applicable when one or more persons are in control of each of two corporations and one acquires stock in the other from the person(s) in control.

    Under Section 1372(a), an S corporation employee who is a 2-percent shareholder must include the value of employer-paid health insurance in their gross income, subject to a deduction under Section 162(l)(1)(B).

    Holding

    The court held that the redemption of Mr. Hurst’s HMI stock qualified as a termination redemption under Section 302(b)(3), as he retained no interest other than as a creditor. The court did not rule on the Commissioner’s Section 304 argument regarding the RHI stock sale due to the issue being raised as a new matter posttrial. The court held that the cost of Mrs. Hurst’s health insurance was taxable to her as a 2-percent shareholder, subject to a 40% deduction under Section 162(l)(1)(B).

    Reasoning

    The court’s analysis for the HMI stock redemption focused on whether Mr. Hurst retained an interest in HMI other than as a creditor. The court found that the cross-default and cross-collateralization provisions did not constitute a prohibited interest, as they were consistent with common commercial practice and aimed to protect the Hursts’ creditor status. The court rejected the Commissioner’s argument that these provisions indicated a retained interest in HMI’s management or earnings.

    Regarding the RHI stock sale, the court declined to apply Section 304 as the issue was not raised until posttrial briefing, constituting a new matter rather than a new argument. The court emphasized the procedural importance of timely raising issues and noted that the Hursts had no opportunity to present evidence relevant to a Section 304 analysis.

    For Mrs. Hurst’s health insurance, the court applied Section 1372, finding her a 2-percent shareholder by attribution through her husband and son’s ownership of HMI stock, making the insurance premiums taxable to her, subject to a partial deduction.

    Disposition

    The court affirmed the termination redemption treatment of Mr. Hurst’s HMI stock sale and did not rule on the Section 304 issue regarding the RHI sale. The court upheld the taxability of Mrs. Hurst’s health insurance but allowed a 40% deduction. The accuracy-related penalty was not sustained.

    Significance/Impact

    This case clarifies the application of Section 302(b)(3) termination redemption rules, particularly the distinction between creditor interests and prohibited interests in the context of family-owned businesses. It underscores the procedural requirement for timely raising issues, as the Commissioner’s late introduction of Section 304 was deemed a new matter. The case also reinforces the tax treatment of health insurance benefits for 2-percent shareholders in S corporations, balancing the inclusion of such benefits in income with a partial deduction. The decision provides guidance on structuring stock sales and redemptions to achieve favorable tax treatment while maintaining creditor protection.

  • Combrink v. Comm’r, 117 T.C. 82 (2001): Application of Section 304 to Corporate Stock Transactions

    Combrink v. Commissioner of Internal Revenue, 117 T. C. 82, 2001 U. S. Tax Ct. LEXIS 57, 117 T. C. No. 8 (U. S. Tax Court 2001)

    In Combrink v. Comm’r, the U. S. Tax Court ruled on the tax implications of a stock transfer between related corporations. The court held that the transfer of LINKS stock to COST in exchange for debt relief must be treated as a redemption under Section 304(a) of the Internal Revenue Code, resulting in dividend income for the shareholder, Gary D. Combrink, to the extent of $161,885. 50. However, a portion of $12,247. 70 was exempted under Section 304(b)(3)(B) due to its use in acquiring the stock, thus not generating gain or loss. This decision clarifies the scope and application of Section 304, impacting how similar transactions are taxed in the future.

    Parties

    Gary D. and Lindy H. Combrink (Petitioners) v. Commissioner of Internal Revenue (Respondent). The Combrinks filed a timely petition with the U. S. Tax Court on August 10, 1999, following a determination of tax deficiency by the Commissioner for their 1996 taxable year.

    Facts

    Gary D. Combrink owned 100% of the stock in two corporations: Cost Oil Operating Company (COST) and Links Investment, Inc. (LINKS). COST, incorporated on January 7, 1983, operated working interests in oil and gas wells. LINKS, incorporated on November 12, 1992, was formed to open and operate a golf course. During 1995 and 1996, COST made remittances totaling $89,728. 73, which were treated as loans from COST to Combrink, followed by loans from Combrink to LINKS. Additionally, Combrink lent funds to LINKS, which were memorialized by promissory notes totaling $252,481. 03. On October 15, 1996, these notes were converted into one note of $77,481. 03 and additional paid-in capital of $175,000. 00. On December 1, 1996, Combrink transferred all his LINKS stock to COST in exchange for COST’s release of his $174,133. 20 liability to COST.

    Procedural History

    The Combrinks filed a timely joint 1996 U. S. Individual Income Tax Return, Form 1040, not reporting any income or loss from the transaction. The Commissioner determined a deficiency of $56,449. 00, asserting that $174,133. 20 should be included in income as a dividend. The Combrinks petitioned the U. S. Tax Court, which initially issued an opinion on May 15, 2001. However, due to a bankruptcy filing by the Combrinks on January 29, 2001, the proceedings were stayed, and the initial opinion was withdrawn on August 14, 2001. Following the lifting of the stay, the current opinion was issued on August 23, 2001.

    Issue(s)

    Whether the transfer of LINKS stock to COST in exchange for the release of Combrink’s liability to COST falls under the redemption provisions of Section 304(a) of the Internal Revenue Code, and if so, whether the transaction qualifies for the exception provided in Section 304(b)(3)(B)?

    Rule(s) of Law

    Section 304(a) of the Internal Revenue Code mandates that certain transactions involving shares in related corporations be recast as redemptions, subject to the tax treatment under Sections 301 and 302. Section 304(b)(3)(B) provides an exception for transactions involving the assumption of liability incurred to acquire the stock.

    Holding

    The court held that the transfer of LINKS stock to COST in exchange for debt release is subject to Section 304(a) and must be recast as a redemption to the extent of $161,885. 50, resulting in dividend income for Combrink. However, $12,247. 70 of the transaction is exempt under Section 304(b)(3)(B), as it was used to acquire the LINKS stock, and thus generates no gain or loss under Sections 351 and 357.

    Reasoning

    The court determined that the transaction met the two elements of Section 304(a): control of both corporations by Combrink and the exchange of stock for property (debt release). The court rejected the Combrinks’ policy-based arguments against applying Section 304(a), emphasizing that the statute’s plain language must be followed. Regarding the exception under Section 304(b)(3)(B), the court found that only $12,247. 70 of the liability was used to acquire LINKS stock, thus qualifying for the exception. The remaining $161,885. 50 did not meet the exception’s requirements, as the Combrinks failed to prove that the liability was incurred to acquire the stock. Consequently, the court applied Section 302 to determine the tax treatment, concluding that the transaction did not qualify for exchange treatment under any of the four categories of Section 302(b) and must be taxed as a dividend under Sections 301 and 302(d).

    Disposition

    The court held that Combrink received dividend income of $161,885. 50 in 1996, while $12,247. 70 of the transaction was exempt from gain or loss. The decision was to be entered under Rule 155 of the Tax Court Rules of Practice and Procedure.

    Significance/Impact

    Combrink v. Comm’r clarifies the application of Section 304 to transactions involving stock transfers between related corporations in exchange for debt relief. The decision underscores the importance of tracing the use of funds to determine eligibility for the Section 304(b)(3)(B) exception. It also reaffirms the broad scope of Section 304(a) and its application to transactions that may not appear to be traditional bailouts. This ruling has implications for tax planning involving related corporations and the structuring of debt and equity transactions to avoid unintended tax consequences.

  • Cox v. Commissioner, 73 T.C. 20 (1979): When Installment Sale Reporting is Precluded by Corporate Redemption Rules

    Cox v. Commissioner, 73 T. C. 20 (1979)

    Section 453 installment sale reporting is unavailable when a transaction is recharacterized as a corporate redemption under Section 304.

    Summary

    In Cox v. Commissioner, the taxpayers attempted to report the gain from selling their stock in New Roanoke Investment Corp. to Rudy Cox, Inc. (RCI) using the installment method under Section 453. However, the IRS recharacterized the transaction as a redemption under Section 304 due to the taxpayers’ control over both corporations. The Tax Court held that the transaction did not qualify as a “casual sale” for Section 453 purposes because it was treated as a distribution under Section 301, thereby requiring the gain to be reported in full in the year of the transaction rather than spread over time.

    Facts

    Rufus K. Cox, Jr. and Ethel M. Cox owned 100% of New Roanoke Investment Corp. (New Roanoke) as tenants by the entirety. On January 2, 1974, they transferred their New Roanoke stock to Rudy Cox, Inc. (RCI), a corporation solely owned by Rufus K. Cox, Jr. , in exchange for five promissory notes totaling $100,000, payable over five years. The Coxes reported the gain from this transfer on the installment method for their 1974 tax return. The IRS determined that the Coxes realized a long-term capital gain of $99,000 in 1974 and could not use the installment method because the transaction was not a “casual sale” but rather a redemption under Section 304.

    Procedural History

    The case was submitted without trial pursuant to Tax Court Rule 122. The IRS issued a notice of deficiency for the 1974 tax year, asserting that the gain should be fully reported in that year. The Coxes petitioned the Tax Court to contest this determination.

    Issue(s)

    1. Whether the Coxes’ transfer of New Roanoke stock to RCI qualified as a “casual sale” under Section 453(b)(1)(B), allowing them to report the gain on the installment method.

    Holding

    1. No, because the transaction was recharacterized as a redemption under Section 304 and thus treated as a distribution under Section 301, which precludes the use of the installment method under Section 453.

    Court’s Reasoning

    The court applied Section 304(a)(1), which treats the transfer of stock between related corporations as a redemption rather than a sale. Since the Coxes controlled both New Roanoke and RCI, the transfer was deemed a contribution to RCI’s capital followed by a redemption. The court emphasized that Section 304’s purpose is to prevent shareholders from “bailing out” corporate earnings at capital gains rates through related-party sales. The court found that the transaction, although formally structured as a sale, was in substance a redemption. As such, it did not meet the “casual sale” requirement of Section 453(b)(1)(B). The court also noted that Section 1. 301-1(b) of the Income Tax Regulations requires all corporate distributions to be reported in the year received, further supporting the denial of installment reporting. The court rejected the Coxes’ argument that the gain should be treated as from a “sale or exchange” under Section 301(c)(3)(A), stating that this provision does not provide the necessary “sale” for Section 453 purposes.

    Practical Implications

    This decision clarifies that taxpayers cannot use the installment method under Section 453 for transactions recharacterized as redemptions under Section 304. Practitioners must carefully analyze transactions between related corporations to determine if they will be treated as redemptions, which could impact the timing of income recognition. This case reinforces the importance of the substance over form doctrine in tax law, requiring attorneys to look beyond the structure of a transaction to its economic reality. The ruling may affect estate planning and corporate restructuring strategies, as it limits the ability to defer gain recognition through installment sales in certain related-party transactions. Subsequent cases, such as Estate of Leyman v. Commissioner, have cited Cox to support similar findings regarding the application of Section 304 and the unavailability of Section 453.

  • Virginia Materials Corp. v. Commissioner, 68 T.C. 398 (1977): No Taxable Distribution from Subsidiary’s Stock Purchase

    Virginia Materials Corp. v. Commissioner, 68 T. C. 398 (1977)

    A parent corporation does not constructively receive a taxable distribution when its subsidiary purchases the parent’s stock from a third party.

    Summary

    In Virginia Materials Corp. v. Commissioner, the Tax Court ruled that a parent corporation did not receive a taxable distribution when its wholly owned subsidiary purchased the parent’s stock from a shareholder. The case centered on the interpretation of Internal Revenue Code section 304, which deals with stock redemptions through related corporations. The court held that the subsidiary’s purchase did not trigger a taxable event for the parent, emphasizing that section 304’s purpose is to prevent shareholders from avoiding dividend taxation, not to tax the parent corporation on the transaction. This decision overturned prior rulings and clarified the tax implications of such transactions, providing guidance on how to structure similar deals to avoid unintended tax consequences.

    Facts

    Virginia Materials Corp. (the parent) was engaged in processing slag into industrial abrasives. Its wholly owned subsidiary, Tidewater Industrial Development Corp. (TIDC), was involved in leasing rolling equipment and land development. On March 16, 1970, TIDC purchased all of the parent’s stock held by General Slag Corp. for $400,000, using funds loaned by the parent. This transaction was designed to circumvent Virginia law, which prohibited the parent from redeeming its own stock directly. The IRS argued that the parent constructively received a $400,000 distribution from TIDC, subjecting it to tax. The parent contested this, asserting no taxable distribution occurred.

    Procedural History

    The IRS determined a tax deficiency against Virginia Materials Corp. for the taxable year ending September 30, 1970, and the case was brought before the U. S. Tax Court. The Tax Court considered the case under Rule 122, adopting the stipulated facts. Prior to this case, the Tax Court had ruled in Union Bankers Insurance Co. that a similar transaction resulted in a taxable distribution to the parent. However, in Helen M. Webb, the Tax Court overturned Union Bankers, a precedent followed in this case.

    Issue(s)

    1. Whether Virginia Materials Corp. constructively received a taxable distribution when its subsidiary, TIDC, purchased shares of the parent’s stock from General Slag Corp.
    2. If the first question is answered affirmatively, whether the amount of the taxable distribution is limited to the accumulated earnings and profits of TIDC.

    Holding

    1. No, because the court found that section 304 of the Internal Revenue Code does not create a taxable distribution to the parent corporation when its subsidiary purchases the parent’s stock from a third party.
    2. This issue was not reached due to the negative holding on the first issue.

    Court’s Reasoning

    The court’s decision hinged on the interpretation of section 304(a)(2) and (b)(2)(B) of the Internal Revenue Code. The court emphasized that these sections were designed to ensure that shareholders could not circumvent dividend taxation by selling stock to a controlled subsidiary. The court rejected the IRS’s argument that the parent should be taxed on the purchase price as a constructive dividend, relying on the Helen M. Webb case, which clarified that section 304 does not apply to the parent corporation in such transactions. The court noted that the legislative history and statutory language supported the view that no taxable distribution to the parent occurred. The court also distinguished this case from prior rulings like Union Bankers, which had been overturned in Webb.

    Practical Implications

    This ruling has significant implications for corporate tax planning. It allows parent corporations to structure stock purchases by subsidiaries without triggering a taxable event for the parent, provided the transaction is with a third party. This can be a useful tool for companies looking to manage their capital structure or buy out minority shareholders while minimizing tax liabilities. The decision clarifies that section 304 is aimed at preventing shareholders from avoiding dividend taxation, not at taxing the parent on the subsidiary’s stock purchase. Practitioners should note this ruling when advising clients on similar transactions and be aware that subsequent cases have followed this precedent, reinforcing its application in tax law.

  • Niedermeyer v. Commissioner, 62 T.C. 280 (1974): Applying Section 304 to Stock Sales Between Related Corporations

    Niedermeyer v. Commissioner, 62 T. C. 280 (1974)

    Section 304(a)(1) applies to treat stock sales between related corporations as redemptions, even when the seller does not directly own stock in the acquiring corporation.

    Summary

    In Niedermeyer v. Commissioner, the U. S. Tax Court ruled that the sale of AT&T common stock by Bernard and Tessie Niedermeyer to Lents Industries, a related corporation, was a redemption under Section 304(a)(1). The court found that despite the Niedermeyers’ lack of direct ownership in Lents, their sons’ control of both corporations triggered constructive ownership rules. The transaction did not qualify as an exchange under Section 302(b)(1) or (b)(3), resulting in the proceeds being taxed as dividends. This case highlights the application of constructive ownership rules and the importance of meeting specific tests for tax treatment as an exchange.

    Facts

    Bernard and Tessie Niedermeyer owned 22. 58% of AT&T’s common stock and 125 shares of its preferred stock. Their sons owned 67. 91% of AT&T’s common stock and 67% of Lents Industries’ common stock. On September 8, 1966, the Niedermeyers sold their AT&T common stock to Lents for $174,975. 12 and later donated their AT&T preferred stock to a charity. The IRS treated this sale as a dividend, not a capital gain, leading to a tax dispute.

    Procedural History

    The IRS assessed a deficiency against the Niedermeyers for 1966, treating the proceeds from the stock sale as a dividend. The Niedermeyers petitioned the U. S. Tax Court, arguing the sale should be treated as a capital gain. The Tax Court ruled in favor of the Commissioner, applying Section 304(a)(1) and determining the transaction did not qualify as an exchange under Section 302.

    Issue(s)

    1. Whether the sale of AT&T common stock by the Niedermeyers to Lents Industries was a redemption through the use of a related corporation under Section 304(a)(1).
    2. Whether the redemption qualified for treatment as an exchange under either Section 302(b)(1) or Section 302(b)(3).

    Holding

    1. Yes, because the Niedermeyers constructively owned stock in both AT&T and Lents, triggering Section 304(a)(1).
    2. No, because the redemption did not result in a meaningful reduction of the Niedermeyers’ proportionate interest in AT&T under Section 302(b)(1), and they did not completely terminate their interest in AT&T under Section 302(b)(3).

    Court’s Reasoning

    The court applied the constructive ownership rules of Section 318(a) to find that the Niedermeyers controlled both AT&T and Lents, thus triggering Section 304(a)(1). The court rejected arguments to avoid attribution rules based on family disputes, emphasizing the mandatory nature of these rules. For Section 302(b)(1), the court found that the Niedermeyers’ ownership decreased from 90. 49% to 82. 96% post-redemption, which was not a meaningful reduction. Under Section 302(b)(3), the court ruled that the Niedermeyers did not completely terminate their interest in AT&T due to retaining preferred stock until December 28, 1966, and failing to establish a firm plan to donate it earlier.

    Practical Implications

    This decision underscores the importance of understanding constructive ownership rules under Section 304 when structuring transactions between related corporations. It serves as a reminder that family disputes do not negate attribution rules. Practitioners should carefully analyze whether transactions qualify as exchanges under Section 302, considering the timing and completeness of interest termination. The case also highlights the necessity of documenting and executing plans to ensure favorable tax treatment. Subsequent cases, such as Coyle v. United States and Fehrs Finance Co. , have reinforced the application of Section 304 and the attribution rules.