Redemption vs. purchase of S stock.

• Author: Wright, Carol E.
• Position: Brief Article

An S shareholder, P, wishes to acquire all the stock of the corporation's other shareholder, T. Should this transaction be structured as a corporate redemption or a shareholder purchase?

P has no cash for this acquisition, but plans to pay T with cash from corporate operations. The corporation has an accumulated adjustments account (AAA) of $40,000 and subchapter C earnings and profits (E&P) of $20,000. T's 40% stock interest will be purchased for $35,000.

A redemption of 40% of the stock would reduce AAA by 40%, or $16,000, under Sec. 1368(e)(1)(B) - leaving a $24,000 AAA balance for the remaining shareholder. The balance of the $35,000 redemption price would be treated as follows:

Reduction of E&P under Sec. 311(n)(7) $ 8,000 Treasury stock 11,000

If the transaction is structured as an installment purchase by P rather than a corporate redemption, AAA and E&P would not be immediately reduced by the purchase. However, as corporate distributions are made to P to provide funds for his installment payments to T, AAA would be reduced by the entire $35,000 These results are illustrated in Chart 1, above.

The total gain recognized by T due to the sale is the same, whether the transaction is a corporate redemption or a sale to P, because T's sales price and basis do not vary. P's basis in his stock also is the same, whether there is a corporate redemption or a purchase by...