Shareholder redemption rights and sec. 305.

• Author: Gillette, Michele R.

Corporations often establish (stock buy-back plans allowing them to redeem a preset amount of their outstanding stock from shareholders. Often, the purpose of such plans is to increase the price of the company's shares. Once established, the plans generally remain in effect for a specified period or until a particular number of shares are redeemed. Such plans may create problems, however, if they are in effect when the corporation declares a stock dividend.

Sec. 305(a)(1), as amended, provides in relevant part that gross income does not include the amount of any distribution of a corporation's stock to its shareholders with respect to its stock. Sec. 305(b)(1) provides that a stock distribution shall be treated as a distribution of property to which Sec. 301 applies, if the distribution is, at the election of any of the shareholders, payable either in the corporation's stock or in property. Regs. Sec. 1.305-2(a) provides in part that if any shareholder has the right to elect to receive a distribution in money or other property, all shareholders are treated as receiving a distribution to which Sec. 301 applies, regardless of whether:

--the election or option is exercised or exercisable before or after the declaration of the distribution; or

--the election governing the nature of the distribution is provided in the declaration of the distribution or in the corporate charter or arises from the circumstances of the distribution.

If a corporation with a buy-back plan declares a stock dividend, a shareholder's redemption right under the plan might be viewed as an election by the shareholder to receive a stock split distribution in either stock or property under Sec. 305(b).

In Rev. Rul. 83-68, the IRS ruled that a distribution of a stock dividend by a Federal Home Loan Bank (FHLB) to its member banks would be treated as a Sec. 301 distribution pursuant to Sec. 305(b)(1), if at least one member of the bank had the right to have the distributed stock immediately redeemed. The Service reasoned that although the distribution was made in FHLB stock, at all times any member had a right to request the redemption of all or part of its stock in the FHLB (subject to Federal minimum requirements). The IRS noted that although the FHLB had discretion regarding whether to redeem the member's stock, it had established a policy to honor all redemption requests.

The Service modified Rev. Rul. 83-68 in Rev. Rul. 90-98, but only to the extent that Rev. Rul. 83-68...