Stock Rights and Stock Dividends — Sections 305 and 306 (Portfolio 765)

Tax Management Portfolio, Stock Rights and Stock Dividends — Sections 305 and 306, No. 765-4th, analyzes the tax problems that arise in connection with dividend distributions of common or preferred stock and stock rights.

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Description

Tax Management Portfolio, Stock Rights and Stock Dividends — Sections 305 and 306, No. 765-4th, analyzes the tax problems that arise in connection with dividend distributions of common or preferred stock and stock rights. The Portfolio provides a framework for analysis of the tax treatment of such distributions by summarizing the early judicial determinations in this area and the statutory responses to such decisions. In addition, the cases, regulations and rulings applicable to stock dividends are discussed in detail. The Portfolio analyzes the issues as to when a distribution will be taxable; what factors must be considered in determining whether stock is common or preferred; when a distribution of preferred stock will be subject to taint under §306; and the basis and holding period issues surrounding stock distributions.

he Worksheets contain a checklist of key factors relating to stock dividends and stock rights; resolutions authorizing a stock dividend and the distribution of stock rights; an extract from a prospectus in which tracking stock was distributed; resolutions adopting a recapitalization plan; an extract from a prospectus issued by a publicly held corporation in which subscription rights were offered; and example computations.

Authors

James W. Forsyth

James W. Forsyth, B.S. (summa cum laude), West Liberty State College (1983); J.D. (Order of the Coif), West Virginia University College of Law (1986); LL.M. (Taxation), University of Florida College of Law (1989); admitted to practice in Pennsylvania and West Virginia; member, Advisory Board (U.S. Income), Tax Management Inc.; member, American Bar Association, Section of Taxation, Committee on Partnerships; member, Allegheny County and Pennsylvania Bar Associations; member, West Virginia Bar Association; certified public accountant (1988); member, American Institute of Certified Public Accountants; member, West Virginia Society of Certified Public Accountants; adjunct lecturer, West Virginia University College of Law (1993–2001).

Table of Contents

Detailed Analysis

I. Introduction

A. Overview of Portfolio

B. Definition of a Stock Dividend

C. Reasons for Issuing Stock Dividends

D. Types of Stock Dividends

E. Stock Bailouts

1. In General

2. Stripped Preferred Stock

F. Statutory Framework

1. Overview of § 305

2. Overview of § 306

3. Overview of § 307

II. Development of the Tax Treatment of Stock Distributions

A. Statutory Treatment Before Eisner v. Macomber

B. Eisner v. Macomber

C. Legislation in Response to Eisner v. Macomber

D. Treatment of Stock Dividends Under the 1954 Code

1. Exception for Distributions in Discharge of Preference Dividends

2. Exception for Election of Shareholders of Medium of Payment

E. Chamberlin and the Stock Bailout Sin

F. Statutory Response to Chamberlin

III. Current Treatment of Stock Dividends

A. Section 305

B. Elections by Shareholders as to Medium of Payment

C. Disproportionate Distributions

1. Antidilution Rules

2. Isolated vs. Periodic Redemptions

D. Deemed Distributions Under § 305(c)

1. Changes in Conversion Ratios and Antidilution Provisions

2. Redemptions

3. Security Arrangements and Reorganizations

4. Purchases for Corporate Purposes

5. Recapitalizations

E. Distributions of Common and Preferred Stock

F. Distributions on Preferred Stock

G. Distributions of Convertible Preferred Stock

H. Treatment of Redemption Premiums

1. Before the 1990 RRA

2. After the 1990 RRA

I. Miscellaneous Issues

1. Tracking Stock

a. Distribution of Tracking Stock as a Substitute for a Spinoff

b. Economic Distinction Between a Spinoff and a Distribution of a New Class or Tracking Stock

c. Tax Consequences of Distributions of Tracking Stock/IRS Stance

d. Recapitalizations Using Tracking Stock

e. Basis Considerations

f. Potential § 306 Taint

2. Fractional Shares

3. Recognition of Income by the Distributing Corporation

4. Effect on Issuing Corporation's Earnings and Profits

5. Deductibility of Costs Incurred by the Corporation

6. Substance vs. Form Issues

7. Distributions Pursuant to Orders of the Securities and Exchange Commission

8. Amount Included in Shareholder's Income

9. Mitigation of Effect of Statute of Limitations

10. Rights to Subscribe to Convertible Bonds

11. Use of Treasury Stock

12. Definitions of "Stock" and "Shareholder"

13. Foreign Shareholders

14. Effective Dates

IV. Section 306 Stock

A. History of § 306

B. Definition of § 306 Stock

1. General Rule

2. Earnings and Profits Requirement

3. Tax-Free Distributions Under § 305 - Stock Other Than Common Stock

C. Interplay Between § 306 and the Reorganization Provisions

1. Purpose of § 306(c)(1)(B)

2. Overview of Reorganizations

3. Nonrecognition of Gain or Loss on Exchange

4. Receipt of Preferred Stock in Exchange for § 306 Stock

5. Reorganizations Having the Effect of a Preferred Stock Dividend

a. General Rule

b. Cash Substitution Test

c. Acquisitive Reorganizations

(1) "A" Reorganizations

(2) "B" Reorganizations

(3) "C" Reorganizations

d. Divisive Reorganizations

e. Recapitalizations and "F" Reorganizations

(1) Preferred Stock Retained

(2) Preferred Stock Surrendered

D. Substituted Basis Stock

1. General Rule

2. Convertible Stock

E. Definitions and Special Rules

1. Stock Rights

2. Changes in Terms of Stock

3. Stock Received Before 1954

V. Dispositions of Section 306 Stock

A. General Tax Consequences of a Disposition

B. Redemption Dispositions

1. Transactions Constituting a Redemption

2. Tax Consequences

C. Nonredemption Dispositions

1. Transactions Which Do Not Constitute Redemptions

2. Tax Consequences

D. Exceptions Under § 306(b)

1. Termination of Shareholder Interest

2. Liquidations

3. Nonrecognition Transactions

4. Transactions Which Do Not Avoid Tax

E. Special Problems

1. Priority Issues

2. Source of Income: § 306(f)

3. Viability of Chamberlin

VI. Avoiding the § 306 Taint

A. Characteristics of Preferred Stock

B. Use of Preferred Stock

C. Use of Nonvoting Redeemable Common Stock

D. Tracking Stock

E. Disposition Planning

VII. Basis and Holding Period Issues

A. Section 305 Distributions

1. Nontaxable Distributions

a. General Basis Rule

b. Exception for Certain Distributions of Stock Rights

c. Holding Period for Tax-Free Distributions

2. Taxable Distributions

a. Basis

b. Holding Period

3. Special Problems

a. Valuation Issues

b. Combined Stock and Warrants Rights

c. Identification Issues

d. Estates and Trusts

(1) Inter Vivos Trust

(2) Testamentary Trust

(3) Trust Beneficiaries

B. Section 306 Stock

1. Section 306(c)(1)(A) Stock

a. Basis

b. Holding Period

2. Section 306(c)(1)(B) Stock

a. Basis

b. Holding Period

3. Section 306(c)(1)(C) Stock

 

 

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Internal Revenue Code of 1954 (P.L. 591), Ways and Means Committee Report To Accompany H.R. 8300: H.R. Rep. No. 1337, 83d Cong., 2d Sess. A81â€"83, A91â€"94 (1954) (Excerpts)

Worksheet 2 Internal Revenue Code of 1954 (P.L. 591), Finance Committee Report To Accompany H.R. 8300: S. Rep. No. 1622, 83d Cong., 2d Sess. 43â€"46, 240â€"246 (1954) (Excerpts)

Worksheet 3 Internal Revenue Code of 1954 (P.L. 591), Conference Report to Accompany H.R. 8300: H.R. Rep. No. 2543, 83d Cong., 2d Sess. 35â€"36 (1954) (Excerpts)

Worksheet 4 Tax Reform Act of 1969 (P.L. 91-172), Ways and Means Committee Report to Accompany H.R. 13270: H.R. Rep. No. 413 (Part 1), 91st Cong., 1st Sess. (1969), and Finance Committee Report: S. Rep. No. 552, 91st Cong., 1st Sess. 111â€"115 (1969) (Excerpts)

Worksheet 5 Budget Reconciliation Act of 1990 (P.L. 101-508), House Budget Committee Report to Accompany H.R. 5835: H.R. Rep. No. 881, 101st Cong., 2d Sess. 346â€"349 (1990) (Excerpts)

Worksheet 6 Key Factors in Stock Dividends and Other Distributions

Worksheet 7 Key Factors in Determining Whether Stock Is Section 306 Stock and Consequences of a Disposition of Section 306 Stock

Worksheet 8 Sample Resolution Authorizing Stock Dividend

Worksheet 9 Sample Resolution Authorizing Distribution of Stock Rights

Worksheet 10 Sample Resolution Adopting a Recapitalization Plan

Worksheet 11 Sample Resolution Authorizing Distribution of Tracking Stock

Worksheet 12 Prospectus Extract: Offering of Rights to Acquire Additional Stock of a Publicly Held Corporation

Worksheet 13 Prospectus Extract: Publicly Held Corporation Proposing the Creation of Tracking Stock

Worksheet 14 Example Illustrating Offer of Rights

Worksheet 15 Example of a Taxable Stock Dividend: Election to Receive Cash in Lieu of Stock

Worksheet 16 Example of Tax Considerations in Issuance of Tracking Stock

Worksheet 17 Preamble to T.D. 8643, 60 Fed. Reg. 66134 (12/21/95) Final Regulations under § 305(c)

Bibliography

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