January 4, 1988
SUBJECT MATTER: Code Secs. 303 and 6166
REFERENCE: Symbol: CC:C:3:10-TR-31-05340-87
UI No. 0303.00-00; Distributions in redemption of stock to pay death taxes
UI No. 6166.00-00; Extension of time for payment of estate tax where estate consists largely of interest in closely held business
This is in response to a letter dated September 23, 1987, in which rulings are requested as to the federal income tax consequences of a proposed transaction. Additional information was submitted in letters dated November 6, 25, and December 17, 1987. The information submitted is summarized below.
X is a State Y corporation which is engaged in an ongoing business and also owns 100 percent of the stock of a subsidiary corporations. More than 80 percent of the value of the assets of each Such corporate subsidiary is attributable to assets used in carrying on a trade or business. X has authorized capital of b shares voting common stock; c shares on-voting common stock; and d shares $100 par value Class A, 5 percent non-cumulative, non-voting stock (Class A stock).
Between 1977 and 1982 A transferred e shares (representing fifty percent) of voting common stock of X to a revocable voting trust (Trust 1) with A as trustee and income beneficiary. The remaining fifty percent of the voting common stock is held by A's brother, B. The sole and equal beneficiaries of Trust 1 are A's sons, C and D.
Prior to A's death, h shares of non-voting common stock of X were deposited in a revocable trust (Trust 2) created by A in i. In addition to the stock held in Trusts 1 and 2, Estate holds directly j shares of the non-voting common stock of X and g shares of Class A stock of X. The total number of shares of X includable in Estate are e shares of the voting common stock; f shares non-voting common stock; and g shares Class A stock. The value of the X stock includable in Estate represents 99.9 percent of A's gross estate.
A's will provides that the residue of his estate, is to be poured over into Trust 2. By virtue of this pourover provision, A's sons, C, D and E, are the residuary beneficiaries of Estate as well as Trust 2.
A's will charges his residuary estate with payment of all inheritance, estate and other death taxes including interest and penalties without contribution except that A's executors may procure funds for such payment from the trustees in accordance with the terms of any trust created by A.
Trust 2 directs its trustees to pay over to Estate, upon request, sufficient funds to pay all or part of the administration expenses and any and all death taxes, interest and penalties which may be assessed against Estate. Pursuant to a redemption agreement, entered into in i between A, B and X (i redemption agreement); X agreed to purchase and redeem from Estate the number of Class A and common shares tendered by the executors, but not in excess of the amount redeemable pursuant to section 303 of the Internal Revenue Code of 1986, at the fair market value er share determined on the date of A's death. The initial price per share is to be adjusted upward or downward to the estate tax value as finally established, and more shares will be tendered to X or returned by X to Estate or Trust 2 when the final estate tax value is established.
Accordingly, in order to pay Estate's death taxes and funeral and administration expenses the following transaction has been proposed:
The executors will pay the nondeferred amount of the federal estate tax, plus the initial State Y estate tax on the due date of the estate tax return and elect to pay the balance, pursuant to section 6166(a) of the Code, over the maximum period allowable. Pursuant to the terms of A's will and the terms of Trust 2 the Executors of Estate will direct the trustees of Trust 2 to turn over to Estate the requisite number of shares of non-voting stock to enable Estate to pay the death taxes and allowable expenses of the Estate. Estate will, in turn, tender the shares to X for cash at the fair market value of such shares determined at the date of A's death, as required by the i redemption agreement. The executors will cause X to redeem these shares in a series of redemptions, timed to meet the cash needs of Estate, as section 6166 installments come due. The initial stock redemptions will be separate redemptions to pay the non-deferred portion of the Federal estate tax and separate redemptions to pay the initial State Y estate tax and administration expenses deducted on
the estate tax return.
In connection with the proposed transaction, the following representations have been made:
(a) At the time of the exchange, the fair market value of the consideration to be received by Estate will be approximately equal to the fair market value of the X stock exchanged therefor.
(b) The aggregate fair market value of all the common and Class A stock of X included in the gross estate of A is more than thirty-five (35) percent of A's gross estate, reduced by the sum of the amounts allowable as deductions under sections 2053 and 2054 of the Code.
(c) The proposed redemption will be the first redemption of shares of stock that are includable in Estate.
(d) No other shareholder of X is obligated to purchase any of the stock to be redeemed.
(e) The amount to be distributed to Estate in exchange for the stock to be redeemed will not exceed Estate's obligation arising under A's will and binding under State Y law, to pay the estate, inheritance, legacy or succession taxes imposed because of A's death (including any interest collected as part of such taxes) and the amount of funeral and administration expenses allowable as deductions to A's estate under section 2053 of the Code. If the redemption distribution is made more than four years after the date of A's death, the amount to be distributed will not exceed the lesser of (i) the aggregate amount of such taxes and expenses referred to in section 303(a)(1) or (2) which remain unpaid immediately before the distribution, or (ii) the aggregate of such amounts referred to in section 303(a)(1) or (2) which are paid during the one year period beginning on the date of the distribution.
(f) X and Estate will pay their own respective expenses, if any incurred in connection with the proposed transaction.
(g) There are no outstanding options or warrants to purchase X stock, nor are there any outstanding debentures or other obligations that are convertible into X stock, or would be considered to be stock. There exists no plan or intention to issue any such options, warrants, debentures or other obligations that may be convertible into X stock, or which would be considered to be stock in X.
(h) X has no plan or intention to issue, redeem, or exchange additional shares of its stock other than the planned redemptions from the Estate.
(i) The price to be paid for X stock to be redeemed will not result in a loss with respect to those shares of stock.
(j) There are no declared but unpaid dividends, or funds set apart for dividends, on any of the stock to be redeemed. X intends to declare dividends to stockholders of record prior to the proposed redemption. In the event that any shares of X are redeemed after the record date but before payment date of the dividends, any such dividends declared on stock to be redeemed shall, in fact, be paid to the holders of record date and reported as such.
(k) There have been no redemptions, issuances, or exchanges by X of its stock in the past five (5) years, except for a redemption in 1983.
(l) The distribution will take place (a) within the period of limitations provided in section 6501(a) for the assessment of the federal estate tax, or within ninety (90) days after the expiration of such period, (b) if a petition for redetermination of a deficiency in such estate tax has been filed with the Tax Court within the time prescribed in section 6213, at any time before the expiration of sixty (60) days after the decision of the Tax Court becomes final, or (c) if an election has been made under section 6166 and if the time prescribed by this part (c) expires at a later time than the time prescribed by part (b) of this paragraph, within the time determined under section 6166 for the payment of the installments.
(m) The interest of Estate in X will be directly reduced by the payment of funeral and administration expenses allowable as deductions to the Estate under 2053 of the Code, and any estate, inheritance, legacy, or succession taxes imposed by reason of the death of A.
(n) In the event any indebtedness shall exist between Estate and X, whether arising out of the redemption or otherwise, none of such indebtedness shall be forgiven, discounted, or otherwise compromised.
(o) None of the stock to be redeemed is "section 306 stock" within the meaning of section 306(c) of the Code because the basis of all stock to be redeemed is determined under section 1014 by reference to its fair market value on the date of A's death.
Based solely on the information submitted and representations set forth above and provided that Trusts 1 and 2 are
includable in A's gross estate, it is held as follows:
(1) As the facts indicate, X is an active corporation that owns 100 percent of the stock of ten corporate subsidiaries. It is represented that more than 80 percent of the value of the assets of each X subsidiary is attributable to assets used in carrying on an active trade or business. Accordingly, X and its ten subsidiaries will be treated as one corporation for purposes of section 6166(b)(9)(B)(ii), which otherwise treats stock of one corporation held by another corporation as a passive asset unless a section 6166(b)(8) holding company election is made. Because the section applies no holding company election under section 6166(b)(8) is required.
(2) The amount received by Estate in exchange for a portion of the X stock it holds, as described above, will be treated as a distribution in full payment for the X stock redeemed as provided in section 303(a) of the Code to the extent the amount received does not exceed the sums specified in section 303(a) and provided that all the requirements of 303(b) are satisfied.
(3) As provided in section 1001 of the Code, gain will be realized and recognized by Estate measured by the difference between the redemption price and the adjusted basis of the stock surrendered as determined under section 1011. Provided section 341 (relating to collapsible corporations) is inapplicable, and the stock is a capital asset in the hands of Estate, the gain, if any, will constitute capital gain subject to the provisions and limitations of Subchapter P of Chapter 1.
(4) Section 6166(g)(1)(B) will apply to distributions in redemption of X stock held by Estate which are used to pay federal estate taxes due with the return to be filed in 1987.
(5) Section 6166(g)(1)(B) will apply to redemptions of the X stock held by Trust 2 and Estate in succeeding years to the extent the proceeds of these redemptions are used to pay federal estate taxes (including interest) imposed on or before the date of the first installment becoming due after the date of the distribution (or, if earlier, on or before the day which is one year after the redemption), provided one-half or more of the combined value of Estate's, Trust 1 and Trust 2's interest in the closely held business has not otherwise been disposed of or withdrawn from the closely held business, as described in section 6166(g)(1)(A). State death tax payment that is creditable against the federal estate tax is not equivalent to the payment of federal estate tax for purposes of section 6166(g) (Rev. Rul. 85-43, 1985-1 C.B. 356).
(5) Estate and Trust 2 will qualify for the section 6166(g)(1)(B) exclusion if a section 303 redemption (or each of a series of redemptions) qualifies under either the cumulative approach or the redemption-byredemption approach (used
interchangeably) as specified in Rev. Rul. 86-54, 1986-1 C.B. 356.
(6) The interest expense paid on federal estate tax liabilities after the expiration of the section 6501 statute of limitations is deductible under section 2053 in recomputing the federal estate tax at the time of each installment payment, in accordance with Rev. Proc. 81-27, 1981-2 C.B. 548.
No opinion is expressed about the tax treatment of the transaction under other provisions of the Code and Regulations, or about the tax treatment of any conditions existing at the time of, or effects resulting from, the transactions that are not specifically covered by the above rulings.
Specifically, no opinion is expressed as to the tax effect of the amount, if any, the distribution by X exceeds or is less than the fair market value of the stock redeemed. A determination of the fair market value of the stock is reserved until the federal income tax return of the taxpayers concerned has been filed for the tax year in which the transaction will be consummated. Furthermore, no opinion is expressed as to the tax effect of the issuance of notes, if any, by X in connection with any redemption from Estate. Finally, no opinion is expressed as to the tax effect of Estate borrowing funds, if any, in order to pay its obligations.
This ruling is directed only to the taxpayers who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
A copy of this letter should be attached to the federal income tax returns of the taxpayers involved for the taxable year in which the transaction covered by this ruling letter is consummated.
This document may not be used or cited as precedent. Section 6110(j)(3) of the Internal Revenue Code.