Stock redemptions in closely-held corporations;

              Stock Redemptions
in Closely-Held Corporations
by Mary J. McCann
Mary J. McCann, manager in the Kansas City office, has been with the
firm since 1954, and has recently received several awards as an outstand­ing
business woman. She is an honoree of Phi Chi Theta, national pro­fessional
business fraternity for women, and received an award as the
outstanding senior woman in the school of business from the University
of Kansas Chapter; she was also one of the first three women honored in
1965 for leadership among women in business from the University of
Missouri Chapter.
Miss McCann is a past president of the American Woman's Society of
Certified Public Accountants and the Kansas City Women's Chamber
of Commerce. She is presently editor of The Woman CPA; a member of
the Missouri Commission on the Status of Women, Small Business
Advisory Council for Missouri, American Institute of Certified Public
Accountants, American Accounting Association, Missouri Society of
CPAs, Kansas Society of CPAs, American Society of Women Account­ants,
American Woman's Society of CPAs, and the American Association
of University Women. Miss McCann received a B.S.B. degree from the
University of Kansas, and is a member of Beta Gamma Sigma.
Capital gain or dividend? This is the first and foremost
question in the mind of a shareholder in a closely-held
corporation who is considering a redemption of stock by
the corporation without complete liquidation of the cor­poration.
If the redemption is considered to be a distri­bution
in payment in exchange for the stock, he will be
taxed on the gain, if any, at capital gain rates. But if it
is not considered to be a distribution in exchange for
stock, the tax consequences may be extremely costly. The
proceeds of the redemption, not just the gain, would then
be taxed as a dividend to the extent of the current year's
or the accumulated "earnings and profits" (as determined
under the Internal Revenue Code) at ordinary income
rates. "Earnings and profits" as determined under the
Internal Revenue Code may be drastically different from
the corresponding amounts in the corporation's records.
The Internal Revenue Code provides in general that a
redemption is to be treated as an exchange unless it is
essentially equivalent to a dividend [Section 302(b) (1)]-
Are there any tests for determining with assurance that
a stock redemption by a closely-held corporation will be
treated as an exchange of stock? In addition to the gen­eral
provision, the Internal Revenue Code within its
framework provides for stock redemptions in the follow­ing
situations to be considered as exchanges of stock if
the qualifying requirements are met:
(1) substantially disproportionate redemption [Sec­tion
302(b)(2)]
10 THE QUARTERLY