IRC §303 provides that, in certain cases, a redemption of stock, the value of which has been included in the gross estate of a decedent for federal estate tax purposes, shall be treated as a sale of the stock, even though it would, but for §303, be taxed as a dividend under §301.
303 contains the following conditions and limitations:
- The value of the redeemed stock must be included in determining the gross estate of the decedent for federal estate tax purposes. This requirement is satisfied if the stock:
- Was owned by the decedent at the time of his death.
- Was not owned by the decedent at death, but was included in his gross estate because, for example:
- it was transferred in contemplation of death;
- the decedent had a power of appointment over it; or
- it was held in joint tenancy with the decedent.
- The value of stock included in the decedent’s estate must be more than 35% of his “adjusted gross estate” (the “adjusted gross estate” for this calculation being the gross estate reduced by deductions allowable under §§2053 and 2054, for claims, expenses, debts, taxes and losses).
- The total application of §303 cannot exceed the sum of (a) the death taxes imposed because of the decedent’s death and (b) the funeral and administrative expenses allowable as deductions for estate tax purposes.
- The benefits of §303 are available only to amounts distributed by the corporation within a limited period after the death of the decedent–If the distributions are made more than 4 years after death, §303(b)(4) limits the amount of qualifying distributions to the lesser of the unpaid death taxes and expenses at such time, or taxes and expenses paid within one year of the distribution.
If only part of the redemption qualifies for §303 sale treatment (the rest constituting a dividend under §301), part of the shareholder’s basis for the redeemed stock should be allocated to that portion of the transaction constituting a sale. Possible alternative methods of making that allocation could include:
By analogy to the “part gift-part sale” rules of Regs. §1.1001-1(e), one possibility would be to apply the total basis against the §303 “sale” proceeds in computing gain. If the basis is not fully recovered, loss would not be allowed; and the unrecovered basis presumably would stay with the stock retained by the redeeming shareholder, as would be the case in a §301(c)(2) distribution.
Another method would be to allocate the basis in proportion to the relative value of the sale and dividend portions of the distribution. Thus, if 25% of the distribution qualified for §303 treatment, the shareholder would be entitled to apply 25% of his basis to that part of the transaction.
Substantially the same result would be achieved by allocating basis in proportion to the relative basis of the stock qualifying for §303 treatment, since the stock, having been inherited, would have a basis equal to its fair market value at the time of death by virtue of §1014.