Even if a corporation doesn’t give shareholders an explicit election, a stock dividend can be taxable under § 305(b)(2) if the result of the distribution (or a series of distributions) is that some shareholders receive property (like cash) and other shareholders increase their proportionate interests.
Rev. Rul. 78‑60, 1978‑1 C.B. 81, illustrates this. Corporation Z had a plan of annual redemptions. It redeemed stock from some shareholders for cash. The other shareholders didn’t receive any property, but their proportionate interests increased. The IRS held that the non‑tendering shareholders received a deemed stock distribution under § 305(b)(2), taxable as a dividend.
The amount of the deemed distribution is determined by a formula: figure out the increase in the non‑tendering shareholder’s percentage ownership, determine how many additional shares he would need to own to achieve that percentage, and multiply that number by the fair market value of the shares after the redemption.
But there’s an important exception: a one‑time, isolated redemption does not trigger § 305(b)(2). Reg. § 1.305‑3(b)(3). The regulation creates a 36‑month presumption – distributions separated by more than 36 months are presumptively not part of a plan.
So if you’re planning periodic redemptions, be aware that the non‑selling shareholders may be deemed to receive taxable stock dividends. If you want to avoid that, keep the redemptions isolated or space them far apart.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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