IRS Notice
2001-45
 
Cumulative Bulletin Notice 2001-45, , I.R.B. 2001-33, 129,
July 26, 2001.
Notice 2001-45
The
Internal Revenue Service and the Treasury Department
have become aware of a type of transaction,
described below, that is being used by taxpayers for
the purpose of generating losses or reducing income
or gains. This Notice alerts taxpayers and their
representatives that the tax benefits purportedly
generated by such transactions are not properly
allowable for Federal income tax purposes. This
Notice also alerts taxpayers, their representatives,
and promoters of such transactions of certain
responsibilities that may arise from participating
in such transactions.
FACTS
The
transaction involves the use of the attribution
rules of §318 of the Internal Revenue Code and §1.302-2(c)
of the Income Tax Regulations to increase the basis
of stock owned by a taxpayer (the
"Taxpayer") that claims a loss upon
disposition of that stock. In the transaction, there
is a redemption of stock that is owned by a person
(other than the Taxpayer) that is not subject to
U.S.
tax or is otherwise indifferent to the Federal
income tax consequences of the redemption.
Purportedly as a result of the application of the
attribution rules of §318 , the redemption of stock
is claimed to be a dividend under §301 rather than
a payment in exchange for stock under §302(a) . A
variety of devices, often including options, is
employed to treat the redeemed shareholder as owning
stock in the redeeming corporation owned or treated
as owned by the Taxpayer under the attribution rules
of §318 . The attribution of ownership of such
shares purportedly prevents the redemption of stock
from reducing the redeemed shareholder's ownership
interest in the redeeming corporation, thereby
causing the redemption to be treated as a dividend.
As
a result of the redemption, the Taxpayer takes the
position that under §1.301-2(c) all or a portion of
the basis of the redeemed stock is added to the
basis of stock in the redeeming corporation that the
Taxpayer owns. The Taxpayer then sells the stock and
claims a loss.
Variations
on the transaction include (1) the use of the
transaction to reduce income or gain (rather than
generate loss) and (2) the transfer of the stock
(the basis of which was purportedly increased by
reason of the redemption) to an entity in a
carryover basis exchange, followed by either a sale
of the entity interest or a sale of the stock by the
entity.
ANALYSIS
Section
302(a) provides that if a corporation redeems its
stock and §302(b)(1) , (2) , (3) , or (4) applies,
such redemption shall be treated as a distribution
in part or full payment in exchange for the redeemed
stock. Under §302(b)(1) , a redemption distribution
will be subject to §302(a) if, based on the facts
and circumstances, the redemption distribution is
not essentially equivalent to a dividend. See
§1.302-2(b) . Section 302(b)(2) provides that a
distribution in redemption of stock will be subject
to §302(a) if the distribution is substantially
disproportionate with respect to the redeeming
shareholder. Under §302(b)(3) , §302(a) will apply
to a distribution in redemption of stock if the
redemption is in complete redemption of all of the
stock of the corporation owned by the redeeming
shareholder.
For
purposes of determining whether a distribution in
redemption of stock is treated as a sale or exchange
of stock, all steps that are part of a single,
pre-arranged plan are taken into account. See
Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954).
Section 302(d) provides that if §302(a) does not
apply, the distribution will be treated as a
distribution subject to §301 . Section 302(c)(1)
provides that, in determining whether the provisions
of §302(b) are satisfied, the attribution rules of
§318 shall apply. Section §301(c)(1) provides that
the portion of the distribution that is a dividend
shall be included in the redeemed shareholder's
gross income.
Section
§1.302-2(c) provides that when an amount received
in a redemption of stock is treated as a
distribution of a dividend, "proper
adjustment" of the basis of the remaining stock
will be made with respect to the stock redeemed. Example
2 of §1.302-2(c) illustrates a proper
adjustment where the entire amount received in
redemption of the stock held by one spouse is
treated as a dividend because the redeemed spouse is
treated as owning stock held by the other spouse. In
that example, the basis of the stock of the
nonredeemed spouse is properly increased by the
basis of the stock of the redeemed spouse.
It
is the position of the Service and the Treasury that
such an adjustment is not proper in every case in
which the redeemed shareholder retains no stock in
the redeeming corporation. The example in the
regulations is premised on the concept that an
adjustment is appropriate where the redeemed spouse
is required to include the full redemption proceeds
as a dividend in gross income that is subject to
U.S.
tax and such spouse retains no stock to which the
basis of the redeemed stock could attach.
The
Service intends to disallow losses claimed (or to
increase taxable income or gains) in the
transactions described in this Notice to the extent
a taxpayer derives a tax benefit that is
attributable to stock basis purportedly shifted from
the redeemed shares. Depending on the facts of the
particular case, reasons for disallowance may
include, but are not limited to, the following: (1)
the redemption does not result in a dividend (and
consequently there is no basis shift) because,
viewing the transaction as a whole, the redemption
results in a reduction of interest in the redeeming
corporation to which §302(b) applies; (2) the basis
shift is not a "proper adjustment" as
contemplated by §1.302-2(c) ; and (3) there is no
attribution of stock ownership or basis shift
because the steps taken to achieve those results are
transitory and serve no purpose other than tax
avoidance.
In
addition, the Service may impose penalties on
participants in these transactions, or, as
applicable, on persons who participate in the
promotion or reporting of these transactions,
including the accuracy-related penalty under §6662
, the return preparer penalty under §6694 , the
promoter penalty under §6700 , and the aiding and
abetting penalty under §6701 .
Transactions
that are the same as, or substantially similar to,
those described in this Notice are identified as
"listed transactions" for purposes of §1.6011-4T(b)(2)
of the Temporary Income Tax Regulations and §301.6111-2T(b)(2)
of the Temporary Procedure and Administration
Regulations. See also §301.6112-1T , A-4. It
should be noted that, independent of their
classification as "listed transactions"
for purposes of §§1.6011-4T(b)(2) and
301.6111
-2T(b)(2) , such transactions may already be subject
to the tax shelter registration and list maintenance
requirements of §§6111 and 6112 under the
regulations issued in February 2000 (§§301.6111-2T
and
301.6112
-1T , A-4), as well as the regulations issued in
1984 and amended in 1986 (§§301.6111-1T and
301.6112
-1T , A-3). Persons required to register these tax
shelters who have failed to register the shelters
may be subject to the penalty under §6707(a) , and
to the penalty under §6708(a) if the requirements
of §6112 are not satisfied.
The
Service and Treasury recognize that some taxpayers
may have filed tax returns taking the position that
they were entitled to the purported tax benefits of
the type of transaction described in this Notice. We
advise these taxpayers to take prompt action to file
amended returns.
The
principal authors of this Notice are Theresa Abell
and Lisa Leong of the Office of Associate Chief
Counsel (Corporate). For further information
regarding this Notice, contact Ms. Abell at
(202)
622-7700
or Ms. Leong at
(202)
622-7530
(not toll-free calls).
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