May 06, 2007

Politicizing the Internal Revenue Code

by PG

I was all set to be annoyed about my Corporate Tax textbook and the Examples & Explanations both referring to the "redemption of stock to pay Death Taxes," until I stopped and looked at Section 303's title: "Distributions in redemption of stock to pay death taxes."

Oh. Don't blame the professors, blame the politicians. And right, first read the Code, McFly.

Notwithstanding the common conservative equating of "estate tax" with "death tax," there is much more covered by 303 than just the estate tax; "inheritance, legacy, and succession taxes," and "funeral and administrative expenses allowable as deductions to the estate" also get counted to up the limit of how much of the corporation's payment for the deceased's redeemed shares gets sale/ exchange treatment.

I'd have to spend a lot more time studying it than I have time remaining until tomorrow morning's exam before I could say for certain, but the provision strikes me as an odd one. Prof. Block says it was enacted in response "to the hardship faced by some family businesses forced to liquidate in order to pay estate and other death taxes," yet the bit I have been able to comprehend of Corporate Tax so far would indicate that redemption distributions (mostly covered by 302) are different from liquidations of a business. Yes, 302(b)(4) gives sale/exchange treatment for partial liquidations, but these seem to require that one trade or business (e.g., Kaplan's LSAT prep business) be liquidated while another (Kaplan's SAT prep business) continues to function, and thus this is distinct from a total liquidation in which the corporation satisfies creditors and then distributes remaining assets or cash to shareholders.

If Congress was worried about the family farm or Pop's Hardware getting liquidated in order to pay estate taxes, why not direct its mercy toward Section 311's treatment of individual shareholders upon complete liquidation? Assisting those who have had to dissolve a family business for tax reasons is much more sensible than assisting those whose inherited estate happens to be substantally made up of stock in a particular corporation. If Arthur Sulzberger, Jr. drops dead tomorrow,
and he didn't diversify his estate much so that 40% of it is made up of Times Co. stock,
and his heirs need to sell the stock to pay the estate taxes,
and the rest of the Family pushes to have the corporation redeem the stock so it won't get sold on the open market where it could get into the hands of non-Family shareholders who might force a change in how the company is run...
why should the Sulzberger heirs get this special treatment for their redeemed shares? I could see the argument if Section 303 were limited to shares that aren't listed on any exchange and for which there isn't much market (e.g. those in a close corporation, which is what family businesses that incorporate normally are), so the corporation really has to redeem the shares for the heirs to get any money out of them if the remaining shareholders can't or won't put up the cash. But there's no such limitation in Section 303, although the requirement that the estate hold 75%+ of each corporation when you try to combine two corporations to reach the "35% of the estate" standard at least comes a little closer; if 75% of a corporation's stock is held by a single person, it's likely to be a close corporation.

The recent shift to allow "qualified dividends" to be taxed at capital gain rates makes the distinction between sale/exchange treatment and dividend treatment less important (at least until 2011, when the provision sunsets), but I just get irked by Death Tax rhetoric about small businesses when the actual laws enacted due to such rhetoric have a much broader scope.

May 6, 2007 03:54 PM | TrackBack
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