E—Partial Stock Redemption

A partial stock redemption under Section 303 offers a very attractive way of paying estate settlement costs, particularly for a corporation that will be continued by the surviving family.
Under most circumstances, a stockholder who has the corporation redeem less than his entire stock interest will be fully taxed on the proceeds as ordinary income. However, under the special provisions of Section 303, his surviving family can do after death what the stockholder generally cannot do during his lifetime . . . namely, sell only a portion of his stock interest to the corporation, and have the sale treated as a capital transaction rather than as a dividend.

DURING LIFETIME. If the stock interest will be more than 35 percent of the stockholder’s adjusted gross estate, then his stock will qualify under Section 303 for a partial redemption at his death. The amount of stock which can be purchased is limited to the sum of all federal and state death taxes, funeral, and administrative expenses. The purchase must also be made from whoever has the obligation to pay these costs, usually the family or estate.

Since few corporations can be expected to accumulate sufficient cash for such a purchase, typically the corporation obtains a life insurance contract insuring the stockholder in his capacity
as an employee. The corporation pays the premiums and is both owner and beneficiary of the contract. This is generally a much better solution to the funding problem than attempting to accumulate large cash reserves over a period of time, borrowing at high interest rates, or selling corporate assets.