Income Tax Aspects of Buy-Sell Planning Using Life Insurance

by Hoon Kang, CPA/PFS, CLU, ChFC, CFP®


Abstract: The buy-sell agreement enables businesses to be transferred by plan, not chance. Few life insurance producers would dispute the importance of buy-sell planning for business owners. Often, the same producers are intimidated by the prospect of addressing concerns and questions raised by CPAs and attorneys over tax consequences of the various buy-sell planning techniques. This article discusses key income tax aspects of buy-sell arrangements to equip and enable the readers to constructively participate in the collaborative planning process with the advisers of their valued clients.

The buy-sell agreement enables businesses to be transferred by plan, not chance. It is a contractual agreement that spells out what will happen to the owners’ business interests when certain events, known as triggering events, occur. Although buy-sell agreements come in many flavors, essentially, there are two types: entity purchase and cross purchase. All others are, in effect, variations of the two basic types of buy-sell agreements. Tax consequences1 can differ significantly depending upon how a buy-sell agreement is arranged, as well as the typesof entity involved.2

Income Tax Issues Related to Entity Purchase

In an entity purchase agreement (also known as a stock redemption), the business will purchase the owner’s interest when a triggering event occurs. If the triggering event is death, and the agreement is funded with life insurance, the death benefit is paid to the business at the owner’s death. The business uses the death proceeds to purchase the deceased owner’s business interest from his or her estate; the surviving owner’s ownership percentage increases proportionately unless, of course, the agreement states otherwise.

Tax Considerations in General

At the most fundamental level, the tax treatment of the insured entity purchase arrangement is fairly straightforward. No deduction is allowed for premiums paid on a life insurance policy to fund the buy-sell agreement.3 Life insurance proceeds are generally received income tax free.4 Additionally, because the business entity, not the owners, is the buyer of the deceased owner’s interest, there is generally no basis step up for the remaining owners. To the decedent’s estate (or the retired owner), sale of a business interest is generally considered to be a sale or exchange of property under IRC Sec. 1221 and receives a capital gain treatment. Since the estate receives a basis step up for the business interest sold, no capital gain results from the sale.5 There are several significant exceptions to these general rules as discussed below.

Alternative Minimum Tax: Additional Tax Burden for the C Corporation

In addition to the so-called regular income tax liability, the C corporation must generally account for what amounts to two more sets of tax rules: the alternative minimum tax (AMT) and the adjusted current earnings (ACE). The AMT, imposed only on “large” C corporations, is equal to 20% of the alternative minimum taxable income (AMTI) above an exemption amount.6 To determine the AMTI, tax-preference items are added to or subtracted from the regular taxable income of the corporation. For example, depreciation is computed differently under the regular method and the AMT method (and the ACE method, for that matter; more on the ACE later).7 The difference between the regular and AMT depreciation methods is a positive or negative adjustment to the regular taxable income. If the AMT liability exceeds the corporation’s regular income tax liability, then the corporation must pay the AMT.8

As mentioned, the AMT applies only to large corporations, and therefore a “small” corporation is exempt from the AMT. A corporation is treated as a small corporation exempt from the AMT for the current year if that year is the corporation’s first tax year in existence (regardless of its gross receipts for the year). Furthermore, for the corporation in existence for more than a year, it is treated as a small corporation if 1) it was treated as a small corporation exempt from the AMT for all prior tax years beginning after 1997, and 2) its average annual gross receipts for the three-tax-year period (or portion thereof during which the corporation was in existence) ending before the current tax year did not exceed $7.5 million ($5 million if the corporation had only one prior tax year).9

One of the preference items added to arrive at the AMTI is ACE. They are similar to the corporate earnings and profits and are determined by the corporation’s accounting method. If the ACE exceed the AMTI (computed without the ACE adjustment), 75% of such excess is added to the regular taxable income base.

For corporate-owned life insurance, both the cash-value buildup and death benefits greater than basis must be adjusted for ACE.10 Stated differently, the current year increase in the cash surrender value over the current year policy premium paid represents an ACE adjustment.11 Similarly, the death benefit received in excess of cash surrender value is an ACE adjustment. These rules are a departure from the general rule that allows for the tax-deferred cash-value buildup and tax-free death benefit. In effect, such adjustments increase the AMTI, which then increases the AMT, thereby increasing the odds of the AMT liability. Thus, though normally tax free, the life insurance proceeds are potentially subject to the AMT at an effective rate of 15% (75% of 20%).

After all is said and done, payment of the AMT is not the end of the world. Rather than treating it as a separate tax, the AMT payments should be viewed as a prepayment of tax. This is because payments of AMT can offset future regular income tax liability of the corporation as credit up to the AMT in any given year.12

Stock Redemption for the C Corporation: Ordinary Income or Capital Gain?

When the C corporation redeems a deceased (or retired) owner’s shares, any distribution of property or cash made by a corporation to redeem such shares is generally a dividend.13 If a transfer of stock in exchange for property qualifies as a sale, the selling shareholder may report the transaction as the sale of a capital asset instead of a dividend.14 This is a favorable treatment to the shareholder for an obvious reason: the gain on the sale of the shares would be a capital gain rather than ordinary income as with a dividend.15 Since the deceased shareholder’s estate gets a step up in basis for his or her shares in the business, there is no gain from the transaction.

To receive the favorable capital gains treatment, however, one of three tests must be met:

1.    Redemption must not be essentially equivalent to a dividend.16

2.    Redemption is substantially disproportionate.17

3.    Redemption is a complete redemption of all the stockholder’s interest in the corporation.18

The first test, which requires that redemption not be “essentially equivalent to a dividend,” is a facts-and-circumstances test and is perhaps the most difficult for which to qualify objectively. It is generally understood that this section should be relied on only if others are not available.19

The two other tests employ objective, mathematical tests. The second test requires that the redemption is “substantially disproportionate.” Substantially disproportionate redemption is accomplished if, immediately after the redemption, all of the following three mathematical tests are met:

1.    The stockholder owns less than 50% of the total combined voting power of all classes of stock entitled to vote.20

2.    The stockholder’s percentage of voting stock is less than 80% of the voting stock, prior to redemption.21

3.    The stockholder’s percentage of common stock (voting and nonvoting) must be less than 80% of the percentage of voting stock owned prior to redemption.22

The third test to accomplish a capital gains treatment instead of a dividend treatment mandates a “complete redemption of all the stockholder’s interest in the corporation.” That is, if all of the shares owned are redeemed—hence complete redemption—the transaction results in a capital gain, not dividend.

In summary, the shareholder (or his or her estate) can avoid a dividend treatment (ordinary income) of a stock redemption if substantially all of the shares owned are redeemed, and control is relinquished.

Attribution Rules: Yet Another Wrinkle for the C Corporation

Even if the C corporation redeems all of the shareholder’s shares, and, in the mind of the shareholder (or the executor of his or her estate), he or she no longer owns the company, it may not be enough to qualify for capital gains treatment under the three exceptions discussed above. In determining how many shares the stockholder owns, shares actually owned and those constructively owned under attribution rules must be added up.23

For the purposes of meeting the substantially disproportionate redemption and complete redemption discussed above, the rules of constructive stock ownership apply. A stockholder will be treated as owning the stock in a corporation that is owned directly or indirectly by:

  • Family attribution: Shares actually owned by spouse, children, grandchildren and parents. There is no attribution among siblings or to grandparents.24
  • Corporations: A 50% or more shareholder of a corporation is deemed to proportionately own the shares of stock that his or her corporation owns.25
  • Partnership: Stock owned by a partnership is attributed proportionately to its partners. Likewise, stock owned by a partner is attributed to the partnership.26
  • Estates: Stock owned by an estate is attributable to the beneficiaries of the estate. Likewise, stock owned by the beneficiaries of an estate is attributable to the partnership.27
  • Trusts: Stock owned by a trust is attributed to its beneficiaries in proportion to their actual interests. Stock owned by beneficiaries of a trust is attributable to the trust.28

Assume a corporation with 100 outstanding shares of stock. The father owns 60 shares and the two daughters own 20 shares each. Immediately after the father’s death, his actual ownership is 60%, but the 40% interest owned by the two daughters is attributed to the father. This makes the father a 100% owner of the corporation. Likewise, after the corporation redeems the father’s 60 shares, even though the two daughters become 100% owners with each owning half of the corporation, the father is still a 100% owner attributed by estate attribution. This transaction will be treated as a fully taxable dividend, not as a sale of capital asset. Using the same example, if the mother owned some shares, it would still be attributed to the father by family attribution.

Attribution rules are highly complex and warrant a separate discussion.29 Suffice to say that the adviser should think constructive ownership as well actual ownership when planning for business continuation for the C corporation.

IRC Section 303 Redemption: Exception to the Attribution Rules

The attribution rules can be avoided under the entity purchase agreement by the so-called Section 303 redemption. It is specifically exempt from the attribution requirements, helping family corporations to make a stock redemption possible without the threat of dividend treatment. Without the Section 303 exception, a redemption may be fully taxable as a dividend; it provides that a portion of the stock can be redeemed without dividend treatment.30 There are several requirements in order to qualify for the Section 303 redemption:

  • Redeemed stock must be includible in the decedent’s gross estate.31
  • Value of the corporate stock must exceed 35% of decedent’s adjusted gross estate. If the decedent owns 20% or more of the value of each of two or more corporations, they can be combined to meet the 35% requirement.32
  • Only death taxes, interest, funeral and administrative expenses are allowed, to the extent that the stock redemption is necessary for administrative costs.33
  • Distributions by the corporation must be made after the shareholder’s death.34

Basis Step Up for Life Insurance Proceeds Available for the Pass-Through Entities

There is generally no basis step up for the surviving owners under the entity purchase. As stated above, this is because the entity is buying the deceased owner’s business interest. The surviving owners’ increase in ownership is simply a function of the deceased owner’s interest vanishing. There is no basis adjustment resulting from the ownership interest adjustment. This rule applies to the C corporation, as well as for pass-through entities such as the partnership, limited liability companies (LLC), and S corporations.35

However, if the buy-sell agreement is funded with life insurance, to the extent the pass-through entities receive tax-exempt death proceeds, each owner receives an increase in basis in proportion to his or her pro-rata share.36 This is the case even though the policy proceeds are received income tax free. To reiterate, it is not the redemption of the deceased owner’s interest that inherently increases the surviving owners’ basis. Rather, it is the tax-exempt life insurance proceeds received by the business entity that result in the increase in the surviving owner’s basis. If cash value insurance policies are used, technically, basis increase equals the net death proceeds minus the net premiums paid. Net premium in this case is the premium expenditures less the corresponding increase in cash value, but not below zero. This is because each premium payment lowers each owner’s basis while cash-value increase adds to the owner’s basis (again, no more than zero).37

Such basis step up is a positive result for the surviving owners because it effectively reduces future gains from a disposition of their interests. For the deceased owner’s estate, however, any basis allocated to such decedent is “wasted.” This is because the decedent’s interest in the business will be stepped up to its fair market value anyway;38 therefore, the basis step up received from the allocation of death proceeds results in no additional benefit. Hence the wasted basis. The partnership and the LLC may be able to draft its agreement so that the death benefit is allocated only to the surviving owners, thus eliminating any such wasted basis. One caveat to the allocation of death proceeds to only the surviving partners: the IRS requires that a special allocation such as allocation of death proceeds have “substantial economic effect.” In other words, the allocation must be substantial and consistent with the underlying economic arrangement of the partnership—any economic burden or benefit that corresponds to an allocation must be borne or received by the partner to whom the allocation is made.39

Contrary to partnerships, which are contractual in nature among the partners and can be extremely flexible, the S corporation cannot be so accommodating in allocations of death benefit to shareholders’ bases. The allocation of basis for the S corporation is based on a “per share/per day” formula.40 For example, if a 50% shareholder dies on June 30, and the death proceeds were $200,000, the death proceeds allocated to the deceased shareholder’s basis is $41,370 ($200,000 × 50% share × 151/365 days). Again, this increase is wasted because the decedent receives a step up in basis regardless of the death proceeds. Under the entity purchase agreement for an S corporation funded with life insurance, the amount of the deceased shareholder’s basis increase becomes, in effect, a function of his or her ownership percentage and, to a larger extent, the timing of his or her death.

However, if the S corporation is a cash basis taxpayer, it is possible to eliminate the wasted basis. An S corporation may terminate a tax year, which has the effect of dividing the normal tax year into two shorter tax years.41 Assume, again, a 50% shareholder of a cash basis corporation dies on June 30, and the corporation receives death proceeds of $200,000 on July 20. The corporation can write a promissory note immediately after the death to the estate of the deceased shareholder and subsequently elect to terminate the tax year as of the same date. When the death proceeds are received on July 20, the only shareholder for that tax year is the surviving shareholder. Therefore, the entire $200,000 of income-tax-free death proceeds increase the remaining shareholder’s basis.

“Hot Assets”

Under the entity purchase arrangement, a partnership’s payments for the retiring or deceased partner’s interest in partnership property are generally treated as distribution in liquidation of such interest.42 Liquidating payments are taxable to the extent they exceed the partner’s basis in the partnership interest. If the liquidation is from a deceased partner’s estate, there is usually no gain or loss since the decedent’s basis is stepped up to the fair market value.

However, several categories of assets are excluded from the favorable liquidation treatment including unrealized receivables,43 goodwill, except to the extent that the partnership agreement provides for a payment with respect to goodwill,44 and substantially appreciated inventory.45

Payments received for these assets (called “hot assets”) are considered either distributive share of partnership income or guaranteed payment, which means that they are treated as ordinary income as such assets receive no basis step up.46 For the decedent, such payments are, in effect, income in respect of a decedent (IRD). IRD refers to income a decedent is entitled to at the time of death but which is not properly includible as gross income in any federal income tax return.47 Commonly, this involves a cash-basis taxpayer with the right to receive income who had not received it at the time of death.

In practical terms, if the partnership is an accrual basis taxpayer, income for the unrealized receivables has been accounted for already and included in income. Thus, there is presumably no ordinary income attributable to unrealized receivables for an accrual basis entity. For a cash-basis partnership with a large unrealized receivable—a group of physicians for example—ordinary income required to be recognized can be significant.

As to the payment received with respect to goodwill, to the extent the partnership agreement provides for payment for goodwill, this amount will receive a capital gain tax treatment.48 On the other hand, if the partnership agreement does not provide for payment for goodwill, payment received will be treated as ordinary income. Moreover, the term “appreciated inventory” is not limited to actual inventory items. Inventory, for this purpose, is defined to include all partnership assets except cash, capital assets, and Section 1231 assets, such as business equipment and furniture.49

Income Tax Issues Related to Cross Purchase

In a cross-purchase agreement, each surviving owner agrees to buy the deceased owner’s business interest. If the triggering event is death, and it is funded with life insurance, at death of an owner each surviving owner/beneficiary will receive the policy proceeds. Then each surviving owner has the funds to buy the deceased owner’s interest. In return, the estate transfers a pro rata portion of the deceased owner’s business interest. The surviving owners end up with 100% of the deceased owner’s business interest.

Tax Considerations in General

Basic tax treatment of the cross-purchase arrangement is similar to that of the entity purchase arrangement: no deduction is allowed for premiums paid on a life insurance policy,50 and life insurance proceeds are generally received income tax free.51 To the decedent’s estate, the sale of his or her business interest receives a capital gain treatment.52 The most notable difference is the basis step up for the remaining owners since the surviving owners, not the business entity, are buying the interest from the deceased owner.53 Since the estate receives a basis step up for the business interest sold, generally there is no gain that results from the sale. Again, some exceptions to these general rules are discussed below.

“Hot Assets”…Again

Unlike the entity purchase arrangement where the partnership’s payments for the partner’s interest in partnership property are generally treated as distribution in liquidation of such interest, such transaction under the cross-purchase arrangement is generally treated as sale or exchange of capital asset.54 The result is the same as the entity purchase in that the payments are taxable as capital gain to the extent they exceed the partner’s basis in the partnership interest. If the liquidation is from a deceased partner’s estate, there is usually no gain or loss since the decedent’s basis is stepped up to the fair market value.

As is the case with the entity purchase, the hot assets—that is, unrealized receivables and substantially appreciated inventory (but not goodwill)55—are once again the caveat. Payments received for hot assets are considered an amount realized from the sale or exchange of property other than a capital asset and treated as ordinary income. Cash basis partnership with large unrealized receivables are once again vulnerable to a potentially significant ordinary income exposure.

“Outside Basis” for Surviving Partners

Under the cross-purchase arrangement, purchase of the deceased owner’s interest results in an “outside basis” step up. That is, the amount the surviving owners paid for the deceased owner’s interest is not reflected on the balance sheet of the entity. Sale and purchase of the business interest takes place outside of the business between the owners without passing through the business “pocket book.”

One practical consequence of the outside basis is that future collection of unrealized receivables by a partnership is taxable even though a part of it was taxed at the decedent’s level. This is because the payments made by the surviving partners with respect to unrealized receivables do not increase the partnership’s basis in the receivables. Thus, double taxation could eventually occur with respect to these unrealized receivables. Furthermore, since depreciable assets on the partnership’s books do not reflect partners’ step up in basis, no additional depreciation can be taken.

To mitigate such problems, the partnership can make an election under IRC Sec. 754. This election allows an adjustment in the basis in partnership assets for payments made by the surviving partners for the deceased partner’s interest, properly reflecting their investment.56

Other Income Tax Issues

Policy Ownership and Beneficiary

Though life insurance is an effective way to fund a buy-sell agreement at death, it is crucial to set up ownership and the beneficiary properly to avoid adverse tax consequences. The cardinal rule is that the one with the legal obligation to buy the deceased owner’s interest should be the applicant, owner, beneficiary and premium payer for policies insuring the lives of each business owner. Thus, for the entity purchase, the owner, beneficiary and premium payer should be the entity; for the cross purchase, it should be the business owner.

A departure from this cardinal rule may result in grave financial consequences. For example, in State Farm Life Insurance Co. v. Fort Wayne Nat’l Bank, 474 N.E. 2d 524 (1985), a son agreed to purchase his father’s business in return for his father’s life insurance policy proceeds. The father was listed as owner of the contract, and the son purchased the business from the father’s estate with the proceeds. At the father’s death, the death benefit and business interest were includible in the father’s estate because the father was the owner of the policy.

Transfer for Value

One of the drawbacks of the cross-purchase arrangement is the large number of policies required to fund the plan. A trusteed arrangement eliminates the need for multiple policies under the traditional cross-purchase plan by employing a third-party trustee (or escrow). It is simply a cross-purchase plan but with a trustee as owner and beneficiary of the policies. Upon death of an owner, the trustee collects the policy proceeds and purchases business interest from the deceased owner’s estate. The trustee then credits each surviving owner per the pro rata increase in the ownership. The deceased owner’s interest in the policies insuring the surviving owners is reallocated to the surviving owners.

While effective in reducing the number of policies, the trusteed agreement may trigger income tax under the transfer-for-value rule when there are three or more owners. This rule is a departure from the general rule that life insurance proceeds are received income tax free. The transfer-for-value rule provides that the death benefit from a policy transferred for consideration is taxable as ordinary income to the extent that the proceeds exceed the consideration paid by the transferee plus any net premiums paid by the transferee subsequent to the transferor.57

When the trustee reallocates surviving owners’ policy interests from the deceased owner to the surviving owners, it could be construed as purchasing the decedent’s beneficial interest in the life insurance policies on the other owners’ lives; hence, the policies are transferred for value to surviving owners. Death benefit of policies that are transferred for value is taxable as ordinary income to the extent the death benefit exceeds basis.58

Some suggest that a partnership (existing or newly formed specifically to effect the buy-sell plan) should be used as a buy-sell agreement vehicle to avoid the transfer-for-value problem because the partnership and partners are exceptions to the transfer-for-value rule. There are four exceptions to the transfer-for-value rule: 1) the insured, 2) the partner of the insured, 3) a partnership in which the insured is also a partner, and 4) a corporation in which the insured is a shareholder or officer.59

Whether creating a partnership for the sole purpose of effecting a buy-sell agreement with little or no business assets other than life insurance policies constitutes a legitimate business purpose is subject to much discussion among tax professionals and is beyond the scope of this article. Regardless, the IRS seems to have become increasingly aggressive recently in challenging the viability of partnerships that do not appear to have a purpose other than tax avoidance.60 Generally, a partnership needs to have a legitimate business purpose in order for the entity to be recognized as a partnership under state law. Additionally, for federal tax purposes, Treasury regulations require that a partnership “must be bona fide and each partnership transaction or series of related transactions must be entered into for a substantial business purpose” to be consistent with the intent of Subchapter K.61

Ineligibility of the S Election

The corporation wishing to make an S election must meet the definition of a “small business corporation”62 which requires that the corporation not, among others

  • have more than 75 shareholders63 (for this purpose, husband and wife are considered as one shareholder)64
  • have a nonperson as a shareholder other than certain estates or trusts65 or certain tax-exempt organizations66
  • have a nonresident alien as a shareholder67
  • have more than one class of stock68

There is a risk of losing the S status if the settlement with the deceased owner’s estate results in not meeting one of the requirements. For example, the number of shareholders may increase beyond 75, or the shares may end up in the hands of an ineligible shareholder.

Begin the Process

By many accounts, this decade will witness the biggest intergenerational transfer of wealth in U.S. history. According to Boston-based Family Firm Institute, a nonprofit trade group for family businesses, there are about 21 million businesses in the United States and about 90% are independently or family owned. Family Firm Institute’s study also tells us that only 30% of all family-owned businesses survive into the second generation, while about 12% will still be viable into the third generation. Needless to say, addressing the retirement or death of the current owner is of paramount importance. The best way to ensure an orderly transfer and continuation of these businesses is to plan. Informed financial advisers are in a unique position to address these concerns. Theirs is a reward much greater than financial—in knowing that they played a significant role in ensuring their clients’ financial well-being.


This issue of the Journal went to press in April 2005. Copyright © 2005, Society of Financial Service Professionals.


Hoon Kang, CPA/PFS, CLU, ChFC, CFP®, is Vice President of Executive Benefits and Case Design for MCM, A Meisenbach Company in Seattle, Washington, a member firm of M Financial Group. He is also Managing Director for Private Insurance Advisors, LLC, and an adjunct in the MBA in Personal Financial Planning Program of City University in Bellevue, Washington. He primarily works in the areas of executive benefits, business continuation and wealth transfer. He may be reached at hkang@mcmnw.com.


(1) Discussions in this article will be limited to federal income taxes; state income taxes are not addressed.

(2) It is important to point out that a great deal has been written on the topic of buy-sell agreements by competent practitioners and scholars alike, including many excellent articles in the Journal of Financial Service Professionals. Readers are advised to refer to previous articles in the Journal as they provide much useful information on various aspects of buy-sell planning.

(3) IRC Sec. 264(a)(1).

(4) IRC Sec. 101(a).

(5) Discussions throughout this article will assume death in years other than year 2010.

(6) IRC Sec. 55(d)(3). AMT exemption for 2004 is $40,000 subject to phaseout, completely phased out at $310,000 of AMTI.

(7) Alas, it is entirely possible for a closely held corporation to be required to assume a burden of keeping track of at least four sets of books for depreciation: for regular income tax, AMT, ACE, and state income tax purposes.

(8) Pass-through entities such as S corporations, partnerships, or LLCs are not subject to AMT at the entity level. Rather, tax-preference items are computed and passed to the owners, which are then used to compute the respective owner’s individual AMT liability. There is no AMT impact on life insurance owned by the pass-through entities at either entity level or owner level since ACE adjustment applies only to C corporations.

(9) IRC Sec. 55(e).

(10) IRC Sec. 56(g)(4)(B)(ii).

(11) It is interesting to note that if the policy premium exceeds the annual increase in cash surrender value, no negative adjustment is allowed.

(12) IRC Sec. 53.

(13) IRC Sec. 301, et seq.

(14) IRC Sec. 302, et seq.

(15) With the new, lower rate on qualified dividends (due to expire after 2008) that are the same as that for a capital gain, the difference in characterization of the income may not be a factor in some cases. That said, although the rate is the same between dividend and capital gain, the taxable amount may be different. Under sale, only the gain is taxed. In contrast, the entire amount of dividend is taxable (assuming the relevant E&P is sufficient).

(16) IRC Sec. 302(b)(1).

(17) IRC Sec. 302(b)(2).

(18) IRC Sec. 302(b)(3).

(19) See US v. Davis, 397 US 301 (1970), a Supreme Court case.

(20) IRC Sec. 302(b)(2)(B).

(21) IRC Sec. 302(b)(2)(C).

(22) Ibid.

(23) IRC Sec. 318, et seq.

(24) IRC Sec. 318(a)(1). Family attribution rules apply only to the C corporation, not to other entity types.

(25) IRC Sec. 318(a)(3)(C).

(26) IRC Sec. 318(a)(3)(A).

(27) Ibid.

(28) IRC Sec. 318(a)(3)(B).

(29) Many additional rules need to be taken into account to compute constructive ownership under the attribution rules. For example, IRC Sec. 302(c)(2) provides for an important exception to the family attribution rule, known as the “ten-year rule.” Three requirements must be met that essentially mandate that the exiting shareholder not reacquire an interest (except by bequest or inheritance) or become involved in the corporation as an employee, officer or otherwise (except as creditor) for 10 years following the redemption. Under IRC Sec 302(c)(2)(C), the ten-year rule does not, but can, apply to a distribution to an entity if certain additional exceptions are met. “Entity” is defined as partnership trust, estate or corporation. Thus, redemption resulting from the shareholder’s death can qualify for the ten-year rule. See Richard etux. v. Commissioner; 124 T.C. No. 2; 15792-02 (Feb. 3, 2005) for a great discussion of the creditor exception.

(30) Though, again, such discussion may be no longer necessary for now due to the new rates on qualified dividends. See note 15.

(31) IRC Sec. 303(a).

(32) IRC Sec. 303(b)(2).

(33) IRC Secs. 303(a) and 303(b)(3).

(34) IRC Sec. 303(b)(1).

(35) For the article, the terms “partnership” and “partner” will be used throughout to include “limited liability company” and “member.”

(36) IRC Secs. 1366(a)(1)(A), 1367(a)(1)(A), and 705(a)(1)(B).

(37) IRC Secs. 1368(e)(1)(A) and 705(a)(2)(B).

(38) IRC Sec. 1014.

(39) Treas. Reg. Sec. 1.704-1(b)(2)(ii).

(40) IRC Sec. 1377(a)(1).

(41) IRC Sec. 1377(a)(2).

(42) IRC Sec. 736(b).

(43) IRC Sec. 736(b)(2)(A).

(44) IRC Sec. 736(b)(2)(B).

(45) IRC Sec. 751(b)(1)(A)(ii).

(46) IRC Sec. 736(a).

(47) IRC Sec. 691.

(48) IRC Sec. 736(b)(2)(B).

(49) IRC Sec. 751(d).

(50) IRC Sec. 264(a)(1).

(51) IRC Sec. 101(a).

(52) IRC Sec. 1221.

(53) IRC Sec. 1012.

(54) IRC Sec. 741.

(55) IRC Secs. 741 and 751.

(56) IRC Sec. 754.

(57) IRC Sec. 101(a)(2).

(58) Ibid.

(59) IRC Sec. 101(a)(2)(B).

(60) See, for example, SABA Partnership, et al. v. Commissioner, T.C. Memo. 2003-31 and Boca Investerings Partnership, et al. v. United States, U.S. Court of Appeals for the District of Columbia Circuit, January 2003.

(61) Treas. Reg. Sec. 1.701-2(a).

(62) IRC Sec 1361(b).

(63) IRC Sec. 1361(b)(1)(A).

(64) IRC Sec. 1361(c)(1).

(65) IRC Sec. 1361(b)(1)(B).

(66) IRC Sec. 1361(c)(6).

(67) IRC Sec. 1361 (b)(1)(C).

(68) IRC Sec. 1361(b)(1)(D).