Rev. Rul. 69-608

Advice has been requested as to the treatment for Federal income tax purposes of the redemption by a corporation of a retiring shareholder's stock where the remaining shareholder of the corporation has entered into a contract to purchase such stock.

Where the stock of a corporation is held by a small group of people, it is often considered necessary to the continuity of the corporation to have the individuals enter into agreements among themselves to provide for the disposition of the stock of the corporation in the event of the resignation, death, or incapacity of one of them. Such agreements are generally reciprocal among the shareholders and usually provide that on the resignation, death, or incapacity of one of the principal shareholders, the remaining shareholders will purchase his stock. Frequently such agreements are assigned to the corporation by the remaining shareholder and the corporation actually redeems its stock from the retiring shareholder.

Where a corporation redeems stock from a retiring shareholder, the fact that the corporation in purchasing the shares satisfies the continuing shareholder's executory contractual obligation to purchase the redeemed shares does not result in a distribution to the continuing shareholder provided that the continuing shareholder is not subject to an existing primary and unconditional obligation to perform the contract and that the corporation pays no more than fair market value for the stock redeemed.

On the other hand, if the continuing shareholder, at the time of the assignment to the corporation of his contract to purchase the retiring shareholder's stock, is subject to an unconditional obligation to purchase the retiring shareholder's stock, the satisfaction by the corporation of his obligation results in a constructive distribution to him. The constructive distribution is taxable as a distribution under section 301 of the Internal Revenue Code of 1954.

If the continuing shareholder assigns his stock purchase contract to the redeeming corporation prior to the time when he incurs a primary and unconditional obligation to pay for the shares of stock, no distribution to him will result. If, on the other hand, the assignment takes place after the time when the continuing shareholder is so obligated, a distribution to him will result. While a pre-existing obligation to perform in the future is a necessary element in establishing a distribution in this type of case, it is not until the obligor's duty to perform becomes unconditional that it can be said a primary and unconditional obligation arises.

The application of the above principles may be illustrated by the situations described below.

Situation 1

A and B are unrelated individuals who own all of the outstanding stock of corporation X. A and B enter into an agreement that provides in the event B leaves the employ of X, he will sell his X stock to A at a price fixed by the agreement. The agreement provides that within a specified number of days of B's offer to sell, A will purchase at the price fixed by the agreement all of the X stock owned by B. B terminates his employment and tenders the X stock to A. Instead of purchasing the stock himself in accordance with the terms of the agreement, A causes X to assume the contract and to redeem its stock held by B. In this case, A had a primary and unconditional obligation to perform his contract with B at the time the contract was assigned to X. Therefore, the redemption by X of its stock held by B will result in a constructive distribution to A. See William J. and Georgia K. Sullivan v. United States of America, 244 F. Supp. 605 (1965), affirmed, 363 F. 2d 724 (1966), certiorari denied, 387 U.S. 905 (1967), rehearing denied, 388 U.S. 924 (1967).

Situation 2

A and B are unrelated individuals who own all of the outstanding stock of corporation X. An agreement between them provides unconditionally that within ninety days of the death of either A or B, the survivor will purchase the decedent's stock of X from his estate. Following the death of B, A causes X to assume the contract and redeem the stock from B's estate.

The assignment of the contract to X followed by the redemption by X of the stock owned by B's estate will result in a constructive distribution to A because immediately on the death of B, A had a primary and unconditional obligation to perform the contract.

Situation 3

All of the stock of X corporation was owned by a trust that was to terminate in 1968. Individuals A and B were the beneficiaries of the trust. Since B was the trustee of the trust, he had exclusive management authority over X through his control of the board of directors. In 1966, A paid to B the sum of 25x dollars and promised to pay an additional 20x dollars to B in 1969 for B's interest in the corpus and accumulations of the trust plus B's agreement to resign immediately as supervisor of the trust and release his control over the management of the corporation. The actual transfer of the stock held in trust was to take place on termination of the trust in 1968. In 1969, X reimbursed A for the 25x dollars previously paid to B, paid 20x dollars to B, and received the X stock held by B.

For all practical purposes, A became the owner of B's shares in 1966. Although naked legal title to the shares could not be transferred until the trust terminated in 1968, B did transfer all of his beneficial and equitable ownership of the X stock to A in exchange for an immediate payment by A of 25x dollars and an unconditional promise to pay an additional 20x dollars upon termination of the trust. The payment by X of 20x dollars to B and 25x dollars to A in 1969 constituted a constructive distribution to A in the amount of 45x dollars. See Schalk Chemical Company v. Commissioner, 32 T.C. 879 (1959), affirmed 304 F. 2d, 48 (1962).

Situation 4

A and B owned all of the outstanding stock of X corporation. A and B entered into a contract under which, if B desired to sell his X stock, A agreed to purchase the stock or to cause such stock to be purchased. If B chose to sell his X stock to any person other than A, he could do so at any time. In accordance with the terms of the contract, A caused X to redeem all of B's stock in X.

At the time of the redemption, B was free to sell his stock to A or to any other person, and A had no unconditional obligation to purchase the stock and no fixed liability to pay for the stock. Accordingly, the redemption by X did not result in a constructive distribution to A. See S. K. Ames, Inc., v. Commissioner, 46 B.T.A. 1020 (1942), acquiescence, C.B. 1942-1, 1.

Situation 5

A and B owned all of the outstanding stock of X corporation. An agreement between A and B provided that upon the death of either, X will redeem all of the X stock owned by the decedent at the time of his death. In the event that X does not redeem the shares from the estate, the agreement provided that the surviving shareholder would purchase the unredeemed shares from the decedent's estate. B died and, in accordance with the agreement, X redeemed all of the shares owned by his estate.

In this case A was only secondarily liable under the agreement between A and B. Since A was not primarily obligated to purchase the X stock from the estate of B, he received no constructive distribution when X redeemed the stock.

Situation 6

B owned all of the outstanding stock of X corporation. A and B entered into an agreement under which A was to purchase all of the X stock from B. A did not contemplate purchasing the X stock in his own name. Therefore, the contract between A and B specifically provided that it could be assigned by A to a corporation and that, if the corporation agreed to be bound by the terms, A would be released from the contract.

A organized Y corporation and assigned the stock purchase contract to it. Y borrowed funds and purchased all of the X stock from B pursuant to the agreement. Subsequently Y was merged into X and X assumed the liabilities that Y incurred in connection with the purchase of the X stock and subsequently satisfied these liabilities.

The purchase by Y of the stock of X did not result in a constructive distribution to A. Since A did not contemplate purchasing the X stock in his own name, he provided in the contract that it could be assigned to a corporation prior to the closing date. A chose this latter alternative and assigned the contract to Y. A was not personally subject to an unconditional obligation to purchase the X stock from B. See Arthur J. Kobacker and Sara Jo Kobacker, et al. v. Commissioner, 37 T.C. 882 (1962), acquiescence, C.B. 1964-2, 6. Compare Ray Edenfield v. Commissioner, 19 T.C. 13 (1952), acquiescence, C.B. 1953-1, 4.

Situation 7

A and B owned all of the outstanding stock of X corporation. An agreement between the shareholders provided that upon the death of either, the survivor would purchase the decedent's shares from his estate at a price provided in the agreement. Subsequently, the agreement was rescinded and a new agreement entered into which provided that upon the death of either A or B, X would redeem all of the decedent's shares of X stock from his estate.

The cancellation of the original contract between the parties in favor of the new contract did not result in a constructive distribution to either A or B. At the time X agreed to purchase the stock pursuant to the terms of the new agreement, neither A nor B had an unconditional obligation to purchase shares of X stock. The subsequent redemption of the stock from the estate of either pursuant to the terms of the new agreement will not constitute a constructive distribution to the surviving shareholder.