Rev. Rul. 83-68

ISSUE

Does the stock dividend described below give shareholders an election to receive either stock or property within the meaning of section 305(b)(1) of the Internal Revenue Code?

FACTS

Bank is a member of the Federal Home Loan Bank of City R (FHLB of R). Section 6(c)(2) of the Federal Home Loan Bank Act (Bank Act), 12 U.S.C. section 1421, requires member banks to maintain a stock interest in a Federal Home Loan Bank (FHLB) equal to a percentage of their net home loan mortgages and a fraction of their borrowings from the FHLB. Section 6(c)(1) of the Bank Act provides that a FHLB may, in its discretion and upon application of a member, retire any shareholdings of the member banks in excess of the amount required to be held under section 6(c)(2) of the Bank Act.

On May 1, 1981, FHLB of R declared a six percent stock dividend payable to all member banks on June 1, 1981. The dividend declaration notice stated that not all members need to hold additional stock, and such members may wish to retire any stock in excess of the required amount. Each member bank was advised that it could notify the FHLB of R that it wished to tender its excess shares for redemption. At least one of the member banks had the option to have all the shares it received as a stock dividend redeemed because it already held excess shares. In accordance with an established policy of the FHLB of R, all redemption requests were honored in full. The FHLB of R has not refused to redeem any stock in the last ten years and apparently will not refuse to redeem stock in the future, although such option would always be available.

LAW AND ANALYSIS

Section 305(a) of the Code provides, generally, that gross income does not include the amount of any distribution of the stock of a corporation made by the corporation to its shareholders with respect to its stock, except as otherwise provided in section 305(b).

Section 305(b)(1) of the Code provides that section 305(a) will not apply to a distribution by a corporation of its stock, and the distribution will be treated as a distribution of property to which section 301 applies, if the distribution is, at the election of any of the shareholders (whether exercised before or after the declaration of the distribution), payable either (a) in its stock, or (b) in property.

Section 1.305-2(a)(2) of the Income Tax Regulations provides that an election within the meaning of section 305(b)(1) of the Code can arise whether the election is exercised or exercisable before or after the declaration of the distribution. Under section 1.305-2(a)(3), an election can arise if the declaration of the distribution provides for a distribution in one medium, unless the shareholder specifically requests payment in the other. Under section 1.305-2(a)(4), an election can arise from the circumstances of the distribution. And, under section 1.305-2(a)(5), an election can arise whether all or some of the shareholders have the election.

Rev. Rul. 76-258, 1976-2 C.B. 95, held that a distribution of preferred stock that is immediately redeemable at the option of a shareholder gives the shareholder an election to receive either stock or property within the meaning of section 305(b)(1) of the Code and therefore is treated as a distribution of property to which section 301 applies.

In the present case, the distribution was to be made in stock of the FHLB of R. However, at all times a member has the right under the Bank Act to request the redemption of all or part of its stock in the FHLB of R to the extent such stock constituted excess holdings. Although it is left to the discretion of the FHLB whether to redeem stock held by a member, it is an established policy of the FHLB of R to honor all redemption requests unless unusual circumstances exist.

Section 305(a) of the Code does not apply to at least a part of the present distribution because, in substance, some or all of the shareholders have an election to receive either stock or money. This is true even though the distribution was to be of stock unless the shareholder chose otherwise. It is also irrelevant for purposes of section 305 that only some members were eligible to have their stock redeemed, and that not all of those members chose to have the stock dividend redeemed.

Example 1 of section 1.305-2(b) of the regulations points out that the portion of a distribution of stock which is not subject to an election to receive property will be treated under section 305(a) of the Code, while the portion of the stock distributed which is subject to such an election will be treated, by reason of section 305(b)(1), as a distribution of property to which section 301 applies.

The amount taxable to a given member bank will be that portion of the stock dividend subject to the excess holding election by the member bank having the largest portion redeemable at its option. Thus, if all of the shares distributed to any member bank constitute excess holdings, the entire distribution will be taxable with respect to every member bank, regardless of whether any of the shares received constitute excess holdings to that bank. On the other hand, if the largest portion of the distribution redeemable is, for example, one half, then one half of the distribution will be taxable to each member bank, regardless of the relative numbers of shares redeemable.

HOLDING

All the members of FHLB of R who received the stock dividend will be treated as having received a distribution to which section 301 of the Code applies by reason of the application of section 305(b)(1). In this instance, because at least one member bank had the option to cause redemption of the entire distribution, the distribution will be entirely taxable to all member banks. The amount of the distribution and the basis of the stock dividend received by the member banks, as determined under section 301(d)(2), will be its fair market value in the hands of FHLB of R immediately before the distribution. See sections 1.301-1(d) and 1.301-1(h)(2)(i) of the regulations.