Rev. Rul. 54-230

Advice is requested with regard to the effect, for Federal income tax purposes, of a proposed redemption by a corporation of that portion of its capital stock held by the estate of a deceased stockholder.

At the time of death the decedent owned 4,420 shares of stock of the corporation. In addition to the stock now held in the decedent's estate, each of the five brothers of the decedent owns 4,420 shares of stock of the corporation, and the remaining 7,530 shares of the corporation are owned by X Corporation. Each of the five brothers owns 16 2/3 percent of the stock in X Corporation and the remaining 16 2/3 percent is owned by the estate of the decedent.

The corporation had entered into an agreement with its stockholders for the acquisition of that portion of its capital stock held by a deceased stockholder at time of death. Pursuant to the agreement each stockholder agrees to sell and the corporation agrees to purchase as much of its capital stock belonging to a deceased stockholder as the proceeds of the insurance policies purchased by the corporation on the life of such stockholder, together with accrued dividends and unearned premiums, will purchase at the price per share fixed by the agreement.

The capital stock held directly and indirectly by the estate of the deceased stockholder represents approximately 15 percent of the total outstanding capital stock of the corporation; therefore, the redemption does not involve a majority stockholder.

Section 115 of the Internal Revenue Code provides in part as follows:

(a) DEFINITION OF DIVIDEND.-The term `dividend' when used in this chapter * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year * * * without regard to the amount of the earnings and profits at the time the distribution was made. * * *

(b) SOURCE OF DISTRIBUTIONS.-For the purposes of this chapter every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. * * *

(c) DISTRIBUTIONS IN LIQUIDATION.-Amounts distributed * * * in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. In the case of amounts distributed * * * in partial liquidation * * * the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits.

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(i) DEFINITION OF PARTIAL LIQUIDATION.-As used in this section the term `amounts distributed in partial liquidation' means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.

Accordingly, it is held (1) that the proposed redemption of that portion of the capital stock of the corporation held by the estate of the deceased stockholder, pursuant to the agreement whereby the proceeds of certain insurance policies on his life will be used by the corporation to redeem the capital stock held by his estate, in case of death, will constitute a partial liquidation within the meaning of section 115(c) and (i) of the Internal Revenue Code; (2) that the total amount received by the estate upon surrender of the capital stock will be treated, for Federal income tax purposes, as in payment in exchange for the stock as provided in section 115(c) and gain or loss will be determined under section 111 of the Code subject to the provisions of section 117 of the Code; and (3) that the excess of the insurance proceeds received by the corporation over the aggregate sum of the premiums paid will constitute earnings and profits available for distribution within the meaning of section 115(a) and (b) of the Code.