Daily Tax Update - April 18, 2006

IRS and Treasury Withdraw Proposed Regulations Relating to Redemptions Taxable as Dividends:
Today, the IRS and Treasury withdrew a notice of proposed rulemaking published in 2002 relating to redemptions of stock treated as dividend distributions.

  • In 2002, the IRS and Treasury issued proposed regulations containing guidance under sections 302 and 304 regarding the treatment of the basis of redeemed stock where the redemption is treated as a section 301 distribution. Under section 301(c)(1), a distribution is treated as a dividend to the extent of earnings of profits. If the distribution is greater than earnings and profits, then the excess first reduces basis under section 301(c)(2) and then is treated as gain from a sale or exchange under section 301(c)(3).
  • The proposed regulations provided that the basis of redeemed stock does not shift to other shares directly owned by the redeemed shareholder or to any other person whose ownership is attributed to the redeemed shareholder. Instead, the proposed regulations provided that to the extent the distribution is treated as a dividend, an amount equal to the adjusted basis of the redeemed stock is treated as a loss recognized on the date of the redemption. The loss, generally, would be taken into account either when the facts and circumstances that caused the redemption to be treated as a section 301 distribution no longer exist, or when the redeemed shareholder recognizes a gain on the stock of the redeeming corporation (to the extent of such gain).
  • After receiving many comments, several of which criticized the proposed regulations as an unwarranted departure from current law or as creating the potential for two levels of tax in certain consolidated return transactions, the IRS and Treasury have decided to withdraw the proposed regulations. Today's notice stated that the IRS and Treasury are continuing to study the approach in the proposed regulations, as well as other approaches, and are interested in receiving further comments.
  • Today's notice also stated that the IRS and Treasury are studying other basis issues that arise in redemptions treated as section 301 distributions. Specifically, the notice stated that the IRS and Treasury are studying whether basis reduction under section 301(c)(2) should be limited to the basis of the shares redeemed or whether it should extend to both the retained and redeemed shares.
  • For additional information, contact Mark Silverman via email or Lisa Zarlenga via email.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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