303 / What is a Section 303 stock redemption?

Estates of decedents comprised largely of close corporation stock commonly have a liquidity problem. Congress enacted IRC Section 303 expressly to aid these estates in solving this problem and to protect small businesses from forced liquidations or mergers due to the heavy impact of death taxes. Within the limits of IRC Section 303, surplus can be withdrawn from the corporation free of income tax.

In certain instances, stock of a public corporation also may be redeemed under IRC Section 303.

Any payments by a corporation to a shareholder generally are treated as dividends ( Q 300). IRC Section 303 provides that, under stipulated conditions (see Q 304), a corporation can redeem part of a deceased stockholder’s shares without the redemption being treated as a dividend. Instead, the redemption price will be treated as payment in exchange for the stock as a capital transaction ( Q 305). An IRC Section 303 redemption can safely be used in connection with the stock of a family-owned corporation because constructive ownership rules are not applied in an IRC Section 303 redemption ( Q 300).¹

The stock of any corporation, including an S corporation, may qualify for an IRC Section 303 redemption. Moreover, any class of stock may be redeemed under IRC Section 303. Thus, a nonvoting stock, common or preferred, issued as a stock dividend or issued in a lifetime or post-death recapitalization can qualify for the redemption.²

Where a corporation issued nonvoting shares immediately prior to and as a part of the same transaction as the redemption, a valid IRC Section 303 redemption was made.³

IRC Section 306 stock is preferred stock distributed to shareholders as a stock dividend, the sale or redemption of which may subject the proceeds to income tax treatment as dividend income because of special rules contained in IRC Section 306. A distribution in redemption of IRC Section 306 stock will qualify under IRC Section 303 to the extent the conditions of IRC Section 303 are met.⁴