26 U.S.C. § 302 — Distributions in redemption of stock

(a) General rule. If a corporation redeems (buys back) its own stock, as section 317(b) defines redemption, and the redemption fits one of the five tests in subsection (b), the law treats it as a sale or exchange of stock — meaning the shareholder is treated as if they sold their stock — rather than as a dividend. (b) Redemptions treated as exchanges. (1) Redemptions not equivalent to a dividend. A redemption qualifies if it is not essentially the same as paying a dividend. (2) Substantially disproportionate redemptions. (A)-(B) A redemption qualifies if it substantially cuts the shareholder's stake, but only if, right after the redemption, the shareholder owns less than 50 percent of all voting stock. (C) A cut counts as "substantially disproportionate" if the shareholder's share of voting stock after the redemption is less than 80 percent of their share before it, and the shareholder's ownership of common stock (voting or not) also drops to less than 80 percent of what it was. If there's more than one class of common stock, this is measured by fair market value. (D) This test does not apply to a redemption that is really one step in a planned series of redemptions which, added together, do not substantially cut the shareholder's stake. (3) Termination of interest. A redemption qualifies if it buys back every share of stock the shareholder owns in the corporation, ending their ownership entirely. (4) Partial liquidation. A redemption qualifies if it buys stock from a shareholder who is not a corporation, and it is part of the distributing corporation's partial liquidation (defined in subsection (e)). (5) Certain regulated investment companies. Unless IRS regulations say otherwise, a redemption of stock in a publicly offered regulated investment company (as section 67(c)(2)(B) defines that term) qualifies if the shareholder demanded the redemption and the company only issues stock that shareholders can demand be redeemed. (6) How the tests interact. Failing the tests in (2), (3), or (4) doesn't stop a redemption from qualifying under (1). And if a redemption qualifies under both (3) and one of (1), (2), or (4), then the special 10-year rule in subsection (c)(2) about acquiring a new interest in the corporation does not apply to it. (c) Constructive ownership of stock. (1) In general. Unless paragraph (2) says otherwise, section 318(a)'s attribution rules — which treat stock owned by relatives or related entities as owned by the shareholder — apply when deciding ownership under this section. (2) Termination-of-interest exception. (A) For a redemption ending a shareholder's whole interest under (b)(3), the family-attribution part of section 318(a)(1) does not apply if: (i) right after the redemption, the person has no remaining interest in the corporation (as officer, director, employee, or otherwise) except as a creditor; (ii) the person doesn't acquire such an interest (other than by gift or inheritance) within 10 years; and (iii) the person signs an agreement, in the way IRS regulations require, to tell the IRS if they do acquire such an interest, and to keep the necessary records. If the person does acquire an interest within 10 years and reports it, the IRS gets one extra year after that report to assess and collect any resulting tax, regardless of normal time limits. (B) This exception does not apply if: (i) any of the redeemed stock was bought, within the 10 years before the redemption, from someone whose ownership would be attributed to the shareholder under section 318(a); or (ii) someone whose stock ownership is attributed to the shareholder under section 318(a) bought stock from the shareholder within that same 10-year window, unless that stock was redeemed in the same transaction — unless the purchase or sale wasn't done mainly to avoid federal income tax. (C) Special rule for entities. (i) For a distribution to an entity (a partnership, estate, trust, or corporation), the exception in (A) applies only if the entity and every "related person" (as defined below) each meet conditions (i)-(iii) of (A), and each related person agrees to be personally responsible for any resulting tax. In that case, certain phrases in (A) and (B)(ii) are read as covering the related persons too. (ii) A "related person" is someone whose stock ownership would be attributed to the entity under the multi-step attribution rules of section 318(a)(1) and (a)(3). (d) Redemptions treated as distributions of property. If a redemption doesn't qualify under subsection (a), it's instead treated as an ordinary corporate distribution under section 301 — generally taxed as a dividend to the extent of earnings. (e) Partial liquidation defined. (1) A distribution counts as a partial liquidation if it isn't essentially like a dividend (judged at the corporate level, not the shareholder level) and it happens under a plan, within the tax year the plan is adopted or the following year. (2)-(3) This includes — but isn't limited to — a distribution where the corporation stops running, or gives out the assets of, a "qualified trade or business" it actively ran throughout the five years before the redemption (and didn't acquire in a taxable transaction during that time), as long as the corporation keeps actively running another qualified trade or business right after the distribution. (4) It doesn't matter whether the redemption is spread evenly among all shareholders. (5) When deciding whether a shareholder is "not a corporation" under (b)(4), stock held by a partnership, estate, or trust is treated as held directly, in proportion, by its partners or beneficiaries. (f) Cross references. This section notes three related rules found elsewhere: redemptions to pay death taxes are covered by section 303; redemptions of "section 306 stock" are covered by section 306; and redemptions of stock in a complete liquidation are covered by section 331.