26 U.S.C. § 306 — Dispositions of certain stock

(a) General rule. This section is about "section 306 stock" -- a special kind of stock defined later in subsection (c). If a shareholder sells or gets rid of section 306 stock, here is what happens: (1) If it is not a redemption (the corporation buying back its own stock under section 317(b)): (A) The money the shareholder gets is treated as ordinary income, not capital gain -- but only up to a limit. Figure out what the stock's fair share would have been if, instead of giving out the stock, the corporation had given cash as a dividend at that time. If what the shareholder actually got is more than that dividend-equivalent amount, only the amount up to that limit counts as ordinary income. (B) Take whatever is left after subtracting (i) the ordinary income from (A) and (ii) the shareholder's basis (cost) in the stock. What is left after that is treated as capital gain from selling the stock. (C) The shareholder can never claim a loss on this stock. (D) For purposes of the qualified-dividend rules in section 1(h)(11), and any other rules the Secretary names, the amount treated as ordinary income under (A) counts as a dividend from the corporation. (2) If it is a redemption, the money the shareholder gets is treated as a regular distribution of property under section 301 (usually taxed as a dividend to the extent of earnings and profits). (b) Exceptions. The harsh rule in (a) does not apply in these cases: (1) The shareholder's ownership completely ends. (A) Not a redemption: this exception applies if the disposal is not a redemption, does not go -- directly or indirectly -- to someone whose stock would count as the shareholder's own stock under the attribution rules of section 318(a), and it wipes out the shareholder's entire stake in the corporation (counting related parties under 318(a)). (B) In a redemption: this exception applies if the redemption qualifies under section 302(b)(3) or (4). (2) The section 306 stock is redeemed as part of a complete liquidation of the corporation, under the rules in sections 331 and following. (3) No gain or loss is recognized on the disposal under any other tax rule. (4) The shareholder proves to the Secretary's satisfaction that neither the original stock distribution and this disposal (or redemption), nor -- if the section 306 stock was itself received by exchanging other section 306 stock -- that earlier or simultaneous exchange, was done mainly to dodge federal income tax. (c) What counts as "section 306 stock." (1) In general. Stock is "section 306 stock" if it fits (A), (B), or (C): (A) Distributed to the seller: stock (other than common stock given for common stock) that the shareholder got as a distribution, where some part of that distribution was not included in the shareholder's taxable income because of section 305(a). (B) Received in a corporate reorganization or spin-off: non-common stock the shareholder got through a reorganization plan (section 368(a)) or a spin-off-type deal under section 355, where gain or loss was not recognized under Part III -- but only if the deal worked essentially like a stock dividend, or the stock was swapped for other section 306 stock. Getting this kind of stock counts as a "distribution" of stock for this section. (C) Stock with a carried-over basis: any other stock whose tax basis is figured by reference to the basis of section 306 stock. (2) Exception when there are no earnings and profits: stock is not "section 306 stock" if none of it would have counted as a dividend had the corporation given cash instead. (3) Stock from a section 351 exchange: non-common stock acquired in a tax-free section 351 exchange also counts as "section 306 stock" if getting cash instead would have been treated as a dividend, at least in part. The attribution rules of section 304(b)(2) apply here too. (4) Attribution rules: the attribution rules of section 318(a) apply when checking (1)(B)(ii) and (3) above; the rules of section 304(c)(3)(B) apply when applying this to later dispositions of that stock. (d) Stock rights. Rights to buy stock count as "stock" for this section. Stock bought by using those rights counts as having been distributed at the same time as the rights -- but only up to the fair market value the rights had back then. (e) Convertible stock. (1) If section 306 stock was issued for common stock, and it is later exchanged for common stock in the same company, the new common stock is usually not "section 306 stock" (except as (2) says). (2) But common stock is not treated as common stock here if it carries the right to convert into something other than common stock, or into property. (f) Source of gain. The ordinary income amount from (a)(1)(A) is treated, for figuring where income "comes from" under the international tax rules, as if it were a dividend paid at the time of the original distribution. If that makes it U.S.-source income, it is treated as the kind of fixed, determinable annual income covered by sections 871(a) and 881(a). (g) Change in the stock's terms. If the stock's terms change significantly, three special rules kick in: (1) use whichever fair market value is higher -- the value at distribution or at the time of the change; (2) use whichever "would-be dividend" ratable share is higher -- as of distribution or as of the change; and (3) the no-earnings-and-profits exception in (c)(2) only applies if the stock meets that test both at distribution and at the time of the change.