In my previous post on the Thomas D. Glascock Blog, we discussed Internal Revenue Code (“IRC”) Section 303, and the potential benefits it can make available. We covered some of the basics of these special stock redemptions, as well as filing deadlines you need to know.
If you missed it, you can read that full article here. I recommend reading that article first, and then coming back here to finish Part 2:
What is an Internal Revenue Code Section 303 Stock Redemption? (Part 1)
Now, let’s continue our conversation about IRC Section 303 stock redemptions.
IRC Section 303 and IRC Section 2057
In prior years, a Section 303 redemption could be made interact with IRC Section 2057, which applied for many estates with family-owned businesses. IRC Section 2057 allowed owners of a family business who died before 2004 (or after 2010) a federal estate tax deduction of up to $675,000 in value of qualified business interests. However, the combination of the family-owned business deduction and the estate tax applicable exclusion amount is limited to $1.3 million. And to qualify for the Section 2057 deduction, 50% or more of the decedent’s adjusted gross estate generally had to consist of family-owned business interests.
When a Section 303 stock redemption was carried out, the adjusted gross estate requirement could be adjusted below 50%. The IRS specifically ruled that Section 303 does not aversely affect qualification for the Section 2057 deduction [Rev. Rul. 2003-61, 2003-24 IRB 1015]. Moreover, a Section 303 stock redemption would not trigger the additional estate tax on certain dispositions of family-owned business interests within 10 years of the deceased owner’s death.
What this all meant was that eligible estates with family-business holdings may be able to utilize a combination of Section 303 stock redemptions and the Section 2057 deduction to reduce estate tax liabilities while re-infusing much-needed capital back into the business and/or helping pay for costly estate expenses with the stock redemption(s).
The above said, IRC Section 2057 was repealed on December 19, 2014, and it is not longer available. Even so, its past utilization is a guide to creative planning, and IRC Section 303 remains an available tool.
Section 303 Qualification Requirements
IRC Section 303 permits the partial redemption of shares in a closely-held corporation following a shareholder’s death to be taxed as a capital transaction. To qualify for this treatment, the following four tests must be satisfied:
- The stock must be included in the decedent’s gross estate; and
- The relevant shares’ value must exceed 35% of the decedent’s adjusted gross estate; and
- The shares must by held by a person whose interest in the estate would be reduced by the payment of estate costs; and
- The redemption must generally occur within four (4) years of the deceased shareholder’s death.
It is important to note that while the decedent’s shares must be part of the gross estate, they do not have to be held by the executor. For example, they can instead be held by a surviving joint tenant.
To satisfy test number 2 above, the decedent is permitted to own 20% or more of two separate corporations, with the combined value of these corporations meeting the 35% requirement. A spouse’s joint tenancy interest, interest as a tenant in common, or community property interest in the shares may also be counted toward this requirement.
With respect to the third test, however, the surviving spouse cannot take advantage of Section 303 if the shares pass to him or her as part of the marital deduction share. In that case, the estate costs are payable out of the residue of the estate. Therefore, the surviving spouse does not carry the burden of paying the estate costs.
Summary
If you are a business owner, it is critical to have an understanding of the relevant tax laws and available tax planning options (including IRC Section 303 redemptions) when designing your estate plan. This can help protect your business when you are gone, as well as protect surviving family members from financial concerns. If you are a surviving spouse or heir who is facing these concerns, you will want to speak with a tax specialist or attorney, who can help you explore your options and assist with your making decisions that will best protect your financial assets. This may include IRC Section 303 stock redemptions.
For help with all your estate tax planning and legal estate management needs, contact us today.
