[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.302-2]

[Page 14-15]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.302-2  Redemptions not taxable as dividends.

    (a) The fact that a redemption fails to meet the requirements of 
paragraph (2), (3) or (4) of section 302(b) shall not be taken into 
account in determining whether the redemption is not essentially 
equivalent to a dividend under section 302(b)(1). See, however, 
paragraph (b) of this section. For example, if a shareholder owns only 
nonvoting stock of a corporation which is not section 306 stock and 
which is limited and preferred as to dividends and in liquidation, and 
one-half of such stock is redeemed, the distribution will ordinarily 
meet the requirements of paragraph (1) of section 302(b) but will not 
meet the requirements of paragraph (2), (3) or (4) of such section. The 
determination of whether or not a distribution is within the phrase 
``essentially equivalent to a dividend'' (that is, having the same 
effect as a distribution without any redemption of stock) shall be made 
without regard to the earnings and profits of the corporation at the 
time of the distribution. For example, if A owns all the stock of a 
corporation and the corporation redeems part of his stock at a time when 
it has no earnings and profits, the distribution shall be treated as a 
distribution under section 301 pursuant to section 302(d).
    (b) The question whether a distribution in redemption of stock of a 
shareholder is not essentially equivalent to a dividend under section 
302(b)(1) depends upon the facts and circumstances of each case. One of 
the facts to be considered in making this determination is the 
constructive stock ownership of such shareholder under section 318(a). 
All distributions in pro rata redemptions of a part of the stock of a 
corporation generally will be treated as distributions under section 301 
if the corporation has only one class of stock outstanding. However, for 
distributions in partial liquidation, see section 346. The redemption of 
all of one class of stock (except section 306 stock) either at one time 
or in a series of redemptions generally will be considered as a 
distribution under section 301 if all

[[Page 15]]

classes of stock outstanding at the time of the redemption are held in 
the same proportion. Distribution in redemption of stock may be treated 
as distributions under section 301 regardless of the provisions of the 
stock certificate and regardless of whether all stock being redeemed was 
acquired by the stockholders from whom the stock was redeemed by 
purchase or otherwise. In every case in which a shareholder transfers 
stock to the corporation which issued such stock in exchange for 
property, the facts and circumstances shall be reported on his return 
except as provided in paragraph (d) of Sec. 1.331-1. See sections 
346(a) and 6043 for requirements relating to returns by corporations.
    (c) In any case in which an amount received in redemption of stock 
is treated as a distribution of a dividend, proper adjustment of the 
basis of the remaining stock will be made with respect to the stock 
redeemed. (For adjustments to basis required for certain redemptions of 
corporate shareholders that are treated as extraordinary dividends, see 
section 1059 and the regulations thereunder.) The following examples 
illustrate the application of this rule:

    Example (1). A, an individual, purchased all of the stock of 
Corporation X for $100,000. In 1955 the corporation redeems half of the 
stock for $150,000, and it is determined that this amount constitutes a 
dividend. The remaining stock of Corporation X held by A has a basis of 
$100,000.
    Example (2). H and W, husband and wife, each own half of the stock 
of Corporation X. All of the stock was purchased by H for $100,000 cash. 
In 1950 H gave one-half of the stock to W, the stock transferred having 
a value in excess of $50,000. In 1955 all of the stock of H is redeemed 
for $150,000, and it is determined that the distribution to H in 
redemption of his shares constitutes the distribution of a dividend. 
Immediately after the transaction, W holds the remaining stock of 
Corporation X with a basis of $100,000.
    Example (3). The facts are the same as in Example (2) with the 
additional facts that the outstanding stock of Corporation X consists of 
1,000 shares and all but 10 shares of the stock of H is redeemed. 
Immediately after the transaction, H holds 10 shares of the stock of 
Corporation X with a basis of $50,000, and W holds 500 shares with a 
basis of $50,000.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 8724, 62 FR 
38028, July 26, 1997]