[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: 26CFR1.302-3]

[Page 15-16]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.302-3  Substantially disproportionate redemption.

    (a) Section 302(b)(2) provides for the treatment of an amount 
received in redemption of stock as an amount received in exchange for 
such stock if--
    (1) Immediately after the redemption the shareholder owns less than 
50 percent of the total combined voting power of all classes of stock as 
provided in section 302(b)(2)(B),
    (2) The redemption is a substantially disproportionate redemption 
within the meaning of section 302(b)(2)(C), and
    (3) The redemption is not pursuant to a plan described in section 
302(b)(2)(D).

Section 318(a) (relating to constructive ownership of stock) shall apply 
both in making the disproportionate redemption test and in determining 
the percentage of stock ownership after the redemption. The requirements 
under section 302(b)(2) shall be applied to each shareholder separately 
and shall be applied only with respect to stock which is issued and 
outstanding in the hands of the shareholders. Section 302(b)(2) only 
applies to a redemption of voting stock or to a redemption of both 
voting stock and other stock. Section 302(b)(2) does not apply to the 
redemption solely of nonvoting stock (common or preferred). However, if 
a redemption is treated as an exchange to a particular shareholder under 
the terms of section 302(b)(2), such section will apply to the 
simultaneous redemption of nonvoting preferred stock (which is not 
section 306 stock) owned by such shareholder and such redemption will 
also be treated as an exchange. Generally, for purposes of this section, 
stock which does not have voting rights until the happening of an event, 
such as a default in the payment of dividends on preferred stock, is not 
voting stock until the happening of the specified event. Subsection 
302(b)(2)(D) provides that a redemption will not be treated as 
substantially disproportionate if made pursuant to a plan the purpose or 
effect of which is a series of

[[Page 16]]

redemptions which result in the aggregate in a distribution which is not 
substantially disproportionate. Whether or not such a plan exists will 
be determined from all the facts and circumstances.
    (b) The application of paragraph (a) of this section is illustrated 
by the following example:

    Example. Corporation M has outstanding 400 shares of common stock of 
which A, B, C and D each own 100 shares or 25 percent. No stock is 
considered constructively owned by A, B, C or D under section 318. 
Corporation M redeems 55 shares from A, 25 shares from B, and 20 shares 
from C. For the redemption to be disproportionate as to any shareholder, 
such shareholder must own after the redemptions less than 20 percent (80 
percent of 25 percent) of the 300 shares of stock then outstanding. 
After the redemptions, A owns 45 shares (15 percent), B owns 75 shares 
(25 percent), and C owns 80 shares (26 2/3 percent). The distribution is 
disproportionate only with respect to A.