## Facts

- Georgia E. Dunn inherited stock in Bresee Chevrolet Co., Inc., a closely held corporation founded by her father.
- By 1970, Georgia owned 249 of 500 shares; her son owned 149 shares; each of her two married daughters owned 51 shares.
- Georgia and her husband were elderly and planned to reduce business involvement; Bresee had paid virtually no dividends, and Georgia sought additional income and to address estate-planning liquidity concerns.
- On May 27, 1970, Georgia and Bresee executed a stock purchase/redemption agreement, with separate counsel representing each side.
- Bresee agreed to redeem Georgia’s 249 shares for $335,154, paying $100,000 on June 1, 1970, and the balance over ten years at 5% interest.
- The promissory note provided that payments would be reduced, deferred, or postponed if needed to avoid impairing Bresee’s compliance with a General Motors franchise requirement to maintain minimum net working capital.
- After the redemption, Georgia held no position and no continuing role in Bresee other than the right to receive payments under the note; her husband continued working only as a salesman and held no stock.
- Georgia reported amounts received in 1970 and 1971 as capital gain from a complete termination redemption; the Commissioner asserted the payments were dividends because the note allegedly created an interest beyond that of a creditor.

## Issues

1. Whether the 1970–1971 payments made under Bresee’s redemption note were taxable as exchange proceeds (capital gain) under I.R.C. § 302(a) and § 302(b)(3) as a complete redemption of all Georgia Dunn’s stock.
2. Whether the note’s payment-contingency clause, tied to Bresee’s working-capital obligations under a GM franchise agreement, gave Georgia an impermissible continuing interest beyond that of a creditor under I.R.C. § 302(c)(2)(A)(i) and Treas. Reg. § 1.302-4(d), requiring dividend treatment under I.R.C. §§ 301 and 316.

## Decision

- The Second Circuit affirmed the Tax Court.
- The court held the redemption was a complete redemption of all Georgia Dunn’s stock within I.R.C. § 302(b)(3).
- The court held that immediately after the distribution Georgia retained no interest in Bresee other than an interest as a creditor.
- The court rejected the Commissioner’s argument that the payment-contingency clause converted the note into an equity-like interest.
- The amounts received in 1970 and 1971 were taxable as capital gain (exchange treatment), not as dividends.

## Legal Principles

- A corporate distribution in redemption of stock is treated as an exchange under I.R.C. § 302(a) if one of the tests in § 302(b) is satisfied.
- Under I.R.C. § 302(b)(3), a redemption qualifies for exchange treatment when it completely redeems all stock owned by the shareholder.
- Under I.R.C. § 302(c)(2)(A)(i), complete-termination treatment requires that immediately after the distribution the shareholder hold no interest in the corporation (including as officer, director, or employee) other than as a creditor.
- A promissory note issued as redemption consideration may leave the former shareholder as a creditor; protective covenants and payment deferrals tied to preserving corporate solvency or satisfying third-party contractual capital requirements do not, by themselves, create a prohibited continuing equity interest.
- Appellate review gives weight to the Tax Court’s supported factual finding that the taxpayer’s post-transaction relationship to the corporation was solely that of a creditor.

## Conclusion

The court held that Georgia Dunn’s stock was completely redeemed and that her only post-redemption connection to the corporation was creditor status under the note; therefore, the payments qualified for exchange (capital-gain) treatment under I.R.C. § 302(b)(3) rather than dividend treatment.


Dunn v. Commissioner, 615 F.2d 578 (2d Cir. 1980)