## Facts

- A closely held family corporation, Connecticut Novelty Corporation, Inc., was owned and managed by Joseph Levine, Beatrice Levin (taxpayer), and her son, Jerome Levin.
- After the taxpayer’s husband died, she succeeded to his business interest; the business later incorporated and issued a single class of common stock.
- In 1957, the corporation recapitalized so Jerome received a substantially increased share position without consideration, reflecting a plan to increase his participation in ownership and management.
- To facilitate Jerome’s effective control, the taxpayer entered a redemption agreement under which the corporation would redeem part of her stock for $96,800, payable in annual $7,000 installments, with no interest and an option to accelerate payment.
- Despite the redemption plan, the taxpayer remained an officer and director, performed services for the corporation, and continued to receive a salary.
- For tax years 1960–1963, the taxpayer reported the $7,000 payments as long-term capital gain; the Commissioner treated them as dividends taxable as ordinary income.
- The Tax Court sustained the Commissioner, concluding the distributions were “essentially equivalent to a dividend” under I.R.C. § 302(b)(1); the taxpayer sought appellate review.

## Issues

1. Whether the corporation’s payments to the taxpayer under the redemption agreement were “essentially equivalent to a dividend” under I.R.C. § 302(b)(1), making them taxable as ordinary income rather than capital gain.
2. Whether, in applying § 302(b)(1), the Tax Court properly considered I.R.C. § 318 family attribution and the transaction’s effect on the taxpayer’s effective ownership and control.

## Decision

- The Second Circuit affirmed the Tax Court.
- The court held the redemption payments were “essentially equivalent to a dividend” under I.R.C. § 302(b)(1) and therefore taxable as ordinary income under the dividend rules rather than as capital gain.
- The court approved considering constructive ownership under I.R.C. § 318 to evaluate whether the redemption caused a meaningful reduction in the taxpayer’s proprietary interest.

## Legal Principles

- A redemption receives sale-or-exchange (capital gain) treatment under I.R.C. § 302 only if it fits within § 302(b); otherwise the distribution is treated as a dividend under I.R.C. § 301 to the extent of earnings and profits.
- Under I.R.C. § 302(b)(1), a redemption is dividend-equivalent when, in substance, it does not meaningfully reduce the shareholder’s ownership or control and instead functions like a distribution of corporate earnings.
- In testing dividend equivalence under § 302(b)(1), courts may apply I.R.C. § 318 attribution rules to measure the shareholder’s constructive ownership and effective control, not merely record title.
- Continued participation in management (e.g., remaining an officer/director and receiving salary) can support a finding that a purported redemption did not materially alter the shareholder’s relationship to the corporation.

## Conclusion

The Second Circuit treated the installment payments to the taxpayer as ordinary-income dividends because, after applying family attribution and considering the taxpayer’s continued role in the corporation, the redemption did not meaningfully reduce her effective ownership or control and therefore was essentially equivalent to a dividend under I.R.C. § 302(b)(1).


Levin v. Comm’r, 385 F.2d 521 (2d Cir. 1967)