## Facts

- Married taxpayers owned all outstanding shares of a closely held corporation in which they served as officers and directors.
- In 1979, the corporation redeemed all of their shares for $299,000, while simultaneously issuing new shares to their adult son, who assumed control.
- After the redemption, the husband continued working for the corporation for about two years as a salaried employee.
- The taxpayers reported the redemption proceeds as long-term capital gain, treating the transaction as a sale or exchange of stock.
- The Commissioner determined the redemption did not qualify for sale/exchange treatment under I.R.C. § 302 and recharacterized the proceeds as dividends taxable under § 301, relying on (i) family attribution under § 318 and (ii) limits on waiving attribution under § 302(c)(2).

## Issues

1. Whether redeeming all of the taxpayers’ shares qualified as a “complete redemption” under I.R.C. § 302(b)(3), producing sale/exchange treatment under § 302(a).
2. Whether the taxpayers could avoid family attribution under § 318 by using the waiver in § 302(c)(2), or whether the husband’s continued employment constituted a prohibited interest under § 302(c)(2)(A)(i).
3. Whether, if § 302(a) did not apply, the redemption proceeds were taxable as dividends under § 301.

## Decision

- The Tax Court sustained the Commissioner’s determination that the redemption did not qualify for exchange treatment under § 302(a).
- Under § 318(a)(1), the husband was treated as constructively owning the son’s shares; therefore, his interest in the corporation was not completely terminated for purposes of § 302(b)(3).
- The court held the husband’s post-redemption employment was a prohibited interest under § 302(c)(2)(A)(i), making the § 302(c)(2) waiver of family attribution unavailable.
- Because the redemption failed the § 302(b) tests, the distribution was treated as essentially equivalent to a dividend and taxed under § 301.

## Legal Principles

- In testing a redemption under § 302(b), both actual and constructive ownership rules apply; under § 318(a)(1), a parent constructively owns stock held by a child.
- A shareholder seeking a “complete termination” under § 302(b)(3) cannot use the § 302(c)(2) waiver if the shareholder retains a prohibited interest, including an interest as an employee, within the meaning of § 302(c)(2)(A)(i).
- If a redemption does not satisfy a § 302(b) safe harbor (including complete termination), the proceeds are treated as a distribution governed by § 301 and taxed as dividends to the extent of earnings and profits.

## Conclusion

The Tax Court held that the redemption proceeds were ordinary dividend income because family attribution treated the parent as still owning stock after the redemption, and the parent’s continued employment constituted a prohibited interest that barred the statutory waiver needed to obtain complete-termination, sale-or-exchange treatment.


Seda v. Commissioner, 82 T.C. 484 (1984)