## Facts

- Donald Zimmerman owned about 67% of Custom Met, Inc. (Custom Met), and his son, Jonathan, owned about 33%.
- Donald owned 80% of Rogers Metal Processing, Ltd. (Rogers Metal), and Jonathan owned 5% of Rogers Metal.
- In 1980, Rogers Metal’s directors authorized Rogers Metal to acquire 100% of Custom Met’s outstanding stock for approximately $35,800.
- Donald and Jonathan received the purchase price for their Custom Met shares and reported the 1980 amounts as received in a stock redemption, claiming long-term capital gain treatment.
- The Zimmermans asserted the transaction was driven by strong business reasons, not by a plan to avoid or reduce taxes.
- The Commissioner agreed the transaction had the form of a redemption, but determined the amounts paid to Donald and Jonathan were essentially equivalent to dividends and therefore taxable as ordinary dividend income to the extent of earnings and profits.
- The Zimmermans filed petitions in the U.S. Tax Court (in consolidated matters that included Donald’s estate) seeking a redetermination of the deficiencies.

## Issues

1. Whether the 1980 acquisition/redemption of Custom Met stock by Rogers Metal should be treated as a sale or exchange under I.R.C. § 302(a) (capital gain) or as a dividend-equivalent distribution under §§ 301 and 316 via § 302(d).
2. Whether, considering the Zimmermans’ continuing ownership and control of the related corporations, the redemption produced a “meaningful reduction” in their interests so as to qualify under § 302(b)(1).
3. Whether asserted business reasons for the transaction change the tax result when the transaction’s effect leaves the shareholders in substantially the same economic position.

## Decision

- The Tax Court sustained the Commissioner’s determinations.
- The court held that the amounts paid to Donald and Jonathan in 1980 were distributions essentially equivalent to dividends rather than proceeds from a sale or exchange.
- The court concluded that, viewed in substance, the transaction did not meaningfully reduce the Zimmermans’ proportionate interests in the corporate enterprise, despite the business reasons offered.

## Legal Principles

- A corporate stock redemption is treated as a distribution under § 301 (and a dividend under § 316 to the extent of earnings and profits) unless the redemption fits within one of the qualifying categories in § 302(b) that permits sale-or-exchange treatment under § 302(a).
- Under § 302(b)(1), a redemption qualifies only if it is “not essentially equivalent to a dividend,” which turns primarily on whether there is a meaningful reduction in the shareholder’s rights and interests (such as voting power, participation in earnings, and rights upon liquidation) after the transaction.
- In evaluating meaningful reduction, the Tax Court looks to the practical effect of the transaction, including the shareholder’s continuing ability to control or benefit from the enterprise after a redemption carried out through a related corporation.
- Business purpose may be considered, but it does not convert a dividend-equivalent redemption into a sale or exchange when the objective ownership and control consequences show no meaningful reduction.
- If § 302(b) is not satisfied, § 302(d) applies and the redemption is treated as a distribution under § 301, taxable as a dividend to the extent of the distributing corporation’s current or accumulated earnings and profits.

## Conclusion

Zimmerman v. Commissioner, 49 T.C.M. 1616 (1985), held that when a closely held corporation controlled by the same family group redeems stock of a related corporation and the shareholders’ effective ownership and control remain substantially unchanged, the payment is essentially equivalent to a dividend and is taxed as ordinary dividend income rather than as capital gain, even if the taxpayers identify business reasons for the transaction.
