Rev. Rul. 84-135

ISSUE

Whether, under the circumstances below, a redeemed shareholder's right to receive payments under an unfunded pension agreement constitutes the retention of a prohibited interest in the redeeming corporation within the meaning of section 302(c)(2)(A)(i) of the Internal Revenue Code so as to violate the section 302(c)(2)(A)(iii) agreement filed by the redeemed shareholder.

FACTS

A and A's children, B and C, owned all the stock of corporation X. Upon A's retirement, X redeemed all its stock held by A for an amount of cash equivalent to the fair market value of the surrendered X stock. B and C took control of the day-to-day operations of X and A resigned as X's president and chairman of the board of directors. Pursuant to an unfunded pre-existing written agreement between X and A, A began receiving a lifetime pension of $1,000 per month. The pension payments are not dependent upon X's future earnings and A's claim to such payments are not subordinate to the claims of the general creditors of X. At retirement, A's life expectancy was 18 years. In order to treat the redemption as in full payment in exchange for the X stock under section 302(b)(3) of the Code, A filed the agreement provided for in section 302(c)(2)(A)(iii) and, except for the question here at issue with respect to the effect of A's unfunded pension agreement with X, otherwise complied with the requirements of section 302(c)(2)(A).

LAW AND ANALYSIS

Section 302(a) of the Code provides that if a corporation redeems its stock and if section 302(b)(1), (2), (3), or (4) applies, such redemption will be treated as a distribution in full payment in exchange for the stock. Section 302(b)(3) provides that section 302(a) will apply if the redemption is in complete redemption of all the stock of the corporation owned by the shareholder. Except as provided in section 302(c)(2), section 302(c)(1) provides that section 318(a) will apply in determining ownership of stock for purposes of section 302.

Section 318(a)(1)(A)(ii) of the Code provides that an individual shall be considered as owning the stock owned by his or her children. Therefore, unless section 302(c)(2)(A) applies, the redemption of the X stock held by A will not qualify as a complete redemption because, after the redemption, A will be treated, under section 318(a)(1)(A), as owning the X stock owned by B and C.

Section 302(c)(2)(A) of the Code provides, in part, that in the case of a distribution described in section 302(b)(3), section 318(a)(1) will not apply if: (i) immediately after the distribution the redeemed shareholder has no interest in the corporation (including an interest as an officer, director or employee), other than an interest as a creditor, (ii) the redeemed shareholder does not acquire any such interest (other than stock acquired by bequest or inheritance) within 10 years from the date of such distribution, and (iii) the redeemed shareholder files an agreement to notify the Secretary of any acquisition described in (ii).

In the present situation, A's pension agreement represents the sole relationship between A and X subsequent to the redemption of A's X stock. Although the pension agreement is unfunded, payments under the agreement are not dependent upon the future earnings of X and A's claim to such payments are not subordinate to the claims of X's general creditors. The only rights in X retained by A are those contract rights available to enforce X's duties under the pension agreement. Such relationship does not provide A with an interest in X that is prohibited by section 302(c)(2)(A)(i) of the Code. See section 1.302-4(d) of the Income Tax Regulations.

HOLDING

A's right to receive payments under the unfunded pension agreement does not constitute the retention of a prohibited interest in X under section 302(c)(2)(A)(i) of the Code, and the section 302(c)(2)(A)(iii) agreement filed by A is valid. Accordingly, the redemption qualifies as a distribution in full payment in exchange for the redeemed stock under section 302(a) and (b)(3).