Tax treatment

Without a Section 303 redemption, the partial sale of stock may be treated as a fully-taxable dividend. With a Section 303 redemption, these funds are treated as a capital gain transaction. Because of the step-up in basis at the shareholder's death, there should be no taxable gain on this transaction.

• Premiums for insurance used to fund Section 303 redemptions are not deductible.
• Proceeds are received by the corporation tax free (except for the alternative minimum tax).

Section 303 partial stock redemption

Example: A businessowner, H, who wishes to transfer her business interest to a family member as going concern, establishes a Section 303 agreement. The corporation owns, pays for and is beneficiary of insurance on H's life. The face amount equals H's estimated estate settlement costs.

At death, the corporation receives the insurance proceeds tax free (except for the alternative minimum tax). The corporation uses the proceeds to redeem the stock from H's estate under the terms of the agreement. The estate uses this money to pay federal and state estate and inheritance taxes, and other estate settlement costs. The corporation is retained by H's family as a going concern.

Only a competent attorney can determine if a businessowner's estate qualifies for a Section 303 redemption. However, to receive favorable tax treatment:

• The value of the deceased's stock must exceed 35 percent of the adjusted gross estate.
• The stock redeemed must be subject to federal estate tax.
• Proceeds may only be used to pay federal and state estate and inheritance taxes, and funeral and administration costs.
• The redemption must take place no later than three years and 90 days after the estate tax return is filed.

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