Do noncorporate and corporate shareholders typically have the same preference for the tax treatment of a stock redemption? Explain

Answer 1

No, noncorporate and corporate shareholders typically do not have the same preference for the tax treatment of a stock redemption. Noncorporate taxpayers generally prefer sale or exchange treatment (a qualifying stock redemption) over that of a dividend distribution. In a qualifying stock redemption, the shareholder is allowed to recover his or her redeemed stock basis tax-free. Also, the excess of the redemption distribution over the stock basis is (typically) a capital gain. If the shareholder has capital losses from other transactions, the capital gain resulting from a qualifying stock redemption can increase the shareholder's deductibility of such capital losses. In a nonqualified stock redemption, the entire distribution is taxable as a dividend (assuming adequate E & P) that cannot be used to increase the utilization of capital losses.

Corporate taxpayers, however, generally prefer dividend treatment (a nonqualified stock redemption) for a stock redemption. This preference stems from the availability of the dividends received deduction for such taxpayers. As a result of the dividends received deduction, only a nominal amount of any dividend resulting from a nonqualified stock redemption would be subject to tax.