Selling One Controlled Corporation to Another Can Produce a Deemed Redemption

Review common control before using a stock-sale model

Section 304 can apply when controlling persons sell stock of one corporation to another controlled corporation for property. The transaction can be treated through a deemed redemption and distribution framework rather than a simple unrelated-party stock sale. Constructive ownership, the relevant control requirements, redemption tests, and earnings and profits all need review. A purchase agreement and a fair price do not automatically establish ordinary capital-gain sale treatment.

Draw the ownership of both corporations before and after the proposed transfer, including relevant family and entity interests. Identify the cash, note, or other consideration and any linked steps. Explain the business reason for moving the stock and what economic ownership actually changes. The tax team should receive the whole reorganization or succession plan, not only the one document titled stock purchase. Related transactions separated by dates or entities can still require analysis together under the applicable rules.

Compare the apparent gain with the distribution question

Assume a hypothetical owner controls corporations A and B and proposes that B buy the owner's A shares for $1 million. The owner's adjusted basis in those shares is $200,000. A conventional sale worksheet would show $800,000 gain before expenses. If section 304 applies, that worksheet is not the complete computation. Distribution treatment can depend on the redemption analysis and relevant earnings and profits, and basis treatment follows the applicable deemed steps.

Do not assume the entire $1 million is necessarily dividend income either. The purpose of the example is to stop an unsupported subtraction of stock basis before classification is established. Ask for a transaction-specific comparison showing the correct tax amounts and where the basis goes after the deemed steps. If the price is paid with a note, review its treatment rather than assuming that ordinary installment reporting automatically defers whatever income the related-company distribution analysis produces.

Collect both corporations’ tax histories

Obtain stock basis, earnings-and-profits schedules, ownership records, prior distributions, and relevant acquisition documents for both corporations. Book retained earnings is not a substitute for a tax earnings-and-profits computation. A company with accumulated accounting losses may still require careful tax analysis. Identify historical adjustments and any periods for which records are missing, and show uncertainty separately instead of filling the gap with a convenient zero.

Review other owners and different stock classes. The result can vary among selling shareholders because their ownership changes and attribution differ. A group-level summary saying the family still owns everything does not determine each person's tax treatment. Ask the preparer to reconcile the ownership model to the actual stock ledger and governing rights. Preserve assumptions about voting power, value, options, and indirect ownership so a later reviewer can understand the conclusion without rebuilding the entire corporate history.

Compare legitimate alternative transition structures

If the objective is combining operations, simplifying ownership, or funding one owner's retirement, compare structures that achieve that actual objective. A merger, contribution, third-party sale, or direct redemption can have different eligibility and economics. Do not select an alternative solely from a headline tax description. Model liabilities, creditor protections, transaction costs, continuing ownership, and tax consequences on the same factual basis.

Have counsel and the tax team document the proposed steps before any transfer. Last-minute cash movements can change the analysis and create unexplained intercompany obligations. If B must borrow to fund the purchase, show the resulting debt service and where the operating cash to repay it will come from. A transaction that produces a large personal cash payment can still leave the corporate group less liquid. The owner proceeds comparison should show that funding burden as well as the individual's tax classification.

Preserve the deemed-step and basis record

The closing file should contain the ownership analysis, relevant earnings-and-profits computations, consideration terms, executed documents, and a clear explanation of the section 304 conclusion. Reconcile the seller's reporting with the acquiring corporation's stock basis and the remaining shareholder basis records. Keep the original and final step plans together when negotiations change. The useful outcome is a documented related-company transaction whose cash, distribution treatment, and continuing investments agree, preventing a seemingly straightforward stock sale from leaving each corporation and shareholder with incompatible tax records.