Distributions of Stock and Stock Rights

DEPARTMENT OF THE TREASURY

26 CFR Parts 1 and 602

[TD 8643]

RIN 1545-AQ42

Distributions of Stock and Stock Rights

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations amending regulations

under section 305(c) of the Internal Revenue Code relating to

constructive distributions on preferred stock. The final regulations

concern the treatment of stock redeemable at a premium by the issuer.

The regulations generally treat a call premium as giving rise to a

constructive distribution only if redemption pursuant to the call

provision is more likely than not to occur. The final regulations also

reflect 1990 amendments to section 305(c).

DATES: These regulations are effective December 20, 1995.

For dates of applicability of these regulations, see Effective

dates under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Kirsten L. Simpson, (202) 622-7790

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations

has been reviewed and approved by the Office of Management and Budget

in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under

control number 1545-1438. Responses to this collection of information

are required to comply with the consistency requirements of the

regulation.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number. The

[[Page 66135]]

estimated annual burden per respondent varies from 5 minutes to 15

minutes, depending on individual circumstances, with an estimated

average of 10 minutes.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be sent to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,

DC 20224, and to the Office of Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and

Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

On June 22, 1994, a notice of proposed rulemaking (CO-8-91),

amending regulations under section 305(c) of the Internal Revenue Code

relating to constructive distributions on preferred stock, was

published in the Federal Register (59 FR 32160). No public hearing was

requested and none was held.

Written comments responding to the notice were received. After

consideration of all the comments, the regulations proposed by CO-8-91

are adopted as revised by this Treasury decision. The principal

revisions are discussed below.

Explanation of Provisions

The primary focus of the final regulations is on preferred stock

callable at a premium at the option of the issuer. The final

regulations retain the approach of the proposed regulations and require

constructive distribution treatment with respect to an issuer call only

if, based on all of the facts and circumstances as of the issue date,

redemption pursuant to the call right is more likely than not to occur.

Safe harbor rule. The proposed regulations provided a safe harbor,

under which constructive distribution treatment does not result from an

issuer call if the issuer and holder are unrelated, there are no

arrangements that effectively require the issuer to redeem the stock,

and exercise of the option to redeem would not reduce the yield of the

stock. In response to comments, the final regulations make certain

modifications to the safe harbor to clarify its scope.

Commentators suggested that the exclusion from the safe harbor

where there are ``arrangements that effectively require the issuer to

redeem'' is too narrow and will permit taxpayers who issue stock with

``understandings'' concerning redemption, whether or not legally

enforceable, to qualify for the safe harbor. Commentators recommended

safeguarding against abuse by changing the effectively requires

redemption test to one that requires a lesser degree of probability.

The IRS and Treasury intend that the safe harbor not be available where

an issuer and a holder have an underlying understanding. Although the

IRS and Treasury believe that the word ``arrangement'' is broad enough

to include such understandings, in response to these comments, this

prong of the safe harbor has been clarified.

To retain greater certainty for non-abusive transactions, however,

the effectively requires redemption test has not been substantially

modified. Instead, the final regulations safeguard against abuse by

lowering the threshold for determining whether an issuer and a holder

are related. The proposed regulations adopted a 50-percent threshold

for determining whether an issuer and a holder are related. The final

regulations lower this threshold to 20 percent. This threshold relates

only to eligibility for the safe harbor, and not to the application of

the general ``more likely than not'' test. When a holder's ownership

interest exceeds this threshold, the IRS and Treasury believe it is

appropriate to determine whether redemption is more likely than not to

occur based on all of the facts and circumstances.

Commentators also suggested that the IRS and Treasury except

preferred stock within the meaning of section 1504(a)(4) in determining

whether the issuer and holder are related. The regulations do not adopt

this suggestion. As noted above, the determination of whether the

issuer and holder are related only governs eligibility for the safe

harbor. The IRS and Treasury believe that when a holder's ownership

interest in an issuer exceeds the threshold, even if all that the

holder owns is preferred stock within the meaning of section

1504(a)(4), it is appropriate to determine whether redemption is more

likely than not to occur based on all of the facts and circumstances.

In response to comments, the final regulations clarify that the

``arrangements'' that effectively require or are intended to compel the

issuer to redeem the stock relate to the issuer call right, and not to

a later mandatory redemption feature.

In testing whether a call right meets the yield prong of the safe

harbor, the final regulations clarify that principles similar to the

principles of section 1272(a) and the original issue discount

regulations apply to determine whether exercise of the right to redeem

would reduce the yield of the stock.

Miscellaneous. The final regulations expand the definition of

issuer in certain circumstances. In particular, the regulations provide

that if preferred stock may be acquired by a person other than the

issuer (a third person), the term issuer includes such third person if

the regulations would apply to the stock if the third person were the

issuer, and acquisition of the stock by the third person would be

treated as a redemption for federal income tax purposes (under section

304 or otherwise). In addition, if the issuer and the third person are

members of the same affiliated group, the term issuer includes the

third person if a principal purpose of the arrangement is to avoid the

application of section 305 and the final regulations. Furthermore, an

agreement or other arrangement for a person other than the issuer of

the stock to acquire the stock may create a conversion transaction

within the meaning of section 1258.

The final regulations provide rules for the treatment of mandatory

redemption obligations and put options that are subject to

contingencies. Generally, premiums on such stock are not subject to

constructive distribution treatment if the contingency renders remote

the likelihood of redemption. For example, where an issuer issues stock

that is mandatorily redeemable in the event of an initial public

offering, the regulations require evaluation of the likelihood of the

occurrence of the initial public offering. The regulations provide,

however, that a contingency does not include the possibility of

default, insolvency, or similar circumstances, or that a redemption may

be precluded by applicable law due to insufficient capital.

The preamble to the proposed regulations requested comments on the

appropriate treatment of unpaid cumulative dividends. Because of the

complexity of this issue, the final regulations do not provide rules

for those dividends. The IRS and Treasury will continue to consider the

issue, as well as other issues involving the implementation of the

amendments to section 305(c) made by the Revenue Reconciliation Act of

1990. The IRS and Treasury continue to invite public comments on these

issues.

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EFFECTIVE DATES. The regulations apply to stock issued on or after

December 20, 1995. Although the regulations do not apply to stock

issued before December 20, 1995, the rules of sections 305(c) (1), (2),

and (3) apply to stock described therein issued on or after October 10,

1990, except as provided in section 11322(b)(2) of the Revenue

Reconciliation Act of 1990 (Pub. L. 101-508 Stat.). Moreover, except as

provided in section 11322(b)(2) of the Revenue Reconciliation Act of

1990 (Pub. L. 101-508 Stat.), with respect to stock issued on or after

October 10, 1990, and issued before December 20, 1995, the economic

accrual rule of section 305(c)(3) will apply to the entire call premium

on stock that is not described in paragraph (b)(2) of this section if

the premium is considered to be unreasonable under the principles of

Sec. 1.305-5(b) (as contained in the 26 CFR part 1 edition revised

April 1, 1995). A call premium described in the preceding sentence will

be accrued over the period of time during which the preferred stock

cannot be called for redemption.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information

The principal author of these regulations is Kirsten L. Simpson of

the Office of Assistant Chief Counsel (Corporate), IRS. However, other

personnel of the IRS and Treasury Department participated in their

development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

the following entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.305-3 also issued

under 26 U.S.C. 305. Section 1.305-5 also issued under 26 U.S.C.

305. Section 1.305-7 also issued under 26 U.S.C. 305. * * *

Par. 2. Section 1.305-3 is amended as follows: 1. In paragraph (e),

remove the parentheses from the numbers in the headings for Examples

(1) through (15).

2. In paragraph (e), Example 15 is revised to read as follows:

Sec. 1.305-3 Disproportionate distributions.

* * * * *

(e) * * *

Example 15. (i) Facts. Corporation V is organized with two

classes of stock, class A common and class B convertible preferred.

The class B stock is issued for $100 per share and is convertible at

the holder's option into class A at a fixed ratio that is not

subject to full adjustment in the event stock dividends or rights

are distributed to the class A shareholders. The class B stock pays

no dividends but it is mandatorily redeemable in 10 years for $200.

Under sections 305(c) and 305(b)(4), the entire redemption premium

(i.e., the excess of the redemption price over the issue price) is

deemed to be a distribution of preferred stock on preferred stock

which is taxable as a distribution of property under section 301.

This amount is considered to be distributed over the 10-year period

under principles similar to the principles of section 1272(a).

During the year, the corporation declares a dividend on the class A

stock payable in additional shares of class A stock.

(ii) Analysis. The distribution on the class A stock is a

distribution to which sections 305(b)(2) and 301 apply since it

increases the proportionate interests of the class A shareholders in

the assets and earnings and profits of the corporation and the class

B shareholders have received property (i.e., the constructive

distribution described above). If, however, the conversion ratio of

the class B stock were subject to full adjustment to reflect the

distribution of stock to class A shareholders, the distribution of

stock dividends on the class A stock would not increase the

proportionate interest of the class A shareholders in the assets and

earnings and profits of the corporation and such distribution would

not be a distribution to which section 301 applies.

(iii) Effective date. This Example 15 applies to stock issued on

or after December 20, 1995. For previously issued stock, see

Sec. 1.305-3(e) Example (15) (as contained in the 26 CFR part 1

edition revised April 1, 1995).

Par. 3. Section 1.305-5 is amended as follows:

1. Paragraph (b) is revised.

2. In paragraph (d), remove the parentheses from the numbers in the

headings for Examples (1) through (9), redesignate Examples 8 and 9 as

Examples 9 and 10, respectively.

3. In paragraph (d), Examples 4, 5, and 7 are revised, and Example

8 is added.

4. Paragraph (e) is added.

The revisions read as follows:

Sec. 1.305-5 Distributions on preferred stock.

* * * * *

(b) Redemption premium--(1) In general. If a corporation issues

preferred stock that may be redeemed under the circumstances described

in this paragraph (b) at a price higher than the issue price, the

difference (the redemption premium) is treated under section 305(c) as

a constructive distribution (or series of constructive distributions)

of additional stock on preferred stock that is taken into account under

principles similar to the principles of section 1272(a). However,

constructive distribution treatment does not result under this

paragraph (b) if the redemption premium does not exceed a de minimis

amount, as determined under the principles of section 1273(a)(3). For

purposes of this paragraph (b), preferred stock that may be acquired by

a person other than the issuer (the third person) is deemed to be

redeemable under the circumstances described in this paragraph (b), and

references to the issuer include the third person, if--

(i) This paragraph (b) would apply to the stock if the third person

were the issuer; and

(ii) Either--

(A) The acquisition of the stock by the third person would be

treated as a redemption for federal income tax purposes (under section

304 or otherwise); or

(B) The third person and the issuer are members of the same

affiliated group (having the meaning for this purpose given the term by

section 1504(a), except that section 1504(b) shall not apply) and a

principal purpose of the arrangement for the third person to acquire

the stock is to avoid the application of section 305 and paragraph

(b)(1) of this section.

(2) Mandatory redemption or holder put. Paragraph (b)(1) of this

section applies to stock if the issuer is required to redeem the stock

at a specified time or the holder has the option (whether or not

currently exercisable) to require the issuer to redeem the stock.

However, paragraph (b)(1) of this section will not

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apply if the issuer's obligation to redeem or the holder's ability to

require the issuer to redeem is subject to a contingency that is beyond

the legal or practical control of either the holder or the holders as a

group (or through a related party within the meaning of section 267(b)

or 707(b)), and that, based on all of the facts and circumstances as of

the issue date, renders remote the likelihood of redemption. For

purposes of this paragraph, a contingency does not include the

possibility of default, insolvency, or similar circumstances, or that a

redemption may be precluded by applicable law which requires that the

issuer have a particular level of capital, surplus, or similar items. A

contingency also does not include an issuer's option to require earlier

redemption of the stock. For rules applicable if stock may be redeemed

at more than one time, see paragraph (b)(4) of this section.

(3) Issuer call--(i) In general. Paragraph (b)(1) of this section

applies to stock by reason of the issuer's right to redeem the stock

(even if the right is immediately exercisable), but only if, based on

all of the facts and circumstances as of the issue date, redemption

pursuant to that right is more likely than not to occur. However, even

if redemption is more likely than not to occur, paragraph (b)(1) of

this section does not apply if the redemption premium is solely in the

nature of a penalty for premature redemption. A redemption premium is

not a penalty for premature redemption unless it is a premium paid as a

result of changes in economic or market conditions over which neither

the issuer nor the holder has legal or practical control.

(ii) Safe harbor. For purposes of this paragraph (b)(3), redemption

pursuant to an issuer's right to redeem is not treated as more likely

than not to occur if--

(A) The issuer and the holder are not related within the meaning of

section 267(b) or 707(b) (for purposes of applying sections 267(b) and

707(b) (including section 267(f)(1)), the phrase ``20 percent'' shall

be substituted for the phrase ``50 percent'');

(B) There are no plans, arrangements, or agreements that

effectively require or are intended to compel the issuer to redeem the

stock (disregarding, for this purpose, a separate mandatory redemption

obligation described in paragraph (b)(2) of this section); and

(C) Exercise of the right to redeem would not reduce the yield of

the stock, as determined under principles similar to the principles of

section 1272(a) and the regulations under sections 1271 through 1275.

(iii) Effect of not satisfying safe harbor. The fact that a

redemption right is not described in paragraph (b)(3)(ii) of this

section does not affect the determination of whether a redemption

pursuant to the right to redeem is more likely than not to occur.

(4) Coordination of multiple redemption provisions. If stock may be

redeemed at more than one time, the time and price at which redemption

is most likely to occur must be determined based on all of the facts

and circumstances as of the issue date. Any constructive distribution

under paragraph (b)(1) of this section will result only with respect to

the time and price identified in the preceding sentence. However, if

redemption does not occur at that identified time, the amount of any

additional premium payable on any later redemption date, to the extent

not previously treated as distributed, is treated as a constructive

distribution over the period from the missed call or put date to that

later date, to the extent required under the principles of this

paragraph (b).

(5) Consistency. The issuer's determination as to whether there is

a constructive distribution under this paragraph (b) is binding on all

holders of the stock, other than a holder that explicitly discloses

that its determination as to whether there is a constructive

distribution under this paragraph (b) differs from that of the issuer.

Unless otherwise prescribed by the Commissioner, the disclosure must be

made on a statement attached to the holder's timely filed federal

income tax return for the taxable year that includes the date the

holder acquired the stock. The issuer must provide the relevant

information to the holder in a reasonable manner. For example, the

issuer may provide the name or title and either the address or

telephone number of a representative of the issuer who will make

available to holders upon request the information required for holders

to comply with this provision of this paragraph (b).

* * * * *

(d) * * *

Example 4--(i) Facts. Corporation X is a domestic corporation

with only common stock outstanding. In connection with its

acquisition of Corporation T, X issues 100 shares of its 4%

preferred stock to the shareholders of T, who are unrelated to X

both before and after the transaction. The issue price of the

preferred stock is $40 per share. Each share of preferred stock is

convertible at the shareholder's election into three shares of X

common stock. At the time the preferred stock is issued, the X

common stock has a value of $10 per share. The preferred stock does

not provide for its mandatory redemption or for redemption at the

option of the holder. It is callable at the option of X at any time

beginning three years from the date of issuance for $100 per share.

There are no other plans, arrangements, or agreements that

effectively require or are intended to compel X to redeem the stock.

(ii) Analysis. The preferred stock is described in the safe

harbor rule of paragraph (b)(3)(ii) of this section because X and

the former shareholders of T are unrelated, there are no plans,

arrangements, or agreements that effectively require or are intended

to compel X to redeem the stock, and calling the stock for $100 per

share would not reduce the yield of the preferred stock. Therefore,

the $60 per share call premium is not treated as a constructive

distribution to the shareholders of the preferred stock under

paragraph (b) of this section.

Example 5--(i) Facts--(A) Corporation Y is a domestic

corporation with only common stock outstanding. On January 1, 1996,

Y issues 100 shares of its 10% preferred stock to a holder. The

holder is unrelated to Y both before and after the stock issuance.

The issue price of the preferred stock is $100 per share. The

preferred stock is--

(1) Callable at the option of Y on or before January 1, 2001, at

a price of $105 per share plus any accrued but unpaid dividends; and

(2) Mandatorily redeemable on January 1, 2006, at a price of

$100 per share plus any accrued but unpaid dividends.

(B) The preferred stock provides that if Y fails to exercise its

option to call the preferred stock on or before January 1, 2001, the

holder will be entitled to appoint a majority of Y's directors.

Based on all of the facts and circumstances as of the issue date, Y

is likely to have the legal and financial capacity to exercise its

right to redeem. There are no other facts and circumstances as of

the issue date that would affect whether Y will call the preferred

stock on or before January 1, 2001.

(ii) Analysis. Under paragraph (b)(3)(i) of this section,

paragraph (b)(1) of this section applies because, by virtue of the

change of control provision and the absence of any contrary facts,

it is more likely than not that Y will exercise its option to call

the preferred stock on or before January 1, 2001. The safe harbor

rule of paragraph (b)(3)(ii) of this section does not apply because

the provision that failure to call will cause the holder to gain

control of the corporation is a plan, arrangement, or agreement that

effectively requires or is intended to compel Y to redeem the

preferred stock. Under paragraph (b)(4) of this section, the

constructive distribution occurs over the period ending on January

1, 2001. Redemption is most likely to occur on that date, because

that is the date on which the corporation minimizes the rate of

return to the holder while preventing the holder from gaining

control. The de minimis exception of paragraph (b)(1) of this

section does not apply because the $5 per share difference between

the redemption price and the issue price exceeds the amount

determined under the principles of section 1273(a)(3)

(5 x .0025 x $105 = $1.31). Accordingly, $5 per share, the

difference between the redemption price and the issue price, is

treated as a constructive distribution

[[Page 66138]]

received by the holder on an economic accrual basis over the five-year

period ending on January 1, 2001, under principles similar to the

principles of section 1272(a). * * *

Example 7--(i) Facts--(A) Corporation Z is a domestic

corporation with only common stock outstanding. On January 1, 1996,

Z issues 100 shares of its 10% preferred stock to C, an individual

unrelated to Z both before and after the stock issuance. The issue

price of the preferred stock is $100 per share. The preferred stock

is--

(1) Not callable for a period of 5 years from the issue date;

(2) Callable at the option of Z on January 1, 2001, at a price

of $110 per share plus any accrued but unpaid dividends;

(3) Callable at the option of Z on July 1, 2002, at a price of

$120 per share plus any accrued but unpaid dividends; and

(4) Mandatorily redeemable on January 1, 2004, at a price of

$150 per share plus any accrued but unpaid dividends.

(B) There are no other plans, arrangements, or agreements

between Z and C concerning redemption of the stock. Moreover, there

are no other facts and circumstances as of the issue date that would

affect whether Z will call the preferred stock on either January 1,

2001, or July 1, 2002.

(ii) Analysis. This stock is described in paragraph (b)(2) of

this section because it is mandatorily redeemable. It is also

potentially described in paragraph (b)(3)(i) of this section because

it is callable at the option of the issuer. The safe harbor rule of

paragraph (b)(3)(ii) of this section does not apply to the option to

call on January 1, 2001, because the call would reduce the yield of

the stock when compared to the yield produced by the January 1,

2004, mandatory redemption feature. Moreover, absent any other facts

indicating a contrary result, the fact that redemption on January 1,

2001, would produce the lowest yield indicates that redemption is

most likely to occur on that date. Under paragraph (b)(4) of this

section, paragraph (b)(1) of this section applies with respect to

the issuer's right to call on January 1, 2001, because redemption is

most likely to occur on January 1, 2001, for $110 per share. The de

minimis exception of paragraph (b)(1) of this section does not apply

because the $10 per share difference between the redemption price

payable in 2001 and the issue price exceeds the amount determined

under the principles of section 1273(a)(3) (5 x .0025 x $110=$1.38).

Accordingly, $10 per share, the difference between the redemption

price and the issue price, is treated as a constructive distribution

received by the holder on an economic accrual basis over the five-

year period ending January 1, 2001, under principles similar to the

principles of section 1272(a).

(iii) Coordination rules--(A) If Z does not exercise its option

to call the preferred stock on January 1, 2001, paragraph (b)(4) of

this section provides that the principles of paragraph (b) of this

section must be applied to determine if any remaining constructive

distribution occurs. Under paragraphs (b)(3)(i) and (b)(4) of this

section, paragraph (b)(1) of this section applies because, absent

any other facts indicating a contrary result, the fact that

redemption on July 1, 2002, would produce a lower yield than the

yield produced by the mandatory redemption feature indicates that

redemption on that date is most likely to occur. The safe harbor

rule of paragraph (b)(3)(ii) of this section does not apply to the

option to call on July 1, 2002, because, as of January 1, 2001, a

call by Z on July 1, 2002, for $120 would reduce the yield of the

stock. The de minimis exception of paragraph (b)(1) of this section

does not apply because the $10 per share difference between the

redemption price and the issue price (revised as of the missed call

date as provided by paragraph (b)(4) of this section) exceeds the

amount determined under the principles of section 1273(a)(3)

(1 x .0025 x $120=$.30). Accordingly, the $10 per share of

additional redemption premium that is payable on July 1, 2002, is

treated as a constructive distribution received by the holder on an

economic accrual basis over the period between January 1, 2001, and

July 1, 2002, under principles similar to the principles of section

1272(a).

(B) If Z does not exercise its second option to call the

preferred stock on July 1, 2002, then the $30 additional redemption

premium that is payable on January 1, 2004, is treated as a

constructive distribution under paragraphs (b)(2) and (b)(1) of this

section. The de minimis exception of paragraph (b)(1) of this

section does not apply because the $30 per share difference between

the redemption price and the issue price (revised as of the second

missed call date) exceeds the amount determined under the principles

of section 1273(a)(3) (1 x .0025 x $150=$.38). The holder is treated

as receiving the constructive distribution on an economic accrual

basis over the period between July 1, 2002, and January 1, 2004,

under principles similar to the principles of section 1272(a).

Example 8--(i) Facts. The facts are the same as in paragraph (i)

of Example 7, except that, based on all of the facts and

circumstances as of the issue date (including an expected lack of

funds on the part of Z), it is unlikely that Z will exercise the

right to redeem on either January 1, 2001, or July 1, 2002.

(ii) Analysis. The safe harbor rule of paragraph (b)(3)(ii) of

this section does not apply to the option to call on either January

1, 2001, or July 1, 2002, because each call would reduce the yield

of the stock. Under paragraph (b)(3)(i) of this section, neither

option to call is more likely than not to occur, because, based on

all of the facts and circumstances as of the issue date (including

an expected lack of funds on the part of Z), it is not more likely

than not that Z will exercise either option. However, the $50 per

share redemption premium that is payable on January 1, 2004, is

treated as a constructive distribution under paragraphs (b) (1) and

(2) of this section, regardless of whether Z is anticipated to have

sufficient funds to redeem on that date, because Z is required to

redeem the stock on that date. The de minimis exception of paragraph

(b)(1) of this section does not apply because the $50 per share

difference between the redemption price and the issue price exceeds

the amount determined under the principles of section 1273(a)(3)

(8 x .0025 x $150=$3).

* * * * *

(e) Effective date. The rules of paragraph (b) of this section and

Examples 4, 5, 7, and 8 of paragraph (d) of this section apply to stock

issued on or after December 20, 1995. For rules applicable to

previously issued stock, see Sec. 1.305-5 (b) and (d) Examples (4),

(5), and (7) (as contained in the 26 CFR part 1 edition revised April

1, 1995). Although the rules of paragraph (b) of this section and the

revised examples do not apply to stock issued before December 20, 1995,

the rules of sections 305(c) (1), (2), and (3) apply to stock described

therein issued on or after October 10, 1990, except as provided in

section 11322(b)(2) of the Revenue Reconciliation Act of 1990 (Public

Law 101-508 Stat.). Moreover, except as provided in section 11322(b)(2)

of the Revenue Reconciliation Act of 1990 (Public Law 101-508 Stat.),

with respect to stock issued on or after October 10, 1990, and issued

before December 20, 1995, the economic accrual rule of section

305(c)(3) will apply to the entire call premium on stock that is not

described in paragraph (b)(2) of this section if the premium is

considered to be unreasonable under the principles of Sec. 1.305-5(b)

(as contained in the 26 CFR part 1 edition revised April 1, 1995). A

call premium described in the preceding sentence will be accrued over

the period of time during which the preferred stock cannot be called

for redemption.

Par. 4. Section 1.305-7 is amended by revising the fourth sentence

in the concluding text of paragraph (a) to read as follows:

Sec. 1.305-7 Certain transactions treated as distributions.

(a) * * *

* * * For example, where a redemption premium exists with respect to a

class of preferred stock under the circumstances described in

Sec. 1.305-5(b) and the other requirements of this section are also

met, the distribution will be deemed made with respect to such

preferred stock, in stock of the same class. * * *

* * * * *

[[Page 66139]]

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 5. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Sec. 602.101 [Amended]

Par. 6. In Sec. 602.101, paragraph (c) is amended in the table by

adding the entry ``1.305-5.........1545-1438'' in numerical order.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: December 11, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 95-30831 Filed 12-20-95; 8:45 am]

BILLING CODE 4830-01-U