Section 303 Qualification Requirements

Section 303 permits a partial redemption of stock following a shareholder's death to be treated as the sale of an asset eligible for capital gains treatment. But four tests must be met before 303 is available:

1. the stock must be included in the decedent's gross estate;
2. the stock's value must exceed 35% of the adjusted gross estate;
3. the stock must be held by a person whose interest in the estate would be reduced by the payment of estate costs;
4. the redemption generally must occur within four years of the deceased shareholder's death.

While the stock must be part of the gross estate, it does not have to be held by the executor. It could, for example, be held by a surviving joint tenant. However, the executor is usually the party that is keenly interested in 303 because he or she needs cash to pay estate costs.

Multiple Corporations

If the shareholder owned 20% or more of two separate corporations, then the value of these corporations is combined in meeting the 35% test above. In meeting this 20% rule, a spouse's joint tenancy interest, interest as a tenant in common, or community property interest in the stock can be counted. Beyond this, no attribution rules apply to 303 redemptions.

Payment of Estate Costs

With respect to the third test, there is a typical problem. If the stock passes to the surviving spouse as part of the marital deduction share, it probably does not have the burden of paying the estate costs. Such costs are usually payable out of the residue of the estate. This means that the spouse could not take advantage of 303.

Estate Tax Extension

The federal estate tax return is normally due no later than nine months following the date of death. A 303 redemption generally must be carried out within 3 years and 90 days of the estate tax return due date, or, in other words, within four years of the date of death in the usual case.

However, if the executor obtains an extension to file the federal estate tax return, this will also extend the permissible redemption period beyond the usual four years.

If Section 6166 (installment payment of estate tax) is elected, the 303 period is extended until the due date of the last installment.

Effect on Family-Owned Business Deduction

IRC Sec. 2057 allows owners of a family business who die before 2004 (or after 2010) a federal estate tax deduction for up to $675,000 in value of qualified business interests. The combination of the family-owned business deduction and the estate tax applicable exclusion amount is limited to $1.3 million. To qualify for the Sec. 2057 deduction, 50% or more of the adjusted gross estate generally must consist of family-owned business interests, among other requirements.

When a 303 redemption is carried out, it may reduce the percentage below 50%. For example, consider a $5 million adjusted gross estate, $3 million of which consists of family-owned business interests. After a 303 redemption, only $2 million of such interests remain in the estate. Has the estate dropped below the 50% minimum for the 2057 deduction?

The IRS has ruled that a 303 redemption does not adversely affect qualification for the 2057 deduction [Rev. Rul. 2003-61, 2003-24 IRB 1015]. Moreover, a 303 redemption will not trigger the additional estate tax on certain dispositions of family-owned business interests within 10 years of the deceased owner's death.

Maximum Redemption Under 303

The maximum amount of stock that may be redeemed under 303 is limited to the sum of:

• state and federal death taxes,
• costs of estate administration, and
• funeral expenses.

Note that debts of the decedent are not included when computing the eligible amount.

If more than one survivor shows up seeking to redeem stock under 303, there is a "first-come, first-served" rule. Once the maximum has been reached, 303 is no longer available.