Stock Redemption Rules


Stock redemption occurs when firms buy shares from their stockholders and shareholders. It is a recognized way of cashing out shareholders in both small and large business. The result is that the company has less shareholders and so those that remain have a greater interest in the organization. This method is popular with shareholders because they gain a large stake in the company, which they would not be able to secure independently because of a lack of personal funds.

Family Owned Stock

Under Title 26 of U.S. income tax law, corporations can redeem stock that is owned by a spouse or former spouse (a transferor spouse), in the event of divorce or death. This type of stock redemption is referred to as internal revenue. If the transfer of stock is considered a constructive distribution, meaning that one party receives financial gain from the transfer, then Federal Income tax must be paid on the gains. If stock is being redeemed because of divorce then official divorce papers must be presented, or a signed written agreement given, from both parties. These laws are valid for all stock redemptions taking place on or after Jan. 13, 2003.

Capital Gains Treatment

Personal tax rates are high in the United States. Consequently, if you are selling stock you should check to see if you are eligible for capital gains treatment on the transaction. Contrary to popular belief, qualification is not automatic; you need to meet specific rules defined under Section 302 of the Internal Revenue Code for stock redemption. For example, capital gains can be claimed if the shareholder sells all the shares, a situation known as total termination of interest. It can also be claimed if, on completion of the sale, the shareholders own less than 80 percent of what they owed before the transaction. Receiving capital gains treatment is only available for corporations; individuals generally have to pay income tax on the amount received -- although there are some exceptions.

Balance Sheets

After the transaction is complete, firms must alter their balance sheet to reflect the change. The balance sheet changes should reflect the value the shares were bought, sold and repurchased at. Typically, shares are resold at the book value or the owner's equity per share value. Shares are often purchased out of future funds using notes and so it is important that the books balance to avoid later tax and financial transparency issues. If you are unsure how to go about altering your balance books then you should consult a financial adviser.

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