Petitioner argues that this drastic reduction in his economic interests or rights in and control over the corporation constitutes a meaningful reduction of his proportionate interest in the corporation. According to petitioner, it fully justifies characterizing the redemption as a sale. Thus, petitioner continues, the redemption was not essentially equivalent to a dividend within the meaning of section 302(b)(1) despite the attribution rules.

The test for dividend equivalency is whether there has been "a meaningful reduction of the shareholder's proportionate interest in the corporation." United States v. Davis, 397 U.S. at 313. (Emphasis added.) Thus, we must analyze petitioner's relative economic interests or rights in the corporation as a shareholder. As discussed at length, supra, we must treat petitioner as if he actually owned the 50 shares his son owned after the redemption. In so doing we must attribute to petitioner all of the economic interests or rights in the corporation represented by his son's 50 shares. To do otherwise would, in effect, ignore petitioner's constructive ownership of those shares. As we said in Metzger Trust v. Commissioner, 76 T.C. at 61-62:

To treat constructively owned stock different from actually owned stock for section 302(b)(1) purposes would be the same as ignoring the attribution rules in the first place. This is clearly contrary to the plain meaning of the statute and its legislative history.

Under the attribution rules of section 318, petitioner is treated as owning 100 percent of the corporation's stock both before and after the redemption. He is also treated as having the economic interests or rights represented by such stock. Thus, there was no reduction in his proportionate interest as a shareholder in the corporation. Moreover, we think the following observations from Metzger Trust v. Commissioner, 76 T.C. at 62, dispose of petitioner's argument that his loss of control over the corporation can help satisfy the meaningful reduction requirement:

Some cases and commentators suggest that where family hostility exists, the concept of "interest" in a corporation can be broken down into two components, ownership and control, for purposes of applying or not applying the attribution rules in determining dividend equivalency. Under such a theory a stockholder, who before the redemption owned 100 percent of a corporation, actually, and who after the redemption owned

no stock, actually, but 100 percent, constructively, could be deemed to have no control over the corporation where the remaining shareholders were unfriendly section 318 relatives or entities. Because his "control" of the corporation went from 100 percent to nothing, the shareholder, according to the theory, had a meaningful reduction in his "interest" in the corporation. This, in effect, ignores the constructively owned stock for the purposes of determining dividend equivalency contrary to the statute, the regulations, the legislative history, and the rule of Davis. Niedermeyer v. Commissioner, 62 T.C. 280, 285-86 (1974), affd. 535 F.2d 500 (9th Cir. 1976), cert. denied 429 U.S. 1000 (1976). Although the degree of control of a corporation is a factor to be considered in testing dividend equivalency (Benjamin v. Commissioner, 66 T.C. 1084 (1976), affd. 592 F.2d 1259 (5th Cir. 1979)), the final determination must take into account constructively owned stock as well as actually owned stock. Such a position is consistent with the effect of attribution in situations where there is no family discord and where the taxpayer, after the redemption, owned no stock, actually, but 100 percent, constructively. In such cases, courts have held the distribution to be essentially equivalent to a dividend. Lewis v. Commissioner, 35 T.C. 71 (1960); Levin v. Commissioner, 385 F.2d 521 (2d Cir. 1967), affg. 47 T.C. 258 (1966). [Fn. ref. omitted.]

III. Section 302(b)(3)—Complete Redemption Test

This case presents the issue of the statutory exception of section 302(c)(2) to avoid the family attribution rules. Section 302(b)(3) provides that a complete redemption of all of the stock of a corporation owned by the shareholder qualifies for exchange treatment under section 302(a). Generally, section 302(c)(1) provides that the attribution rules apply in determining whether the requirements of section 302(b)(3) have been satisfied. However, under section 302(c)(2), the attribution rules of section 318(a)(1) do not apply in the case of a complete redemption under section 302(b)(3) if, inter alia, "immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee), other than an interest as a creditor." (Emphasis added.)

Petitioner argues that the redemption satisfied the complete termination of interest requirement of section 302(b)(3). His primary basis for this argument is that the attribution rules of section 318 should not apply because of the hostility between petitioner and his son. As discussed at length above, family hostility does not prevent application of the attribution rules. Thus, unless petitioner satisfies the

requirements of section 302(c)(2), petitioner did not completely terminate his interest in the corporation as required by section 302(b)(3).

Respondent argues that there was no complete termination of petitioner's interest because petitioner was an employee of the corporation after the redemption. Thus, respondent contends, petitioner retained a prohibited interest in the corporation within the meaning of section 302(c)(2). According to respondent, this causes the attribution rules to apply (sec. 302(c)(1)), and precludes the redemption from being a complete redemption within the meaning of section 302(b)(3).

This Court recently examined the application of section 302(c)(2)(A)(i) in two cases, one involving an independent contractor and the other involving an employee. Lynch v. Commissioner, 83 T.C. 597 (1984); Seda v. Commissioner, 82 T.C. 484 (1984) (Court-reviewed). Earlier cases involving claims of a prohibited interest under section 302(c)(2)(A)(i) had involved an interest as an independent contractor or as something other than an officer, director, or employee of the corporation. Chertkof v. Commissioner, 72 T.C. at 1124 (interest under a management contract); Estate of Lennard v. Commissioner, 61 T.C. 554 (1974) (independent contractor providing accounting services to the corporation after the redemption). Our Court-reviewed opinion in Seda v. Commissioner, supra, is the only case in which this Court has squarely faced a claimed prohibited interest as an employee. In Seda, the taxpayers owned all of the outstanding stock of B & B Supply Co. (B & B). The taxpayer-husband, Mr. Seda, was B & B's president and chairman of the board. The taxpayer-wife, Mrs. Seda, was a director, vice president, and secretary of B & B. Because of their deteriorating health, the taxpayers decided to have B & B redeem all of their stock therein. The taxpayers resigned from their positions as officers and directors the same day the redemption was effected. Pursuant to the redemption agreement, B & B also issued 1,000 shares of its stock to the taxpayers' son, who thus was the sole shareholder of B & B after the redemption. Mr. Seda, however, continued to work for B & B after the redemption at a monthly salary of $1,000. Approximately 2 years after the redemption, imme

diately after learning that his employment relationship could result in the gain from the redemption of his stock being taxed as ordinary income, Mr. Seda terminated his employment relationship with B & B. Mrs. Seda never served as an officer, director, or employee of B & B after the redemption.

In Seda, respondent argued that the taxpayers were not entitled to the relief from the family attribution rules provided by section 302(c)(2) because Mr. Seda remained an employee of B & B after the redemption. The taxpayers argued that section 302(c)(2)(A)(i) does not prohibit all employment relationships. They further contended that Mr. Seda's employment after the redemption was not the retention of a prohibited interest in B & B. We disagreed. In concluding that the taxpayers failed to satisfy section 302(c)(2)(A)(i), and that they therefore did not satisfy the requirements of section 302(b)(3) because of their constructive ownership of their son's stock, we stated as follows:

This Court has previously stated that it is reasonable to infer from the legislative history that in enacting section 302(c)(2)(A) Congress was primarily concerned with a situation where a redeeming shareholder retained a financial stake in the corporation or continued to control the corporation and benefit by its operations after making only a nominal transfer of his stock. Estate of Lennard v. Commissioner, 61 T.C. 554, 561 (1974).

Although section 302(c)(2)(A)(i) may not prohibit the retention of all employment relationships, it is clear that the level of employment engaged in by Mr. Seda herein is prohibited. After the redemption, Mr. Seda continued to work for the company for almost 2 years and received a salary of $1,000 per month. By receiving that salary, Mr. Seda did retain a financial stake in the company. Moreover, petitioners have failed to show that Mr. Seda ceased to be involved in the management of the company after the redemption. The fact that petitioners did not know that Mr. Seda's continued employment would prevent them from achieving long-term capital gain treatment is unfortunate, but not controlling. *** [Seda v. Commissioner, 82 T.C. at 488. Fn. ref. omitted; emphasis added.]

Thus, we concluded that Mr. Seda's employment for almost a 2-year period gave him a financial stake in the company which constituted a prohibited interest under section 302(c)(2)(A)(i). 35

35 Eight judges, in a concurring opinion, thought that in adopting the parenthetical language of sec. 302(c)(2)(A)(i), Congress intended to "prohibit the retention of all employment

Lynch v. Commissioner, supra, decided a few months after Seda, involved an independent contractor rather than an employee, but reaffirmed the rationale of Seda. The taxpayer-husband, Mr. Lynch, was originally the sole shareholder of W.M. Lynch Co. (the company). The taxpayers' son was employed by the company as a salesman. He was also elected a director and officer of the company. Later, Mr. Lynch sold some of his stock in the company to his son. The taxpayers resigned as directors and officers of the company. Shortly thereafter, the company redeemed the rest of Mr. Lynch's stock. At the same time, Mr. Lynch entered into a consulting agreement whereby he agreed to provide such consulting services of an advisory nature as the company might reasonably request. After the redemption, Mr. Lynch performed some services for the company pursuant to a consulting agreement. He received a monthly fee under the agreement. He also received other minor benefits from the company.

Asserting that the true nature of Mr. Lynch's relationship with the company was that of an employee, the Commissioner argued that Mr. Lynch had retained an interest in the company prohibited by section 302(c)(2)(A)(i). The taxpayers argued that under the consulting agreement, Mr. Lynch was merely an independent contractor. After carefully examining the relationship between the taxpayerhusband and the company after the redemption, we determined that the weight of the evidence established that he was not an employee of the company after the redemption. In light of that conclusion, we examined the facts and circumstances to determine whether Mr. Lynch had retained a financial stake in the company or continued to control the company after the redemption of his stock and ultimately concluded that he had done neither. 83 T.C. at 605-606, 608. We indicated that such an examination of the facts and circumstances was particularly required "where the interest retained is not that of an officer, director, or employee." 83 T.C. at 605.

relationships." They would have applied the per se rule they considered mandated by the statute. The concurring judges questioned the majority's "insistence on judicially legislating this Court into the additional burden of inquiring into the level of employment." Seda v. Commissioner, 82 T.C. 484, 490-492 (1984) (Court-reviewed). See generally Rose, "The Prohibited Interest of Section 302(c)(2)(A)," 36 Tax L. Rev. 131 (1981).