IRC 318 Constructive Ownership of Stock
IRC 318 & Constructive Ownership of Stock: When a person owns an asset – such as stock – and they paid for the stock and/or acquired it under their own name, they are considered the direct owner of the stock. But, not all stock ownership is direct ownership. When it comes to the IRS and tax law, “direct ownership” is only one kind of ownership. Another very common type of ownership is referred to as indirect ownership or “constructive ownership.” Constructive ownership of stock refers to ownership that is attributed to a person (usually) due to their relationship with another person.
For example, the spouse of someone who owns stock in a corporation may be deemed as the constructive owner of the stock owned by the other spouse.
The Internal Revenue Code codified the rule in section 318.
Here is the key aspects of IRC 318:
The first part of the code refers to attribution from and next portion refers to the attribution to.
Family Member Attribution under IRC 318
(a) General Rule
“For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable—
(1) Members of family
(A) In general
An individual shall be considered as owning the stock owned, directly or indirectly, by or for —
(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and
(ii) his children, grandchildren, and parents.”
From Partnerships and Estates
Stock owned, directly or indirectly, by or for a partnership or estate shall be considered as owned proportionately by its partners or beneficiaries.
(i) Stock owned, directly or indirectly, by or for a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by its beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust.
(ii )Stock owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by such person.
If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.
Attribution to Partnerships, Estates, Trusts, and Corporations
(A) To partnerships and estates
Stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate.
(B) To trusts
(i) Stock owned, directly or indirectly, by or for a beneficiary of a trust (other than an employees’ trust described in section 401(a) which is exempt from tax under section 501(a)) shall be considered as owned by the trust, unless such beneficiary’s interest in the trust is a remote contingent interest. For purposes of this clause, a contingent interest of a beneficiary in a trust shall be considered remote if, under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property.
(ii) Stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by the trust.
(C) To corporations
If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person.
Operating rules for IRC 318
(A) In general
Except as provided in subparagraphs (B) and (C), stock constructively owned by a person by reason of the application of paragraph (1), (2), (3), or (4), shall, for purposes of applying paragraphs (1), (2), (3), and (4), be considered as actually owned by such person.
(B) Members of family
Stock constructively owned by an individual by reason of the application of paragraph (1) shall not be considered as owned by him for purposes of again applying paragraph (1) in order to make another the constructive owner of such stock.
(C) Partnerships, estates, trusts, and corporations
Stock constructively owned by a partnership, estate, trust, or corporation by reason of the application of paragraph (3) shall not be considered as owned by it for purposes of applying paragraph (2) in order to make another the constructive owner of such stock.
(D) Option rule in lieu of family rule
For purposes of this paragraph, if stock may be considered as owned by an individual under paragraph (1) or (4), it shall be considered as owned by him under paragraph (4).
(E) S corporation treated as partnership
For purposes of this subsection—
(I) an S corporation shall be treated as a partnership, and
(ii) any shareholder of the S corporation shall be treated as a partner of such partnership.
1.318-2 Regulation Examples for IRC 318
Regulation 1.318-2 provides insight to how the rules are applied.
Let’s review some of the examples:
Individual and Corporate Attribution
H, an individual, owns all of the stock of corporation A.
Corporation A is not considered to own the stock owned by H in corporation A.
H, an individual, his wife, W, and his son, S, each own one-third of the stock of the Green Corporation. For purposes of determining the amount of stock owned by H, W, or S for purposes of section 318(a)(2)(C) and (3)(C), the amount of stock held by the other members of the family shall be added pursuant to paragraph (b)(3) of § 1.318-1 in applying the 50-percent requirement of such section.
H, W, or S, as the case may be, is for this purpose deemed to own 100 percent of the stock of the Green Corporation.
Explanation of the Example
In example 1, the attribution rules do not reverse, so that the corporation is not considered the owner of the stock held by the individual.
In the above-referenced example 2 (which is very common), when a parent or child own stock, that stock ownership is attributed to the other spouse/parent and each other.
So here, family members H, W and S (Husband, Wife and Son) are each deemed to own 100% of the stock.
Here is another example provided by the regulation 1.318-2
The application of section 318(a)(1), relating to members of a family, may be illustrated by the following example:
An individual, H, his wife, W, his son, S, and his grandson (S’s son), G, own the 100 outstanding shares of stock of a corporation, each owning 25 shares.
- H, W, and S are each considered as owning 100 shares.
- G is considered as owning only 50 shares, that is, his own and his father’s (not his grandparents’ shares as well).
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