Also known as: § 306 stock · 306 stock · Section 306 · IRC 306 stock
Written by attorneys · grounded in primary & secondary sources — see below
Preferred stock acquired by a shareholder in a tax-free transaction such as a stock dividend or section 351 exchange. The stock is subject to rules that treat the proceeds from its later disposition as ordinary income or a section 301 distribution rather than capital gain.
Sofia Stern receives preferred stock in a section 351 exchange with Summit Bank. Several years later she sells the shares for cash. The disposition triggers ordinary income treatment on the amount of the corporation's earnings and profits allocable to the shares because the stock qualifies as section 306 stock.
Sebastian Santos transfers section 306 preferred stock to Sapphire Holdings in a section 351 exchange. He receives common stock in return. The common stock he receives is itself treated as section 306 stock, so a later sale will produce ordinary income rather than capital gain.
Sarah Sullivan holds section 306 preferred stock in Southland Foods. The corporation redeems the shares for cash. The redemption is taxed as a section 301 distribution to the extent of earnings and profits, converting what would have been capital gain into ordinary income treatment.
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Section 306 prevents shareholders from using preferred stock received in tax-free transactions to convert what would otherwise be ordinary dividend income into capital gain upon later sale or redemption.
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Preferred stock received in a section 351 exchange is section 306 stock if the receipt of money instead of stock would have been a dividend under section 304. Stock received in exchange for already-tainted section 306 stock is also tainted even if it is common stock.
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The amount realized is treated as ordinary income to the extent of the corporation's earnings and profits at the time of distribution. Any excess reduces basis and any remainder is capital gain, while unused basis shifts to the shareholder's remaining stock.
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