Background Analysis
Formation and Capitalization of Widell Engineering Associates (WEA)
Fifteen years ago, Stuart and Marsha Widell created Widell Engineering Associates (WEA), a
Delaware corporation that builds, repairs, and oversees waste treatment plants in the Southwest.
In exchange for a $500,000 cash capital contribution and some industrial equipment with an
adjusted basis of $4.5 million, WEA issued 2,500 shares of WEA common stock to Stuart and
Marsha.
Gift of Shares to Weymouth Widell
Three years after establishing WEA, Stuart and Marsha they transferred 1,000 shares of their
WEA stock to their son, Weymouth. This was in the greater scheme of arrangements of bringing
Weymouth into the family business and, perhaps, setting the company on the course of an easy
transition in management at WEA.
Redemption of Weymouth's Shares
The decade of coproducing the business he had produced solid disagreement between Stuart and
Weymouth over WEA's direction and management. Consequently, Weymouth desired to resign
and establish his engineering company, Fortunelle. To smooth the separation and keep the
business in family hands, WEA bought back all 1,000 of Weymouth's shares for waste treatment
property valued at $ 8.5 million.
Weymouth secured a waiver of the family attribution rules under IRC Section 302(c)(2) to
ensure the redemption was treated as a capital gain and not ordinary income. The second part of
the waiver agreement included Weymouth never acquiring any equity interest in WE A for at
least ten years and notifying the IRS if he did.
Health Concerns and Reconciliation
Stuart had suffered a heart attack recently, and after this incident, he patched up with Weymouth.
Considering the health conditions of Stuart and the fact that the business was to be kept within
the family at any cost, the Widells suggested a contract where Fortunelle could look after the
waste treatment plants of WEA. According to this contract, Fortunelle would get 20% of the
gross rental revenues from WEA every year, but there would be no equity interest of Weymouth
in WEA.
Proposed Management Agreement
The long and short of it goes to whether this management contract will violate any of the
provisions of Weymouth's waiver agreement with the IRS. The management agreement must not
cause Weymouth's activity in the business through Fortunelle to be construed as a reacquisition
of an interest prohibited under WEA that otherwise put the capital gains at risk for redemption if
it is so recharacterized as ordinary income.
Summary of Legal Authorities
To alleviate such concerns, relevant legal authorities should be taken into account:
IRC Section 302(c)(2): This exception permits a shareholder to waive the family attribution rules
when the shareholder has no interest in the corporation other than being a creditor for ten years
following the redemption. Interpreted from the above judgment, it is clear that for redemption to
be allowed under Section 302, the taxpayer must not reacquire a prohibited interest within the
stipulated period. Chercof v. Commissioner, 48 AFTR 2d 81-5194 (4th Cir. 1981): Here, one
could see that the management contract, with so much control given by it back to the taxpayer,
violated the waiver under Section 302(c)(2) and hence attracted the unusual treatment of
ordinary income tax rather than capital gains. Key Considerations Operative vs. Controlling
Mandate: The mandate of management established at Fortunelle must be safety operative,
without rights to vote, make policies, or exercise strategic controls over WEA. Legal and Tax
Compliance: Checking that the document complies with all relevant tax laws and consulting with
legal and tax consultants on how to structure the document. IRS Notification and
Documentation: Proper record keeping and notification of the IRS to coordinate transparency in
light of the Weymouth's waiver agreement.
