Revenue Ruling 78-401: The Retained Control Test of Section 302(b)(1)

One of the questions remaining unanswered after United States v. Davis is whether loss of control over corporate acts requiring supermajority stockholder approval constitutes a "meaningful reduction" in a shareholder's proportionate interest so as to qualify for sale or exchange treatment under section 302(b)(1). Recently, in Revenue Ruling 78-401, the Service ruled that such a limited loss of control does not qualify, contrary to two cases holding that it does. The author analyzes the rationale underlying the use of control to test for essential equivalency to a dividend and concludes that the test established in Revenue Ruling 78-401 is correct.