Tender Offer Tax Treatment: Section 302 Tests and Sale vs. Dividend

Cash you receive in a tender offer is taxed either as a capital gain on a stock sale or as a dividend on the full amount, and which one applies depends on who is buying. Third-party acquisitions are straightforward stock sales. When the issuing corporation itself is buying back its shares, the IRS runs the transaction through the ownership-reduction tests in Section 302 of the Internal Revenue Code to decide whether you get sale treatment or dividend treatment. That choice can mean thousands of dollars of extra tax, because dividend treatment taxes the whole payout rather than just your gain above cost.

If a Third Party Is Buying, It’s a Sale

The first question is who is making the offer. If an outside company is offering to buy your shares as part of an acquisition, the transaction is a simple sale of stock. Subtract your adjusted basis from the cash received; the difference is your capital gain or loss, long-term if you held the shares more than a year. Section 302 does not apply, because no one is redeeming shares on behalf of the issuing corporation.

Section 302 applies only when “a corporation redeems its stock,” meaning the company whose shares you own is buying them back from you, directly or through an intermediary acting on its behalf.¹ Self-tenders and share buybacks are the transactions that trigger everything in the rest of this article. If your tender is a third-party acquisition, you can stop here and report a normal capital gain or loss.

Why the Sale vs. Dividend Call Matters So Much

When a self-tender qualifies as a sale, you pay tax only on the gain. When it fails the Section 302 tests and defaults to dividend treatment, you pay tax on the full cash payout to the extent the corporation has current and accumulated earnings and profits (E&P) to support it.² You cannot offset your basis against the dividend portion. The basis instead shifts to any shares you still hold.

A simple example makes the difference concrete. You tender 100 shares with a $3,000 basis and receive $5,000. Under sale treatment, you are taxed on the $2,000 gain. Under dividend treatment, with the corporation holding sufficient E&P, you are taxed on the full $5,000. Your $3,000 of basis moves to any remaining shares rather than reducing the current year’s bill. Being taxed on $5,000 instead of $2,000 is where the real damage lives.

The rate side is less dramatic than it used to be. Long-term capital gains are taxed at 0%, 15%, or 20% depending on your income.³ Dividends from domestic corporations generally qualify for the same preferential rates, provided you held the stock more than 60 days during the 121-day window around the ex-dividend date.⁴ Most shareholders who have owned stock for any meaningful period will clear that bar. The real cost of dividend treatment is losing the basis offset, not necessarily paying a higher rate. Dividends that fail the holding-period test, or dividends from certain foreign corporations treated as passive foreign investment companies, are taxed as ordinary income at rates reaching 37% in 2026.⁵

The Three Section 302 Tests That Get You Sale Treatment

A self-tender gets sale treatment only if it passes one of three tests under Section 302(b). Fail all three and the distribution is taxed as a dividend under Section 301.¹ Every test uses constructive ownership, meaning shares held by certain family members and related entities count as yours.

Substantially Disproportionate Redemption

This is the most mechanical test and the safest to rely on, because it is pure math. All three of these conditions must be true after the tender closes:

You own less than 50% of the corporation’s total voting power.
Your percentage of voting stock is less than 80% of what it was before. Owned 10% before? You need to own less than 8% after.
Your percentage of all common stock, voting and nonvoting combined, is also less than 80% of what it was before.¹

Miss any one of these and the test fails. All percentages are run through the constructive ownership rules.

Complete Termination of Interest

Surrender every share you own, voting and nonvoting, and the redemption qualifies as a complete termination. The trap is constructive ownership: if your spouse or child still holds shares in the same corporation, those are attributed to you and you have not terminated anything.

There is a family attribution waiver that lets you ignore shares held by family members, but it comes with conditions. You cannot be an officer, director, or employee of the corporation after the redemption. You must agree not to acquire any interest in the corporation for ten years, other than by inheritance. And you must file a written agreement with the IRS, usually attached to the return for the year of the redemption, promising to notify the IRS if you reacquire a prohibited interest.¹ Breaking any of those within the ten-year window can retroactively convert the whole thing into a dividend.

Not Essentially Equivalent to a Dividend

When the first two tests do not work, this catch-all is the last chance at sale treatment. It requires a “meaningful reduction” in your proportionate interest, judged on the facts and circumstances. The Supreme Court held in United States v. Davis that the constructive ownership rules apply here as well, and that a redemption that does not change the shareholder’s proportionate interest is always essentially equivalent to a dividend.⁶

Courts look at whether the redemption reduced your voting rights, your share of future dividends, and your claim on assets in a liquidation. A minority shareholder who drops from 3% to 1.5% has a much better case than a controlling shareholder whose percentage barely moves. There is no bright-line safe harbor. If you are relying on this test, expect to document ownership percentages before and after and support the position with legal analysis if the IRS pushes back.

Constructive Ownership Can Flip the Result

Every Section 302 test counts not only your own shares but shares attributed to you under Section 318.⁷ These rules exist to stop shareholders from parking shares with related parties to manufacture a reduction. The one that catches individuals most often is family attribution: you are treated as owning shares held by your spouse, children, grandchildren, and parents. Siblings and grandparents are not on that list.

Attribution also runs through entities. Shares held by a partnership, estate, or trust are attributed to partners and beneficiaries, and shares you hold individually are attributed back to those entities. If you own 50% or more of another corporation, you are deemed to own a proportionate share of the stock that corporation holds in the issuer, and the attribution runs the other way too. Options, warrants, and convertible securities count as the underlying stock. Before you decide which Section 302 test you pass, map out every family member’s holdings, every entity you have an interest in, and every option outstanding. A single missed attribution path can convert the entire transaction from sale to dividend.

The 3.8% Net Investment Income Tax

Whether the payout ends up as capital gain or dividend, high-income shareholders face an additional 3.8% net investment income tax under Section 1411. It applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds $200,000 for single filers, $250,000 for joint filers, or $125,000 if you are married filing separately.⁸ Those thresholds are not indexed to inflation. Net investment income includes capital gains, dividends, interest, rents, and royalties, so a large tender payout can push you well over the line in a single year even if your income is normally below it.

Reporting the Transaction

You will generally receive a Form 1099-B from the paying agent reporting the gross proceeds.⁹ The 1099-B often will not classify the payment correctly as sale proceeds versus a distribution, and the cost basis it shows may be wrong. Getting the characterization right is on you.

If the redemption qualifies as a sale, report the gain or loss on Form 8949 and carry the totals to Schedule D.¹⁰ If the 1099-B treats it differently, you can override that on Form 8949 using the adjustment columns and attach a statement explaining which Section 302 test you satisfy, with your ownership percentages before and after.

If the tests fail and the distribution is a dividend, report the dividend portion on Schedule B when it exceeds $1,500.¹¹ Any amount beyond the corporation’s E&P that reduces basis is not reported as income, and anything left after basis hits zero is a capital gain on Schedule D. Because the 1099-B may lump the whole thing together as sale proceeds, splitting the payment correctly often requires E&P information from the corporation, which may not be available until well after the tender closes.

1
Office of the Law Revision Counsel. 26 U.S. Code 302 – Distributions in Redemption of Stock
2
Office of the Law Revision Counsel. 26 U.S.C. 301 – Distributions of Property
3
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
4
Legal Information Institute. 26 U.S.C. 1(h)(11) – Dividends Taxed as Net Capital Gain
5
Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates
6
Justia. United States v. Davis, 397 U.S. 301 (1970)
7
Office of the Law Revision Counsel. 26 U.S. Code 318 – Constructive Ownership of Stock
8
Office of the Law Revision Counsel. 26 U.S.C. 1411 – Imposition of Tax
9
Internal Revenue Service. Instructions for Form 1099-B
10
Internal Revenue Service. Instructions for Form 8949
11
Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions