Six years ago, Coastal Drillers, Inc., redeemed all of the stock owned directly by Jeremiah Cranston (6870 Vinton Court, Los Angeles, CA 90034). At the time of the redemption, Jeremiah and his immediate family members owned 100% of the stock of Coastal Drillers. Jeremiah satisfied all of the requirements of the family attribution waiver [under section code 302(c)(2)]; thus, the transaction qualified as a complete termination redemption and resulted in a significant long-term capital gain. Coastal Drillers’ E&P at the time of the transaction exceeded the redemption proceeds. Treatment of the redemption proceeds as a dividend would have resulted in a $200,000 greater tax liability for Jeremiah. Now, six years later, Coastal Drillers has offered Jeremiah a consulting engagement. The consulting engagement would be for a one-year term, but options to renew could extend the contract to a total of five years. Assuming all options are exercised, Jeremiah would earn $150,000 under the contract. Based on the terms of the contract, Jeremiah would properly be classified as an independent contractor, not as an employee of Coastal Drillers. Jeremiah has contacted you regarding the effect, if any, of the proposed consulting engagement on the tax treatment of his earlier stock redemption. Prepare a letter to Jeremiah and a memo for the file documenting your conclusions.
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