For 355 to Apply
Four Critical Tests:
- Business Purpose
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- Trade or Business
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- No Device
- Continuity of Interests
Corporate & Partner Tax
Instructor: Dwight Drake
Active Trade or Business – 355(b)
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Both distributing and controlled corps must be engaged in active trade or
business after distribution that has a 5 year history.
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Passive business activity won’t work. Corp itself must perform active and
substantial management and operational functions.
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Vertical division of single integrated business permitted.
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Functional division is permitted if active, even though all income from
related source.
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Geographical divisions not controlling. Regs. follow Lockwood case.
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Active business may not have been acquired within 5 yr period prior to
redemption in transaction where gain or loss recognized.
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Real estate – no hope unless provide substantial services.
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Control (80% voting and 80% all classes) of corp conducting business not
acquired by corporate distributee or distributing corp within 5 yr period in
which gain or loss recognized.
``
Corporate & Partner Tax
Instructor: Dwight Drake
Continuity of Interest – Reg 1.355-2(c)
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After distribution, at least 50% of both distributing and controlled
corps must be owned by historic shareholders of distributing corp.
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Heavily overlaps “Device” requirement.
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Historic shareholder is anyone who acquires distributing corp stock
before plan to distribute. Some claim includes any person who
bought stock at least two years before distribution.
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Post-Distribution activity (sell off of distributed stock) relevant and
may kill if part of the overall plan.
``
Corporate & Partner Tax
Instructor: Dwight Drake
Device Requirement – 355(a)(1)(B)
1. Safe zones (presumed innocent):
- No E&P in distributing corp and controlled corp.
- Absent 355, distribution would qualify to cover death taxes and
expenses per 303.
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- Absent 355, distribution would qualify as exchange under 302(b).
2. Device Factors – Pro rata distribution to shareholders; subsequent sell
off of stock of either corp; nature of assets in controlled corp (cash
and investment assets).
3. Non-Device Factors - Strength of business purpose; publicly traded
or widely held stock; availability of 243 dividends deduction to
corporate distributee shareholders of distributing corp.
Corporate & Partner Tax
Instructor: Dwight Drake
Tax Impact to Distributing Corp if 355 Apply
General Rule: No gain or loss to distributing corp on distribution of controlled
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corp stock or securities. 361(c) and 355(c). If other appreciated boot also
distributed, must recognize gain on it.
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Exception 1: Stock of controlled corp acquired by distributing corp within five
yrs of distribution considered boot. Must recognize gain on it. 355(c)(2)(A)
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Exception 2: If after distribution 50% or more of interest in either distributing or
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controlled corp owned by persons who acquired by “purchase” within 5 year
period, then stock distributed is “disqualified stock” in “disqualifying
distribution” per 355(d). ``````````
Distributing corp must recognize gain. Distributee
shareholder not impacted. “Purchase” exists if no carry-over basis.
Exception 3: Gain recognized as if taxable sale if “pursuant to plan” 50% or
more of stock of distributing or controlled corp acquired by non-historic
shareholders within 4 yr period starting 2 yrs before distribution. 355(e).
Anti-Morris trust provision to prevent tax-free dumping of unwanted assets
in connection with tax-free reorgs.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 801- 1
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business in Boston and San Jose for 10 yrs, with R&D in each
location.
(a) M and C dispute. Boston assets (both computer and R&D) contributed to P
Corp and P Corp stock distributed to C in redemption of C stock in L Corp.
355 apply? Dispute resolution valid business purpose. Vertical division of
single active business run for more than 5 yrs satisfies 355 “trade or
business” requirement if actively conducted by both corps afterwards.
(b) Same as (a) but Boston facility opened three years old through internal
expansion. Under final Regs, new facility in same line of business is not a
separate business. Reg. 1.355-3(b)(3)(ii). Hence. If primary business run
for five years may still qualify as vertical division of a single more-than-five
year business and qualify for 355 treatment. No requirement that separate
facilities must have been operated as integrated operation. Reg. follows
Lockwood Estate.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 799- 1
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business in Boston and San Jose for 10 yrs, with R&D in each
location.
(c) Same as (a) but Boston facility acquired three years ago for cash. Per final
Regs, taxable acquisition in same line of business run for five years is just
considered an expansion, not a new business. Reg. 1.355 – 3(b)(3).
Consistent with Lockwood Estate. Hence, still just vertical division of single
more-than-five yr old business and qualifies under 355.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 801- 1
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business in Boston and San Jose for 10 yrs, with R&D in each
location.
(d) Court divestiture order requires spin-off of R&D to new R Corp, which stock
is distributed pro rata to L Corp shareholders. Business purpose requirement
met by court order. Trade or business requirement met under Reg. if R&D
operation specific group of activities carried on to earn profit even though
source of profit is other related business. Thus R&D qualifies as trade or
business even if L Corp only customer for research.
Big issue here is “device”. Factor favoring device is pro rata distribution and
R&D support of L Corp. Regs say major device factor if R Corp primarily
services L Corp post spin-off but R Corp could be independently sold
without adversely effecting either corp. Need more infor here. Strong
business purpose will help mitigate “device” finding.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 801- 1
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business in Boston and San Jose for 10 yrs, with R&D in each
location.
(e) Same as (d) but purpose was to allow separate compensation and retirement
plan for employees. Query whether valid business purpose. May not need
separate R Corp for separate employment and retirement plans. Plus, spinoff may be unrelated to plans. If so, no valid business purpose.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 801- 2
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business and R&D in one location for 10 years. Bought for cash 6
yrs ago D Corp, a software manufacturer. L Corp and D Corp of equal value.
(a) To resolve shareholder dispute, L Corp distributes all D Stock to C in
complete redemption of C’s L Corp stock. Business purpose and trade or
business issues slam dunk. Issue here is “device”. But since non-pro rata
and complete termination of C’s interest under 302(b)(3) absent 355, any
device risk very low. Should fly under 355.
(b) Same as (a), buy before redemption M sold all M stock in L Corp to
unrelated N, who wanted hardware business but not software business.
Transaction fail under 355 because no continuity of interest. Reg. 1.355-2©
requires that at least 50% of the stock of both entities (distributing and
controlled) must be owned by historic shareholders. Otherwise, just purchase
with attempted tax-free bailout of unwanted assets.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 802- 2
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business and R&D in one location for 10 years. Bought for cash 6
yrs ago D Corp, a software manufacturer. L Corp and D Corp of equal value.
(c) State law prohibits L Corp from owning and operating D Corp. L Corp starts
negotiating sell to S Corp. L Corp than spins out D Corp stock pro rata and
shareholders sell stock to S Corp two months out. Here, high risk of device.
Subsequent sale of stock major factor of device and killer if pursuant to prenegotiated plan. Reg. 1-355-2(d)(2)(iii).
(d) Same as (c), but L Corp refuses S Corp offer and then spins out D Stock.
Four months later, shareholders sell D stock to another party. Although sell
not prearranged, still strong evidence of device because so close in time.
What did shareholders intend at distribution? Facts here very tough.
Parenthetical language of 355(a)(1)(B) (subsequent sale not presume device)
is watered down (nearly rejected) by Regs. Also may have continuity of
interest problem if historic shareholders not own D stock long enough. This
transaction is very high risk.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 802- 2
Basic Facts: L Corp common stock equally owned by M and C. Computer
hardware business and R&D in one location for 10 years. Bought for cash 6
yrs ago D Corp, a software manufacturer. L Corp and D Corp of equal value.
(e) Same as (d) but shareholder sale is to S Corp on same terms as L Corp board
rejected when offered by S Corp. Issue: Was there prearrangement?
Probably, based on facts. Plus, all the problems in (d). Little hope of 355
here.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 808
Basic Facts: F sole shareholder of S Corp, operator of department store of 15
yrs. Stock basis 200k, FMV 2 mill. New branch store bought 3 yrs ago
represents 500k of 2 mill value and basis of 100k. S Corp transfers branch
store assets (500k) to new B Corp for 400k common stock and 100k
securities; S Corp then distributes B Corp stock and securities to F; F then
gifts B Corp stock to children as part of estate plan. 400k E&P.
Is this valid 355 transaction? – Is estate planning valid business purpose?
Probably not; slit of authority. Trade or business requirement satisfied? Yes,
vertical division of 15 yr old business. Device? Planned gift may kill.
Continuity of interest? Planned gift may kill.
Tax consequences if valid:
- Transfer of assets to B Corp in exchange for stock and securities valid D
reorg and S Corp recognizes no gain or loss under 361(a). 361(a), unlike
351, includes securities as nonrecognition property. 361(a) trumps 351.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 808
Tax consequences if valid:
- S Corp basis in stock and securities substituted 100k asset basis per
358(a)(1) – 80k allocated to stock and 20k allocated to securities.
- 25% of S Corp E&P allocated to B Corp (based on relative FMV of
assets). Reg.1.312 -10(a).
- S Corp has no gain or loss on distribution of stock and securities to father.
362(c). S Corp’s E&P reduced by basis in securities (20k) to 280k. This
done pursuant to 312(a)(3) and (b) by increasing 300k basis by 80k
appreciation and then reducing by 100k FMV distributed.
- B Corp no gain or loss on issuing stock. 1032. Carryover 100k basis in
assets. 362(b). Holding period tacking under 1223(2). Picks up 100k of S
Corp E&P.
- Father: Securities boot – taxed as dividend to extent of 100k FMV. Basis
in securities 100k. F’s 200k stock basis allocated to S Stock and B Stock per
FMV (1.5 mill v. 400k) – 158k to S; 42k to B. Full tacking.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 808
Tax consequences if valid:
- Gift by F to son non-taxable. Son takes 42k carryover basis per 1015 with
tacking of holding period per 1223(2).
Transaction fails under 355.
- 351 on formation of B Corp. 100k securities are boot so S Corp has 100k
gain on formation of B Corp. Basis in securities 100k. S Corp basis in B
stock is carryover 100k basis. No E&P allocation to B Corp because no
reorg.
- S Corp distribution of B Corp stock to F triggers 300k gain on distribution
(400k FMV over 100k basis) per 311(b).
- S Corp E&P increased by 300k gain on B Corp stock distribution and then
decreased by 500k (FMV of distribution of stock and securities distributed).
- B Corp no gain or loss on stock or securities issuance. 1032. Basis in assets
is S Corp carryover basis (100k) plus 100k recognized by S Corp – 200k.
362.
Corporate & Partner Tax
Instructor: Dwight Drake
Problem 808
Transaction fails under 355.
- F has 500k dividend under 301 on receipt of B Corp stock and securities
(FMV). S Corp has sufficient E&P by virtue of 100k gain on formation of B
Corp and 300k gain under 311 on distribution of B stock. F basis in stock is
400k, basis in securities is 100k, under 301(d). No tacking of holding period.
Basis in S Corp stock remains at 200k.
- Gift to child tax free and child takes carryover basis of 400k in stock and gets
tacked holding period from F. 1223(2).
Corporate & Partner Tax
Instructor: Dwight Drake