CORPORATE TAX I & II
Table of Contents
Unit I.A—Why Tax Corporate Income? ................................................................................................................ 6
Problems ............................................................................................................................................................. 6
Unit I.B—Choice of Form and Entity Classification.............................................................................................. 8
Problems ............................................................................................................................................................. 9
Unit II.A—Money (Cash) Distributions ............................................................................................................... 11
Problems ........................................................................................................................................................... 13
How to Calculate E&P—§ 312, § 1.312-6(b) ............................................................................................... 14
Effect of Distributions on E&P ..................................................................................................................... 15
AEP Deficit with positive CEP ..................................................................................................................... 17
Positive AEP and CEP Deficit—CEP deficit MATTERS!! ......................................................................... 18
Preferred Stock (**NOTE: preferred distribution doesn’t enter the CEP formula) ..................................... 19
UNIT II.B—Non-Cash Distributions.................................................................................................................... 21
Problems ........................................................................................................................................................... 22
Distribution of Built-in Gain Property .......................................................................................................... 22
Distribution of Properties, Gain and Loss Property ...................................................................................... 25
Distribution of Property Subject to Liability ................................................................................................ 26
Distribution of Notes from the Distributing Corporation ............................................................................. 27
Unit II.C—Disguised Dividends ........................................................................................................................... 29
Problems ........................................................................................................................................................... 29
Disguised Dividend—Sale of Property at price below FMV to shareholders .............................................. 29
Whether Corporation Getting 3rd Party to Pay Money Directly to Shareholders is a Dividend ................... 32
Whether Property Distributed to Employee is Salary or Dividend ............................................................... 33
Whether Money Transferred to a Shareholder in Closely Held is a Loan of Dividend................................ 34
Unit II.D—Dividends Received Deduction .......................................................................................................... 36
Problems ........................................................................................................................................................... 38
What Tax Liability where 70% owner causes dividend to be paid in the form of a note from company
owned and then sells stock to a 3rd party for an amount that reflects a reduction of that note—If respected
....................................................................................................................................................................... 38
What Tax Liability where 70% owner causes dividend to be paid in the form of a note from company
owned and then sells stock to a 3rd party for an amount that reflects a reduction of that note—If respected
....................................................................................................................................................................... 40
Corporation Buys Stock that Pays Dividend 1 month later, then Corp. Sells stock for a Loss .................... 41
Does § 246(c) or § 1059 apply to the above transaction? ............................................................................. 41
What happens where the above transaction occurs and it is outside the scope of § 246(c), but § 1059
applies. .......................................................................................................................................................... 42
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Illustrates 10% threshold not applicable to § 246(c), only § 1059 ............................................................... 43
Unit III.A—Redemptions “Not Essentially Equivalent to a Dividend” and “Substantially Disproportionate
Redemptions” ........................................................................................................................................................ 44
Simple Sale of Stock Between Shareholders ................................................................................................ 48
Ownership requirements under § 302(b)(2) .................................................................................................. 48
Redemption that Fails § 302(b)(2)  Use § 302(b)(1) “meaningful reductions” ........................................ 49
Redemption that Fails § 302(b)(1),(2)  § 302(d) sends to § 301 AND Requires Tacking Basis .............. 51
Corporation receiving § 302(d)  § 301 deemed distribution, DRD Automatic—§ 1059, BUT Have to
REDUCE Basis By Untaxed Portion (DRD) per § 1059(e)(1)(A)(ii) .......................................................... 52
Two Redemptions in equal Amounts, One Shortly After the Other—Step Transaction .............................. 52
Simultaneous Redemption of Preferred Stock with § 302(b)(2) Common Stock Redemption .................... 54
Redemption of Only Nonvoting Preferred Stock.......................................................................................... 55
Unit III.B—Attribution and Complete Terminations ........................................................................................... 56
Attribution/Constructive Ownership—§ 318(a)(1)—Family Members Doesn’t Include Siblings .............. 58
Attribution from Corporation to Shareholder ............................................................................................... 58
Option to Purchase Stock Treated as Owned—§ 318(a)(4).......................................................................... 59
Redemption of All of a Shareholder’s Stock—Termination of Interest—§ 302(b)(3) ................................. 60
Termination of Interest where Family Member Retains Stock—Possible §302(c) Waiver ......................... 60
Prohibited Interest under Waiver of Family Attribution—Paid Consultant prohibited. ............................... 61
Application of the Proposed Regulations: .................................................................................................... 62
Stock redeemed purchase from Family Member < 10 years prior to Redemption ....................................... 63
Unit III.C—Partial Liquidations and Bootstrap Acquisitions............................................................................... 65
Partial Liquidation under § 302(b)(4)—not applicable for corporate shareholders ..................................... 66
Unit III.D—Redemptions by Related Corporations ............................................................................................. 69
Redemption through Use of Related Corporation/Brother-Sister Redemptions—§ 304(a) with Sale or
Exchange Treatment—passes § 302(b) ........................................................................................................ 72
Redemption through Use of Related Corporation—§ 304(a) with §301 treatment (Fails § 302(b)) ............ 73
Redemption through Use of Related Corporation where § 304 Does not Apply—§1001 Sale/Exchange... 76
Unit IV.A—Stock Dividends ................................................................................................................................ 77
Common Stock Dividend—§ 305(a) General Rule ...................................................................................... 79
Stock Dividend—Distributions on Preferred Stock—§ 302(b)(4) ............................................................... 81
Stock Dividend—Disproportionate Distributions—§ 305(b)(2)—2 Classes of Common/Cash to One and
Stock to the Other ......................................................................................................................................... 81
Pro Rata Cash Redemption—Certain Transactions Treated as § 301 Distribution—§ 305(c)..................... 82
Cash Distribution on Preferred Stock  Simple § 301 Cash Distribution................................................... 85
Common and Convertible Preferred Outstanding—Stock distributed on Common and $6 dividend to
preferred Every year—§ 305(d)(1) ............................................................................................................... 85
Unit IV.B—Dispositions of Tainted Stock ........................................................................................................... 87
Preferred on Common Stock Dividend, § 306 Tainted Preferred Sold, then Common Sold ....................... 89
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Preferred on Common Stock Dividend, § 306 Tainted Common Sold, then Preferred Sold—Taint Lifted—
§306(b)(1)(A) ................................................................................................................................................ 91
Preferred on Common Stock Dividend, § 306 Tainted, Preferred Stock REDEEMED ............................... 92
Unit V.A—Liquidations in General ...................................................................................................................... 93
Corporation Adopts Plan of Liquidation, Sells Assets, Distributes Cash to Shareholders (No § 336)—
Shareholder in Gain Position ........................................................................................................................ 96
Corporation Adopts Plan of Liquidation, Distributes Assets to Shareholders, Shareholder Sells Assets (§
336 applies)—Shareholder in Gain Position................................................................................................. 97
Sale of Stock to 3rd Party—Shareholder in Gain Position ............................................................................ 97
Corporation Adopts Plan of Liquidation, Sells Assets, Distributes Cash to Shareholders (No § 336)—
Shareholder in Loss Position ........................................................................................................................ 98
Corporation Adopts Plan of Liquidation, Distributes Assets to Shareholders, Shareholder Sells Assets (§
336 applies)—Shareholder in Loss Position ................................................................................................. 98
Sale of Stock to 3rd Party—Shareholder in Loss Position ............................................................................ 98
Unit V.B—Parent-Subsidiary Liquidations ........................................................................................................ 100
Corporation Owned 100% by Another Corporation Liquidates, Distributes Property ............................... 101
Liquidation Where Minority Shareholder is Present 80/20 Ownership Ratio ............................................ 102
Liquidation Where Property Held by Liquidating Corp in Loss Position .................................................. 103
Unit V.C—Section 338 Elections ....................................................................................................................... 105
§ 338(g) Election Consequences ................................................................................................................. 108
§ 338(h)(10) Election .................................................................................................................................. 109
Unit VI.A—Incorporation of Assets—§ 351 ...................................................................................................... 112
Simple § 351 Application—Contribution of Property in Exchange for Corp Stock .................................. 116
Contribution of Services in Exchange for Stock—§ 351(d) disallows § 351 Treatment ........................... 118
Part Cash Contribution/Part Service ........................................................................................................... 119
Contribution of Property Qualifying for § 351, Followed By Sale of Stock Received One Week Later ... 120
Contribution of Property and Receive Stock AND Cash—“Solely”/Boot ................................................. 121
Contribution of Property that Is Encumbered by Debt ............................................................................... 121
Contribution of Property Encumbered by Debt Where Debt Assumed Exceeds Contributors Basis in the
Property ....................................................................................................................................................... 123
Unit VII.A—Acquisitive Reorganizations (“A” and “C” Reorgs) ..................................................................... 124
THE HUB ........................................................................................................................................................... 124
Statutory Merger (“A” Reorg) ........................................................................................................................ 126
Use of 20 Year Bonds, Convertible into Common Stock After 5 years in Merger .................................... 128
Use of Non-voting Preferred Stock in Merger ............................................................................................ 128
Stock Used in to Acquire Target Represents 1% of Acquiror Stock Outstanding—No problem .............. 128
Use of 2-year Notes, 20-year Bonds, and Common Voting Stock—COI (40%) and Tax Consequences of A
Reorg. .......................................................................................................................................................... 130
Post Contract Price Fluctuation—§ 1.368-1(e)(2) ...................................................................................... 133
Dissenter’s Rights in A Reorg Situation ..................................................................................................... 134
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Sale of Shareholder Stock Before or After Reorg to Unrelated Parties ...................................................... 134
Sale of Stock Post Reorg to Related Party—Treat as Cash and Determine Bucket ................................... 135
Stock Buy Back Agreement ........................................................................................................................ 135
After Reorg Sells Target’s Old Business Assets But Continues Business (and sells under Old Business
Name) .......................................................................................................................................................... 136
“C” Reorganization ......................................................................................................................................... 137
Use of Bonds in C Reorg—Not Voting Stock—Not Good “C” Reorg ...................................................... 138
Use of Nonvoting Preferred Stock—Not Voting Stock—Not Good “C” Reorg ........................................ 138
Use of Voting Preferred Stock—Representing 1% of Acquiror Stock—Good “C” Reorg ........................ 138
Voting Preferred Stock AND Liabilities..................................................................................................... 139
"C" reorganization -- "solely" relaxation rule. ................................................................................................ 139
Voting Stock, Non-voting Stock, and Liabilities Used in C Reorg ............................................................ 140
Voting and Non-voting Stock Used AND Voting Common Given to Debt Holders/Creditors ................. 141
Use of Cash to Pay off Debt Holders, Paid By Acquiror Through Target to Creditor ............................... 142
“C" reorganization -- "Substantially All". ...................................................................................................... 143
Sub All Test in C Reorg (90% Net Assets and 70% Gross Assets) ............................................................ 143
Sub All where Debt Assumed in C Reorg, Example of Failed Sub All ..................................................... 144
Sale of Assets Prior to C Reorg .................................................................................................................. 144
Unit VII.B—Acquisitive Reorganizations (“B” Reorganizations) ..................................................................... 146
All Target Stock Solely in Exchange for Acquiror Stock—“B” Reorg...................................................... 148
“B” Reorg Where 15-year Acquiring Corp Bonds Exchanged for 3rd Party Bonds Held in Target Corp.. 149
Acquire All Target Stock in Exchange for Acquiring Corp Stock AND Cash .......................................... 150
Acquisition of Some Target Shareholder’s Stock for all Cash and Some for All Acquiror Stock ............. 150
Acquisition of Target Stock over Time/Separate Transactions—Some for Acquiror Stock, Some for Cash
..................................................................................................................................................................... 150
How to Salvage a “B” Reorg Poisoned by Stock Acquired for Cash ......................................................... 151
Acquiring Corp Acquires Target Stock for Acquiror Stock BUT Has Sub Acquire Some Target Stock for
Cash............................................................................................................................................................. 152
Unit VII.C—Acquisitive Reorganizations: Triangular Reorganizations ............................................................ 154
C Reorg with Drop Down—Assets for Stock and then Drop Assets to Acquiror Sub ............................... 154
Triangular “C” Reorg—Sub Uses Parent Stock to Acquire Target ............................................................ 155
Sub Uses Parent Stock To Acquire Target—Type “A” Forward Triangular Merger: Sub Remains ......... 156
Sub Uses Parent Stock to Acquire Target—Type “A” Forward Triangular Merger: Sub Remains AND
BOOT [20-year debentures] is Used........................................................................................................... 158
Forward Subsidiary Merger with Use of Parent Voting Stock and Subsidiary Non-voting Stock............. 160
Reverse Subsidiary Merger ......................................................................................................................... 161
Reverse Subsidiary Merger; Cash-out of Dissenter (Target Redeems Shareholders for Cash) ................. 164
Creeping Reverse Subsidiary Merger (Already own 25%) ........................................................................ 165
Reverse Triangular “B” Reorg—Stock for Stock BUT Sub Using Parent Stock to Acquire Target ......... 166
Unit VIII—Divisive Reorganizations & Spin-Offs ............................................................................................ 168
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Introductory Problem: Acquisitive "D" reorganizations................................................................................. 168
“D” Reorg Attempt that Fails 50% Control, Still Possible to Satisfy § 368(a)(1)(C) ................................ 169
“D” Reorg with 50% Control Requirement Satisfied ................................................................................. 170
Use of Non-voting Stock in a “D” Reorg is Allowed; However, Would No Longer Meet “C” Reorg ...... 171
Section 355 Problem ....................................................................................................................................... 171
Split-UP—§ 368(a)(1)(D) and § 355 Met Where New Subs Created for Transaction ............................... 175
Split-Off: § 355 and D Reorg...................................................................................................................... 179
Effect of 3rd Party Buying Historic Shareholder Interest Before Split Off ................................................. 180
Active Business Requirement—§ 355(b)—General ................................................................................... 181
Active T/B—§ 355(b)—Acquired in 5-year period Tax Free?—§ 355(b)(2)(D)....................................... 184
Control Requirement of § 355(a)—§ 368(c) .............................................................................................. 185
Split Off—§ 355(d) Situation (Purchase of Stock One Year Before Distribution) .................................... 187
Partial Liquidation, Morris Trust & § 355 ...................................................................................................... 187
§ 355(e) Triggered Where 50% or Greater of Distributing Corp Stock Acquired by 3 rd Party .................. 189
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CORPORATE TAX I
Unit I.A—Why Tax Corporate Income?
Theory:
I.
II.
The Classical System
 Double Tax System
The Harberger Model
 Basic Setup
o Two sectors: corporate and non-corporate
o Two factors of production: labor and capital
 Who bears a tax on corporate sector?
o Not just shareholders of corporations!
o Instead, all holders of capital—investors in corporations and in non-corporate entities bear
the burden of the corporate tax.
 Ex.
o Two roads, one ends up with a toll imposed on it. What happens? If A has the toll, highway
B will bear the burden of the toll because people who do not want to pay he toll will start
using the other road.
 Bottom Line:
o Under several assumptions, capital bears entire burden of corporate tax
o In the long run, capital owners in both the corporate and the non-corporate sector will enjoy
reduced returns to capital
o This occurs as a result of the corporate tax.
 This is why economists hate the corporate tax.
Problems
In the eyes of the U.S. federal tax law, a corporation is a person. Like any individual taxpayer, a corporation
pays a separate federal income tax based on a calculation of its annual gross income less certain business
expenses. Like any individual taxpayer, a corporation interacts with the IRS on its own behalf: it files annual
federal income tax returns, requests tax refunds, responds to audit notices, disputes IRS findings of deficiencies
and pays tax penalties.
1. Why do we impose a separate tax on corporations?
Corporations are taxed individually because they are an entity, separate and distinct from the
shareholders. As a result of Congress deciding to treat corporations as separate entities, it necessarily
followed that they must be taxed. Additionally the treatment of a corporation as a separate entity
gives rise to a second tax, as part of the double tax regime, when dividends are paid out to
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shareholders. This is because it is a taxable event between separate entities—the shareholder and the
corporation.
2. Would you describe the corporate income tax as an efficient way to raise revenue? Why or why not?
The answer to this question is not certain. Arguably the answer is no. As pointed out in the
Auerbach article, the impact of raising the corporate tax is to push business into the non-corporate
sector. In doing so, the available non-corporate return is reduced. Consequently, the after tax
returns between the two must be equal.
3. In his letter to the editor, W. Rudy Kamuf addresses the problem of chewing gum deposits on city streets.
He implies that the government should impose a “chewing gum tax” on corporations that manufacture the
product as a way to ensure that they “pay something back to the community.” Do you think Mr. Kamuf’s
proposal will achieve his objective? Why or why not?
The issue being presented is whether an increased tax on corporations that create products that harm
the community would reduce the harm. It seems unlikely that Mr. Kamuf’s suggestion would have
the intended effect. The burden would ultimately be pushed onto the consumers of the gum. The
corporation producing the gum would simply change its business tactics. If the corporation must pay
tax on selling gum, it will raise the price to the customer. Therefore, the only result that occurs is that
the consumers pay to clean up the gum, not the corporation.
4. Is your answer to Question 3 affected in any way by the discussion in Alan Auerbach’s Who Bears the
Corporate Tax? A Review of What We Know? Please explain.
Yes, the idea that corporate tax incidence falls on shareholders in proportion to their ownership.
Consequently, a tax on the corporation for the gum that it produces only affects the shareholders.
These investors will be taxed as a result of the tax imposed on the corporation, not the corporation
itself. Therefore, taxing the corporation is, in essence, taxing the shareholders. The goal is not
achieved as a result.
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Unit I.B—Choice of Form and Entity Classification
I.
II.
Entity Form
 C-Corp
o Limited liability
o Tax free reorganizations
o Double tax (negative)
 S-Corp
o § 1361
o 100 or fewer shareholders
o Shareholders must be individuals
o No non-resident alien shareholders
o Only one class of stock
o Some corporations are ineligible (insurance companies, some banks)
o Only one level of tax!!
Rates
 Rates—Corporate—§ 11
o 0-50,000  15%
o 50k – 75k  25%
o 75k – 10m 34%
o Above 10m  45%
o Flat rate 35% > 18,333,333
 Rates—Individual (§ 1(a), (i))
o Single: 406,750 + = 39.6%
o Married: 457,600 + = 39.6%
 In Class we will ALWAYS use 35% corporate rate!!
 Long-Term Capital Gains Rates
o Corporations §1201(a)
- No preference
o Individuals – §1(h)(1), §1(i)
- TI up to 73,800 = 0%
- TI 73,801 to $457,600 = 15%
- TI $457,600+ = 20%
 All figures for married filing joint returns
 Qualified dividends – § 1(h)(11)
o Must be paid by domestic corporation or qualified foreign corporation AND
o Shareholder must hold stock in company for more than 60 days during the 121-day period
beginning 60 days before ex-dividend date.
- Ex dividend date
 Corporation will say shareholders of day will receive the dividend declared.
The ex-dividend date will be the first day after the declared day, which
shareholders who purchase the stock no longer will get the dividend.
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
I----------ex-dividend------------I (60 days on either side) and total days owned
more than 60days.
- Domestic corporation
 Any corporation incorporated in the US
Problems
1. Potter Corp. is a U.S. entity taxable as a corporation under Subchapter C of the Code. Potter Corp. is an
accrual method taxpayer that uses the calendar year. Harry and Katie, married individuals who are both U.S.
citizens, own 100% of the stock of Potter Corp. Potter Corp. has taxable income for 2014 of $29 million. On
December 31, 2014, Potter Corp. distributes to Harry and Katie, who are in the top marginal federal income
tax bracket, the (after‐tax) proceeds of its last (pre‐tax) $2 million of earnings.
a. How much of the distribution do Harry and Katie retain after all applicable federal income tax has
been paid on the $ 2 million?
The 2 million is taxed at the corporate level at 35%, leaving 1.3 million to be distributed to
Harry and Katie. However, Harry and Katie will then pay tax on the dividends at 20%.
Ultimately, Harry and Katie will receive $1,040,000 million.
This leaves an effective tax rate is 48%
b. What if Potter Corp. were treated as a partnership (not subject to §7704) for U.S. federal income tax
purposes instead of as a C corporation?
If taxed as a partnership, the income would flow through to Harry and Katie. The result is
that only one level of tax occurs. The highest tax rate for individuals is 39.6%. Therefore,
Harry and Katie would receive $1,208,000.
This leaves an effective tax rate of 39.6%
2. Same facts as in Question (1), but assume that Potter Corp. is incorporated in the United Kingdom. Assume
for purposes of this question that the UK imposes a corporate tax of 35% on corporate earnings and that
Potter Corp.’s shares are listed on the London Stock Exchange.
a. How much of the distribution do Harry and Katie retain after all applicable UK and US income tax
has been paid on the $2 million?
The Potter Corp. will be taxed as a qualified foreign corporation because the US and UK have
a tax treaty, also listed on Notice 2006-101. Because these dividends are qualified dividends
within the meaning of § 1(h) they will be taxed at 15%. The UK will tax the 29 million at 35%,
which will leave 1.3 million. The dividends will then be taxed at 20%, leaving $1,040,000.
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Additional problem: what if Potter Corp were instead incorporated in Brazil?
 Assume shares are listed on the Sao Paulo Stock Exchange
 And options are listed on the Chicago Board Options Exchange
Options are not enough! The stock itself would have to be listed on an established market.
Dividends are paid on stock that is listed on an “established US securities market—Notice
2003-71.
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Unit II.A—Money (Cash) Distributions
I.
II.
Distribution—§ 301(b)—Amount distributed
 Cash Distributed;
 PLUS FMV of Property Received;
 MINUS Liabilities Assumed by SH;
 MINUS Liabilities to Which Prop is Subject;
 PLUS Cancellation of SH Debt.
What is a Dividend?
 Dividend Defined—§316
o Means any distribution of property made by a corporation to its shareholders—
- Out of accumulated E&P (after February 28, 1913 to the year)
- Out of E&P for the taxable year (computed as of the close of the taxable year without
diminution by reason of any distribution made during the taxable year), without
regard to the amount of the E&P at the time the distribution was made.
- § 316(c) Flush Language—look to CEP first
- But from the language, you must wait until the end of the year to determine E&P,
without decreasing the number as a result of distributions from the year.
 Therefore, for calendar year taxpayer, can’t know this number until December
31.
- Distribute E&P proportionately (ratably) among the distributions made during the
year.
 1.316-2(b), (c).
 How much the specific distribution was in comparison to the total
distributions.
 SO it is not based on ownership, it is based on the proportionate
distribution to all distributions made in the year.
 Formula (USE THIS WHEN CALCULATING)
1. Distribution x (Current E&P/Total distributions)
 Ex. $75 x (82/150) = $41
o § 312(a)(1)—Reduce CEP, but not below -0-.
o § 316(a)(2)
- So figure out the distributions, calculate the dividends and E&P, and then make the
deductions to E&P.
- Nimble dividends concept. Use the CEP before AEP, even if there is a deficit in AEP
- 1.316-1(a) provides additional explanation.
- Why is this the case? It came about as a result of undistributed income tax in 1946. It
allowed the corporations to pay dividends even when it had past years of losses.
 § 301(a) Generally, a distribution of property made by a corporation to a shareholder with respect to
its stock shall be treated in the manner provided in (c).
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


III.
IV.
o § 317(a) defines property: means money, securities, and any other property; except that such
term does not include stock in the corporation making the distribution (or rights to acquire
such stock). Stock is referring to the corporations own stock.
§ 301(c)(1)
o Dividend shall be included in gross income
§ 301(c)(2)
o Amount which is not dividend shall be applied against and reduce the adjusted basis of the
stock.
o Can reduce down to -0-, but not below.
§ 301(c)(3)
o Amount in excess of basis shall be treated as gain from the sale or exchange of property (the
stock is property).
- This is a deemed transaction.
Dividends Received Deduction—§ 243(a)
 100% DRD
o If corp. receives “qualifying dividends” by member of same affiliated group.
o Corp. A from the previous example gets a deduction of the entire dividend received.
 80% DRD
o If corp receives dividend where it owns between 80% and 20% of paying corporation’s
stock. §243(c).
 70% DRD
o If corp receives dividend where it owns less than 20% of paying corp’s stock. §243(a)(1).
 **the 80% and 70% DRD situations alleviate the cascading dividends problem, which is where it
would be nontaxed repeatedly.
 § 312(a)(1)
o …on the distribution of property by a corporation with respect to its stock, the earnings and
profits of the corporation (to the extent thereof) shall be decreased by the sum of—
- the amount of money…
- so distributed.
How to Calculate E&P—§ 312, § 1.312-6(b)
 Start with taxable income
o (Business income + dividends + net capital gain) – (deductible business expenses)
 Add back excluded items that increase corporation’s ability to pay dividends—1.312-6(b)
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V.
VI.
o Ex. tax exempt interest, insurance proceeds.
 Add back deductible items that do not represent decrease in actual wealth
o Ex. DRD
 Subtract non-deductible items that reduce actual economic income
o Ex. municipal bond interest
o Net LTCL
Takeaway:
 Distributions:
o First come from CEP
- We have to wait until the close of the year.
- If distribution > CEP, we have to allocate CEP ratably (proportionately)
- Pay attention to deficit
 Pro rate up to day of distribution
o AEP
- Distribution made earlier is important
 Burn through
- Don’t pay attention to deficit
Rev. Rul. 62-131
 The date of payment, rather than the date of declaration, constitutes the date of distribution of a
dividend.
Problems
1. Clementine Corp, a U.S. corporation on the accrual method of accounting, is owned by two shareholders,
Pennypacker Corp., a U.S. corporation on the accrual method of accounting, and Margaret, an individual on
the cash method of accounting. Both are calendar year taxpayers. Each shareholder owns 100 shares of the
common stock of Clementine Corp. Pennypacker Corp.’s aggregate tax basis in its stock of Clementine
Corp is $200 and Margaret’s aggregate tax basis in her stock of Clementine Corp is $20.
During the course of 2013, Clementine Corp engaged in an exchange of real estate with a third party. In the
exchange, Clementine Corp realized a gain of $75, none of which was recognized by reason of § 1031(a) of
the Code. Under § 1031(d), Clementine Corp’s basis in the property received in the exchange is the same as
that of the property exchanged. In addition, Clementine Corp had receipts and incurred expenses as follows:
RECEIPTS
Gross income from
business operations
Interest earned on
municipal bonds
Long-term capital gains
TOTAL RECEIPTS
$600
$200
$200
$1,000
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EXPENSES
Deductible business
expenses
Interest expense of $120
on a loan incurred to
purchase municipal
bonds (see § 265(a)(2))
Long-term capital losses
TOTAL EXPENSES
NET
$520
$120
$250
$890
$110
Clementine Corp’s marginal and effective federal tax rate is 35% on all income.
a. What are Clementine Corp’s earnings and profits for 2013?
How to Calculate E&P—§ 312, § 1.312-6(b)
 Start with taxable income
o (Business income + dividends + net capital gain) – (deductible business expenses)
 Add back excluded income items that increase corporation’s ability to pay dividends—1.3126(b)
o Ex. tax exempt interest, insurance proceeds.
 Add back deductible items that do not represent decrease in actual wealth
o Ex. DRD
 Subtract non-deductible items that reduce actual economic income
o Ex. municipal bond interest
o Net LTCL
o Federal Tax Paid—[Taxable Income x 35% Corporate Rate]
100 shares each. P has basis of $200. M has basis of $20.
Calculate E&P
Determine taxable income:
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1) 600 [Bus. Income] – 520 [Deductible Bus. Expenses] = $80.
2) 80 Taxable Income and start adding and subtracting for E&P Adjustments
Add: 80+200 [interest received on municipal bonds] = $280
**Don’t add back gains from § 1031 [LTCG]. Regs. 1.312-6, -7
3) Add back deductible items that do not represent decrease in actual wealth—N/A
4) Subtract: (280-120[interest expense]-50[net capital loss] – 28[Federal Tax Paid]) = $82!!!
What about tax? Federal tax is a non-deductible item that must be taken into account. Use the
taxable income ($80)*35% = $28.00 in tax
Also, in regard to the $75 gain on the exchange of real estate, the gain of $75 was not recognized
under § 1031(a). Treas. Reg. § 1.312-7(b)(1) says “the gain or loss so realized increases or
decreases the E&P to, but not beyond, the extent to which such gain or loss was recognized in
computing taxable income under the law applicable to the year in which such sale or disposition
was made.” Therefore, it will not impact the E&P calculation
 Gain or loss must be recognized to impact E&P
2. Same facts as Question 2, except that in addition, on April 2, 2013, Clementine Corp distributed cash in the
amount of $75 to Pennypacker Corp. and $75 to Margaret.
a. What are the federal tax consequences to Pennypacker Corp., Margaret and Clementine Corp. of
Clementine Corp.’s April 2, 2013 distribution?
Effect of Distributions on E&P
2013 E&P = $82
Total Distributions made: $150
Treas. Reg. § 1.316-2(b): current E&P divided up “ratably” based on distributions made during the
year. ALLOCATE RATABLY [Formula = Distribution to S/H * (CEP/Total Distributions for Current
Year)].
Margaret ($20 basis in stock) —Individual Shareholder
Received $75. E&P are $82.
§ 301(c)(1): $75 x ($82/$150)—$41 ratable share of E&P, which will be treated as a dividend.
The $41 will be taxed as qualified dividend (20%) per § 1(h)(11). There would be $8.20 of tax
liability so far.
§ 301(c)(2): M’s $20 in basis is then reduced down to $0. This leaves $14 of the distribution.
§ 301(c)(3): The remaining $14 is treated as a gain and is taxed at long-term capital gains rates
(20%). $2.80 in tax.
Total Tax: $11 [$8.20 + $2.80]
Pennypacker ($200 basis)—Corporate Shareholder
Received $75. E&P are $82.
15
§ 301(c)(1): P’s share is $41. Therefore, per § 301(a) and (c) and § 316 the $41 will be treated as a
dividend.
BUT remember §243(c)—DRD. $41x.2 [1-.8] = $8.20 Dividend. This is taxed at 35% = $2.87 tax.
§ 301(c)(2): The remaining $34 [75-41] will be recovery of basis. This leaves P with a $166 basis.
§ 301(c)(3): N/A
Total Tax = $2.87
Clementine (Corporation making distribution)
The $82 of CEP is gone. § 312(a)(1) decrease earnings and profits to the extent thereof. So you
don’t go below -0-. This leaves 0 CEP. §316(a)(2) explains when the deduction to E&P is made.
Final 2013 E&P: $0
Alteration of Facts: (Illustrates what happens where AEP and CEP)
$82 CEP and $50 AEP
4/2/13 $75 distribution to Pennypacker
5/2/13 $75 distribution to Margaret
Current E&P is ratable, it doesn’t matter when the distribution is made—$41 still represents
E&P.
1.316-2(a) so after ratably distribute CEP, you then dish out AEP on a first come first serve basis.
So the $34 will be entirely dividend because it comes out of the $50 AEP—this because P’s
distribution was made first. Consequently, ALL of the distribution made to P would be
considered dividend. This distribution leaves $16 in AEP.
So for M she gets $41 of the CEP and $16 of AEP. She has $57 of dividends. The remaining $18 is
return of basis.
b. Suppose that the common stock distribution described above was declared on December 1, 2013,
payable on December 31, 2013 to shareholders of record on December 15, 2013. Clementine Corp
mailed checks to Pennypacker Corp. and Margaret on December 31, 2013. The checks were received by
Pennypacker Corp. and Margaret on January 3, 2014 and January 5, 2014. Do these new facts change
your answer to Question 2(a)?
Treas. Reg. § 1.301-1(b): A distribution made by a corporation to its shareholders shall be included in
the gross income of the distributees when the cash or other property is unqualifiedly made subject to
their demands.
Unqualifiedly
 Actual or constructive receipt; Overrides the accrual method, and puts S/H on cash method.
Reg § 1.451-1: Accrual Reg.
The answer does not change because:
Start out by determining when the distribution has to be included in M’s and P’s gross income.
§1.301-1(b) makes everyone cash method for the purpose of distributions. So, P has income when
it receives the check in 2014.
M receives the check in 2014, Clementine sent the check in 2013. Which year controls?
16
The date of payment controls—2013. Rev. Rul. 62-131. An additional authority, Rev. Rul. 65-23,
states that date of mailing is the date of payment.
c. Suppose that Clementine Corp had current earnings & profits of $100 in 2013 and an accumulated
earnings & profits deficit of $100 as of December 31, 2012. Do these new facts change your answer to
Question 2(a)?
AEP Deficit with positive CEP
CEP: $100
AEP: ($100)
Yes, although there is an accumulated deficit, there are current E&P.
Therefore, the money paid to the shareholders—to the extent of current E&P—will be deemed a
dividend. See Reg. § 1.316-2(b)—this is the “nimble dividend” concept.
§ 316(a)(2): states distributions made out of accumulated OR current. The flush language states that
current is to be used first, we don’t pay attention to AEP at this point. Ignore accumulated deficit—
says take out of most recent E&P first, meaning that you can have dividends from CEP where there is
an AEP deficit.
What about AEP Deficit? We don’t do anything with the AEP deficit. We just ignore it. It isn’t
mentioned in the Code or the Regs.
Margaret
$75 x ($100 [E&P]/ $150 [Total distributions]) = $50 share of E&P.
§ 301(c)(1): $50 dividend x 20% = $10 tax
§ 301(c)(2): $20 received will constitute return of investment and decrease basis, leaving $0 basis
in stock
§ 301(c)(3): $5 gain on sale of stock, presumably taxed as long-term capital gain. $5 x 20% = Tax
Total Tax = $11
Pennypacker Corp.
$75 * ($100/$150) = $50
§ 301(c)(1): $50 dividend – ($50*.8  DRD) = $10 * 35% = $3.50 tax
§ 301(c)(2): $25 Return of Capital; Basis is reduced to $175 from $200.
Total Tax = $3.50
REMEMBER: DRD, § 243(c)!!!
Clementine
§ 316(a): Reduce CEP to -0-, before reducing E&P.
Final 2013 E&P: $82-$150 = 0 —Reduce by distribution but not below -0AEP = (100) – not affected by distribution of “nimble dividends”
17
d. Suppose that Clementine Corp had a deficit in current earnings and profits of $100 in 2013 and
accumulated earnings and profits of $100 in its earnings and profits account as of December 31, 2012.
Do these new facts change your answer to Question 2(a)?
Positive AEP and CEP Deficit—CEP deficit MATTERS!!
CEP (100)
AEP 100
Distributions of $75 both occur April 2.
You must be aware of deficit amounts in CEP.
Reg. 1.316-2(b)—gives two options: (1) If you can pinpoint the current loss, then you can assign the
$100 loss to a particular date, then the entire deficit would be reduced from the AEP at that date, but
this is unlikely; (2) pro rate the loss up until the time of the distribution.
Takeaway: Pro-rate the loss to the date of distribution analyzed, and then subtract it from
Accumulated E&P.
Formula: Days accrued/365 days x CEP loss = Deduction to be made to AEP
RR 74-164—“the deficit in earnings and profits of the taxable year will be prorated to the dates of
distribution.”
Pro-rate loss
April 2, 2013 distribution is made
CEP (100) x ((31 days + 28 days +31 days +1 day)/365 days) = 91/365 x 100 = $24.93—this is the
portion of the losses that have occurred up until the time of the distribution.
The $24.93 will reduce the AEP (this is reducing the AEP by the amount of loss that occurred up
until this point.
$ 75.07 left in AEP
This would be split in half, each shareholder would receive dividend treatment / undergo §
361(c)(1)—(3) analysis.
Takeaway: Deficit in CEP is relevant.
Keep in mind that under § 316(a) we cannot drop E&P below 0 only for distributions/ the scope of
this rule is limited to distributions.
e. Same basic facts as described at beginning of Question 2. What if, in addition to the outstanding
common stock, Clementine Corp. has 10 shares of preferred stock outstanding, each of which entitles
the holder to an annual cumulative dividend of $3 per share payable on December 15th each year. Under
Clementine Corp.’s charter, holders of Clementine Corp. common stock are not entitled to receive
dividends unless all preferred cumulative dividends are paid each year. Assume that Margaret owns all
10 shares of Clementine Corp. preferred stock. Describe the federal tax consequences if, in addition to
the April 2, 2013 common stock distributions, on December 15, 2013, Clementine Corp. distributes $30
to Margaret in respect of the Clementine Corp. preferred stock.
18
Preferred Stock (**NOTE: preferred distribution doesn’t enter the CEP formula)
What is preferred stock?
Preferred stock receives dividends before common shareholders are paid. You are guaranteed
that you get your dividends.
Characteristics:
 Guaranteed in payment;
 Limited in growth;
 Limited in terms of participation; and
 Preference on liquidation
Rev. Rul. 69-440. “It is apparent that E&P are used first for the preferred stockholders, and if the
E&P are thereby exhausted, the payments to the common stockholders merely reduce their equity and
constitute in effect a return of capital.”
Preferred Stock Dividends reduce E&P before common stock dividends.
Therefore, the 10 shares of stock will allow Margaret to receive E&P for the $30 in preferred
distribution before any common shares receive E&P.
Current E&P = $82
$75 paid to each M and P
Margaret
Preferred stock reduces E&P first—$82-$30 = $52 E&P remaining
$75 x ($52/$150) = $26 share of E&P for Common Stock. **although, I’m not sure why total
distributions is 150 instead of 180.
§ 301(c)(1): $26 dividend x 20% = $5.20 Tax
§ 301(c)(1): $20 Return of Capital, Basis left at -0§ 301(c)(3): $29 Capital Gain x 20% = $5.80 Tax
Preferred Dividend Rate of $30 x 20% = $6
Total Tax = $17
Pennypacker
$75 x ($52/$150) = $26
§ 301(c)(1): $26 dividend – ($26 x 80%  DRD) = $5.20 x .35 = $1.82 tax
§ 301(c)(2): $49 Return of Capital; Basis is reduced to $151 from $200.
Total Tax = $1.82
Clementine Corp.:
Final 2013 E&P: $52-$150 = 0.
Takeaways:
Distributions:
19


First come from CEP
o We have to wait until the close of the year.
o If distribution > CEP, we have to allocate CEP ratably (proportionately)
o Pay attention to deficit
 Pro rate up to day of distribution
AEP
o Distribution made earlier is important
 Burn through
o Don’t pay attention to deficit
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UNIT II.B—Non-Cash Distributions
I.



II.

III.






Taxability of Corporation on Distribution—§ 311
(a)—General Rule
o Except as provided in subsection (b), no gain or loss shall be recognized to a corporation on the
distribution (not in complete liquidation) with respect to its stock of—
 (1) its stock (or rights to acquire its stock),OR
 (2) property.
(b)—Distributions of Appreciated Property (overturn General Utilities)
o (1)—In General—IF
 (A) a corporation distributes property (other than an obligation of such corporation) to a
shareholder in a distribution to which subpart A applies, and
 (B) the FMV of such property exceeds its adjusted basis (in the hands of the distributing
corporation),
 Then gain shall be recognized to the distributing corporation as if suh property were sold
to the distributee at its FMV
o Plain English: Where the distributed property is appreciated property (built-in gain), then the
corporation will be deemed to sell the property and then distribute the cash proceeds to its
shareholders.
Ex. A corporation distributes appreciate property to its shareholders with AB 50 and FMV 100. What
consequences?
o Deemed Sale by corporation—AR 100 – 50 AB = $50 § 311(b) gain.
o Distribution to shareholder still treated as a distribution under § 301.
o § 301(b)—Distribution considered to be the FMV of the property distributed. FMV as of date of
distribution.
Adjusting E&P as a Result of Liabilities
§ 312(c)
Step-By-Step for determining the “Interim E&P,” which is a term of art—this Seems to become
relevant when distributing property to shareholders, causing Corporation to realize gain and pay
tax on that gain—allows a step-up in E&P
Step 1: If a corporation distributes appreciated property, the distribution itself results in a gain as a
result of the application of Section 311(b).
Step 2: That gain must be recognized for tax purposes during the taxable year—§ 311(b).
Step 3: The CEP is increased by the amount of the gain recognized—§ 312(b)(1).
Step 4: At the same time, since the distribution of appreciated property created a federal tax obligation
as a result of the gain recognition under § 311(b), the earnings & profits must also be reduced during
the taxable year by the amount of tax taxes—Rev. Rul. 63-63 for the proposition that federal taxes
must be deducted from current year e&p.
Step 5: After we have increased earnings and profits by the amount of the Section 311(b) gain per
Section 312(b)(1), we reduce earnings and profits by the amount of federal taxes paid, as I describe
in step 4 above. The resulting amount is “interim e&p.”
Step 6: Finally, after analyzing the dividend treatment for our shareholders, we reduce the interim e&p
account by the fair market value of any property distributed during the taxable year per Section
21
312(b)(2). We do not make this reduction until after analyzing the dividend treatment for the
shareholders. Why? Because Section 316(a)(2) tells us to calculate current earnings and profits for the
year “without diminution by reason of any distributions made during the year”—This is the Final Step
and leaves us with “Final E&P”
Problems
Percy Corp., a U.S. corporation on the accrual method of accounting, is owned equally by two shareholders,
Tyson Co., a U.S. corporation on the accrual method of accounting, and Clarisse, an individual on the cash
method of accounting. Both are calendar year taxpayers. Tyson Co.’s tax basis in its stock of Percy Corp. is
$500 and Clarisse’s tax basis in her stock of Percy Corp. is $220.
On September 3, 2013, Percy Corp. distributed A Bonds of Chiron Corp. with a fair market value of $400 to
Tyson Co. and B bonds of Chiron Corp. with a FMV of $400 to Clarisse. Prior to the distributions, Percy Corp.
held the A Bonds of Chiron Corp. with a basis of $150 and the B Bonds of Chiron Corp. with a basis of $80.
Percy Corp.’s current earnings & profits for 2013 are $300. Percy Corp. has no accumulated earnings & profits.
Tyson and Clarisse are 50% owners of Percy Corp
Tyson has $500 basis
Clarisse has a $200 basis
Percy distributes A bonds FMV 400 to Tyson and B Bonds FMV 400
Percy has basis of 150 in A bonds. B bonds with basis of 80.
CEP: $300
AEP: -0§ 311(a): General Rule – Except as provided in subsection (b), no gain or loss shall be recognized to a
corporation on the distribution (not in complete liquidation) with respect to its stock of – (1) its stock (or
rights to acquire its stock), or (2) property.
§ 311(b): Distribution of Appreciated Property: (1) In General – If- (A) a corporation distributes property
(other than an obligation of such corporation) to a shareholder I a distribution to which subpart A applies,
and (B) the fair market value of such property exceeds its adjusted basis (in the hands of the distributing
corporation), then gain shall be recognized to the distributing corporation as if such property were sold to the
distributee at its fair market value.
Hint: with these problems start with the distributing corporation in order to calculate Interim E&P and the
gain from the appreciated property.
1. Describe the federal income tax consequences of the distribution of the Chiron Corp. bonds to:
Distribution of Built-in Gain Property
22
a. Tyson Co. (Although listed first, START with Percy (Distributing Corp.)
Tyson Co.
Receives a $400 distribution
§ 301(b)(1) says that the amount distributed shall be the amount of money received, plus the fair
market value of the other property received.
Therefore, FMV of the bonds (property) is the value of the distribution to Clarisse.
$400 * (IEP$670/Total Distribution$800) = $335
§ 301(c)(1): $335 dividend –
§ 301(c)(2): $65 Return of Capital; Basis is reduced to $435 from $500.
Total Tax = $23.45
Basis in A Bonds = $400
§ 301(d): Basis: the basis of property received in a distribution to which subsection (a) applies
shall be the fair market value of such property.
So Tyson will have a $400 basis in these bonds.
b. Clarisse
Clarisse
Receives a $400 distribution
§ 301(b)(1) says that the amount distributed shall be the amount of money received, plus the fair
market value of the other property received. Therefore, FMV of the bonds (property) is the value
of the distribution to Clarisse.
$400 * ($670/$800) = $335
§ 301(c)(1): $335 dividend * .20 = $67 tax
§ 301(c)(2): $65 Return of Capital; Basis is reduced to $155 from $220.
Total Tax = $67
Basis in B Bonds = $400;
§ 301(d): Basis: the basis of property received in a distribution to which subsection (a) applies
shall be the fair market value of such property.
At this point you have to go back up and adjust the “Interim E&P” for the distributions made,
which will leave the “Final E&P”
§ 312(b)(2)—we take the interim E&P and reduce the interim E&P of the appreciated
property (BUT we will NOT go below 0—§ 312(a)).
This leaves 0 E&P!!
c. Percy Corp. (START HERE)
23
Percy Corp
A Bonds
FMV
400
AB
150
§ 311(b)
250
B Bonds
400
80
320 = 570 Total § 311(b) gain.
The $570 gain results in a tax of $200 (570 x 35% = $199.50).
§ 312(b): Distributions on Appreciated Property: on the distribution, by a corporation, with respect
to its stock, of any property (other than an obligation of such corporation) the fair market value of
which exceeds the adjusted basis thereof – (1) the earnings and profits of the corporation shall be
increased by the amount of such excess, and (2) subsection (a)(3) shall be applied by substituting
“fair market value” for “adjusted basis”. For purpose of this subsection and subsection (a), the
adjusted basis of any property is its adjusted basis as determined for purposes of computing
earnings and profits.
§ 312(a): On a distribution of property by a corporation with respect to its stock, E&P of the
corporation (to the extent thereof) shall be decreased by the sum of – (1) the amount of money, (2)
the principal amount of the obligations of such corporation . . ., and (3) the adjusted basis of other
property, so distributed.
Here substitute fair market value for adjusted basis when dealing with appreciated property.
Effect on E&P from this gain
§ 312(b)(1)—on the distribution by Percy Corp with respect to its property that is appreciated in
value, increase E&P by the amount of excess (i.e. the gain).
So $300 CEP + $570 Gain = $870.
*This distribution creates E&P (i.e., the distribution of appreciated property will create E&P).
§ 312(b)(1) E&P Adjustments on Appreciated Property
Formula: Starting E&P + § 311(b) Gain – Tax on § 311(b) Gain
300 E&P + $570 Gain - $200 Tax = $670 Interim E&P
This is “Interim E&P” — It is necessary to analyze these situations!!!
**NOW GO BACK UP AND ANALYZE EFFECTS TO SHAREHOLDERS
LAST STEP OF PROBLEM
Then we have to deal with FINAL E&P
§ 312(b)(2)—we take the interim E&P and reduce the interim E&P of the appreciated
property (BUT we will NOT go below 0—§ 312(a)).
This leaves 0 FINAL E&P!!
24
2. How would your answer to (1) above change if Percy Corp.’s tax basis in the Chiron Corp. B Bonds that it
distributed to Clarisse was $450 instead of $80?
Distribution of Properties, Gain and Loss Property
A Bonds: FMV=400 B=150
B Bonds: FMV=400 B=450
T basis = 500; C basis = 220
CEP = 300
Percy HERE I JUST STARTED OUT WITH DISTRIBUTING CO.
-§ 311(b) requires the appreciate and the non-appreciated distributions to be calculated separately. The
loss in the B bonds will not be recognized because of § 311(a).
Calculate Gain and Loss Separately—§ 311(b)
A Bonds: § 311(b) gain of $250 (400AR-150AB)
Tax liability 250 x 35% = $87.50
B Bonds: $50 loss (400AR-450AB) BUT not recognized per § 311(a).
Interim E&P
Gain of 250 is recognized, which creates $87.50 in tax = $162.50.
Interim E&P = $300 + $250 [gain] – $87.50 [Federal Tax] = $462.50
Final E&P = $462.50 – 400 A Bonds (FMV of appreciated property—substitute FMV for AB per §
312(b)(2)) = $ 62.50 per § 312(a)(3) and § 312(b)(2).
= $62.50 - $450 = 0 (this is the limitation—“to the extent thereof”).
Clarisse
She received bonds worth $400 (FMV of property received)—§ 301(b)
§ 301(c)(1): $400 x (462.50 [interim]/800 [total distributions]) = $231.25 = Dividend.
Tax: 231.25 x 20% = $46.25
§ 301(c)(2) $168.75 is return of capital. 220 Basis - $168.75 = $51.25 bases left.
Basis: $400 basis in bonds received—§ 301(d)— FMV of the property received.
Tyson Co. (Don’t forget DRD)
Receives bonds worth $400
§ 301(c)(1): 400 x (462.50/800) – ($231.25 x 80% [DRD]) = $46.25
Tax: 46.25 x 35% = $16.20.
§ 301(c)(2): 168.75 return of capital, leaving $331.25 basis in stock
25
Basis: $400 basis in bonds received—§ 301(d)—FMV of the property received.
BACK UP TO PERCY TO CALCULATE FINAL E&P!!
3. How would your answer to (1) above change if the two holdings of bonds that Percy Corp. distributed to
Tyson Co. and Clarisse were each subject to a $100 non-recourse liability?
Distribution of Property Subject to Liability
A Bonds: FMV=400 B=150 $100 liability
B Bonds: FMV=400 B=80 $100 liability
T basis = 500; C basis = 220
CEP = 300
§ 311(b)(2): Treatment of Liabilities – Rules similar to the rules of section 336(b) shall apply for purposes
of this section.
§ 336(b): Treatment of Liabilities – If any property distributed in the liquidation is subject to a liability or
the shareholder assumes a liability of the liquidating corporation in connection with the distribution, for
purposes of subsection (a) and section 337, the fair market value of such property shall be treated as not
less than the amount of such liability.
§ 312(c): Adjustments for Liabilities – In making the adjustments to the earnings and profits of a
corporation under subsection (a) or (b), proper adjustment shall be made for – (1) the amount of any
liability to which the property distributed is subject, and (2) the amount of any liability of the corporation
assumed by a shareholder in connection with the distribution.
Percy Corporation
A Bonds: § 311(b): A/R $300 + $100 [debt relief is included in the A/R under the Crane] = $400 - $150
AB = $250 gain
Tax liability = $250 x 35% = $87.5
B Bonds: § 311(b): A/R $300 + $100 [debt relief is included in the A/R under the Crane] = $400 - $80
AB = $320 gain
Tax liability = $320 x 35% = $112 tax
**In determining the amount realized you are giving $300 cash + $100 DR (this is a
Interim E&P: 300 [CEP] + (570 (250+320) [Gain] – 200 [Federal Tax Liability]) = $670
Final E&P (usually calculate this at the end of every problem): $670 - $800 (FMV of the Bonds §
312(b)(2)) - $200 (increase E&P by the amount of liability subject to the Bonds 312(c)(1)) = $70 =
Final E&P.
Clarisse
26
Received $400, BUT look to § 301(b)(2)(B). Must reduce the distribution by the amount of liability
the property is subject to. So only $300 of the distribution is a §301 distribution (400 [FMV of
property received] – 100 [liability]).
§ 301(c)(1): 300 x (670 [IEP]/600 [Total Distribution also is reduced by liability—§ 301(b)(1), (2)]) =
$300 dividend
Tax Liability: 300 x 20% = $60
Because the ratio is greater than 1 the entire distribution will be taxed as dividend. So $300 in
dividend.
Taxed at 20%, so tax = $60
Basis in B Bonds: § 301(d) says take the FMV of the property distributed. Therefore, the basis is
$400.
Tyson Corp.
§ 301(c)(1): 300 x (670 [IEP]/600 [Total Distribution also is reduced by liability—§ 301(b)(1), (2)]) =
$300 dividend BUT DRD $300 – ($300 x 80%) = $60
Tax Liability: $60 x 35% = $21 tax
Basis in A Bonds: § 301(d) basis = $400
4. How would your answer to (1) above change if, instead of distributing Chiron Corp. bonds, Percy Corp
distributed to each of Tyson Co. and Clarisse its own negotiable (but not publicly traded) note with a face
amount of $400 and a fair market value of $370?
Distribution of Notes from the Distributing Corporation
§ 311(b) “other than an obligation of such corporation.” So you don’t have to recognize gain where the
corporation distributes obligations that it owes. So § 311(b) gain does not apply where dealing a
corporation distributes its own negotiable note.
A Bond: FMV = $370 Face Value = $400
**Principal and face mean the same thing.
B Bond: FMV = $370 Face Value = $400
T basis = 500; C basis = 220
CEP = 300
Percy
CEP: 300
27
§ 311(b) “other than an obligation of such corporation.” So you don’t have to recognize gain where the
corporation distributes obligations that it owes. So § 311 is inapplicable here.
Interim E&P = $300 No E&P adjustment because there was no § 311(b) gain on the distribution.
Final E&P: $300 § 312(b) does not apply. § 312(a) controls. Must reduce by principal amounts. So
$300 - $800 (face/principal value of bonds) = 0. Cannot reduce below 0.
Clarisse
Amount received $370. § 301(b)—money plus fair market value of other property received. They are
worth $370.
§ 301(c)(1): $300 x ($370/$740) = $150 of dividend
Tax Liability = $150 x 20% = $30
§ 301(c)(2): $220 Return of Capital, leaving -0- basis
Total Tax = $30
Basis in B Bonds of $370—§ 301(d)
Tyson
Amount received $370—§ 301(b)
§ 301(c)(1): $300 x ($370/$740) = $150 – ($150 x 80% [DRD]) = $30 Dividend
Tax Liability = $30 x 35% = $10.50
§ 301(c)(2): $220 Return of Capital, leaving 280 basis in stock.
Total Tax = $10.50
Basis in A Bonds = $370—§ 301(d)
28
Unit II.C—Disguised Dividends
I.



3 Types:
Result in no corporate income
o Problem 2 of IIC
Are deductible to the corp.
o Nicholas Cage and Saturn corp. Saturn corp deducted all of nicholas cage’s expenses under the
corporation. Cage is a 100% owner of shareholder. Almost like a constructive dividend.
 But Nicholas Cage would have 301 distributions of value to him, assuming they are not
business expenses.
o Dad is shareholder in Corp. Corp. pays son $ 1 mil salary. Son would have $1 mil ordinary
income. Corp. would have $1 mil deduction for business expenses/salary. If only 10k, instead
of $ 1 mil, then the son will be taxed a lower tax bracket.
 If the IRS disallows this treatment what happens?
 Treat the 10k to dad as a distribution. In this situation for federal income tax
purposes, the son would not be taxed at all. BUT the corp would be taxed on
income and the dad would be taxed on the dividend.
Result in no shareholder income
o The situation where a shareholder is allowed to rent corporate property at a discounted rate.
What is the result? It will be treated as a § 301(c) distribution to the extent of FMV
 Why is this a benefit, you are receiving a benefit without being taxed.
o Rev. Rul. 58-1
 If a corporation allows a shareholder to rent property it owns for less than FMV, the
excess amount (FMV–Amount Paid) will be treated as a distribution to the shareholder.
o The situation where a shareholder takes a loan from the corporation.
o Weigel Case
 Sets out a list of factors to determine whether money given to a shareholder from a
corporation is a loan or a disguised dividend?
Problems
1. BeastCo, a U.S. corporation, has earnings and profits for its 2013 tax year of $300. BeastCo owns two
parcels of land that are each worth $100 and its tax basis in each parcel is $60. On April 15, 2013, BeastCo
sells one parcel of land to its 50% shareholder Skor Corp., a U.S. corporation, for $75 cash and the other
parcel to its other 50% shareholder, Vipero, an individual, for $75 cash. Describe the federal income tax
consequences of the sales to BeastCo, Skor Corp. and Vipero.
Disguised Dividend—Sale of Property at price below FMV to shareholders
Below-Market Sale: Treas. Reg. § 1.301-1(j): Transfers for less than fair market value – If property is
transferred by a corporation to a shareholder (I omitted “which is not a corporation” because treat
individual and corporate S/Hs the same now) for an amount less than its fair market value in a sale or
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exchange, such shareholder shall be treated as having received a distribution to which section 301 applies.
In such case, the amount of the distribution shall be the difference between the amount paid for the property
and its fair market value. These first two sentences of this Regulation are good law, but the rest of the
Regulation is bad law because this Regulation was not updated yet to agree with § 311(b), and thus
Individual and Corporate Shareholders shall be treated the same under this Regulation by referring to
these first two sentences of the Regulation.
-where property is purchased by a shareholder for less than FMV, the shareholder will be deemed to
receive a distribution equal to the amount FMV exceeds the amount paid
Treas. Reg. § 1.61-6(a): Gains derived from dealings in property: (a) In general - . . . When a part or a
larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among
the several parts, and the gain realized or loss sustained on the part of the entire property sold is the
difference between the selling price and the cost or other basis allocated to such part. The sale of each part
is treated as a separate transaction and gain or loss shall be computed separately on each part. Thus, gain
or loss shall be determined at the time of sale of each part and not deferred until the entire property has
been disposed of.
•Formula for Allocation of Basis: Total Basis * (Total AR / Total value of land and “pretend
property”).
Assumption: Think of the $25 for both Shareholders as pretend property and not cash.
Beast Co. (Distributing Corporation)—Do this first because of § 311(b) gain
**This effectively splits the transaction into a sale and a pretend property distribution.
Sale of Land 1 & 2: § 1001 Realization Events:
Basis Allocation: Formula: Total Basis * (Total AR / Total value of land and “pretend property”)
($60 Basis + $60 Basis) * [($75 cash + $75 cash) / ($150 land + $50 pretend property)] = $90 Basis
allocated to the Total Land (in the sale)
$90 / 2 = $45 Basis Allocated to Land 1 and Land 2
Land 1: § 1001 R/E: A/R $75, A/B $45; RG =$30; tax liability: $30 * .35 = $10.50 tax
Land 2: § 1001 R/E: A/R $75, A/B $45; RG =$30; tax liability: $30 * .35 = $10.50 tax
Pretend Property:
Basis Allocation: $120 (total basis) -$90 (basis allocated to sale) = $30 Basis for pretend property
§ 311(b): A/R $50 (200 FMV of land – 150 cash paid for land: Can break this up into two § 311(b) ‘s if
I wanted to), A/B $30; RG = $20; tax liability = $20 * .35 = $7 tax
CEP = $300;
IEP = $300 + ($20-$7)+($30-$10.50)+($30-$10.50) = $352 = IEP
Final E&P: $352 - $50 (FMV of the pretend land § 312(b)(2)) = $302 = Final E&P.
Skor Corp.:
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FMV of the Property Received/Purchased = $100
-Amount Paid for the Property = $75
§ 301 Distribution = $25
$25 * ($352/$50) = ratio > 1 therefore, full amount will be a dividend.
§ 301(c)(1): $25 dividend – (25*.8) = $5 * .35 = $1.75 tax
Total Tax = $1.75
Basis in the Land § 1012: the basis of the property shall be the cost of such property: $75 + $25 (§ 301
distribution) = $100
Vipero:
FMV of the Property = $100
-Amount Paid for the Property = $75
§ 301 Distribution = $25
$25 * ($352/$50) = ratio > 1 therefore, full amount will be a dividend.
§ 301(c)(1): $25 dividend * .20 = $5 tax
Total Tax = $5
Basis in the Land § 1012: the basis of the property shall be the cost of such property: $75 + $25 (§ 301
distribution) = $100
Additional Thought process from class:
If treated as a normal sale.
There would be a $15 gain recognized on the sale because there is a $60 basis and Beast Co received $75.
The purchasers would receive the basis of $75 per § 1012.
If not, treated as sale and then
Treat individual and corporate shareholder the same way. The code and the reg differ.
BeastCo treated as having made a $25 distribution of property to shareholders.
Each shareholder would receive a $25 § 301(c). Each shareholder would take a § 1012 cost basis of $75 in
the property they receive.
Is there basis in the $25? Yes, per §301(d) says that the shareholder will take a basis in the pretend basis.
BUT the reality of this situation is that it is pretend property that cannot be sold. So § 301(d) and § 1.3011(j) adds the pretend value to the basis in the land, leaving a $100 basis in the land. This fiction allows them
to receive value for the money they pay in tax on $25.
2. Candy Corp, a U.S. corporation, has no current earnings and profits for its 2013 tax year and $10,000 of
accumulated earnings and profits. At the start of 2013, Candy Corp entered into a leasing agreement with
Carlson, an individual, under which Candy Corp would rent its sugar refinery to Carlson for a one-year
period. Under the terms of the lease, Carlson is obligated to make a one-time $6,000 rental payment directly
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to the equal shareholders of Candy Corp, George and Lennie. Describe the federal income tax
consequences of the leasing agreement to Carlson, Candy Corp, George and Lennie.
Whether Corporation Getting 3rd Party to Pay Money Directly to Shareholders is a Dividend
Candy rents the sugar factory to Carlson for 6k, to be paid to G&L. 3k each.
If we respect the transaction
There is no tax to the corporation. The shareholders will then be taxed at 39.6% based on the 3k to
each of them. The total tax would be $2,376.
IRS WILL recharacterize the transaction as a § 301 distribution
Consequences
Carlson (3rd Party Making payment)
No federal income tax consequences other than $6,000 rental expenses—§162
George
§ 301 distribution analysis:
§ 301(c)(1): $3,000 dividend * .20 = $600 tax
Total Tax = $600
Lennie
§ 301 distribution analysis:
§ 301(c)(1): $3,000 dividend * .20 = $600 tax
Total Tax = $600
Candy Corp.
Initial CEP: 0
AEP: $10,000
Recharacterization:
CEP: $6,000 [business income from rent] - $2,100 [Federal Taxes Paid ($6,000 x 35%)] = $3,900
§ 312 adjustments to E&P on distributions—$6,000 distribution will reduce CEP first, then AEP
Final CEP: $3,900 - $ 6,000 = 0
Final AEP: $10,000 - $2,100 = $7,900
Total tax in this situation is $3,300.
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NOTE: **Why say 6k paid to shareholders when tax will be paid on the 6k and they actually will not
have that. Doesn’t matter. They will be deemed to receive whatever they are holding as a result of
the transaction.
3. Same facts as Question 2, except that instead of entering into a leasing agreement with Carlson, on October
15, 2013, Candy Corp distributed a candy-wrapping machine to George in complete satisfaction of a claim
by George against Candy Corp for unpaid salary (George is also employed by Candy Corp as a candy
inspector). Candy Corp held the candy-wrapping machine as a capital asset and with a tax basis of $2,000.
At the time of the distribution the fair market value of the candy-wrapping machine was $10,000. Describe
the federal income tax consequences of the distribution to Candy Corp and George.
Whether Property Distributed to Employee is Salary or Dividend
George:
If no re-characterization:
§ 61: Ordinary Income (Salary) = $10,000
Basis in the Candy Machine = $10,000
Re-characterization:
§ 301 distribution analysis with the distribution amount = $10,000
Candy Corp:
If no re-characterization:
§ 1001 Realization Event: A/R $ 10,000, A/B $2,000; RG = $8,000
§ 162 Salary Deduction of $10,000
Re-characterization:
The IRS may re-characterize it as a § 311(b), distribution of appreciated property, and thus E&P
changes and no salary deduction.
Under §311(b), Candy corp would have taxable gain of $8,000 in the distribution of the candy
machine. This distribution would increase Candy’s E+P by $8,000. Candy is taxed at 35% which
equals $2,800. Candy’s interim E&P is $5,200 and AEP is $10,000. Final E&P would be reduced by
amount of distribution under §312.
Differences: if treated as salary gets deduction. As distribution, there is no deduction.
**From the shareholder’s perspective, both dividends and salary are fully taxable. There is one
important distinction, however. Salary payments are taxable without regard to the corporation’s
E&P account. On the other hand, a constructive dividend is taxable as a dividend under section 301,
only to the extent of the corporation’s E&P. From the corporation’s perspective, the distinction is
even more significant. Salary payments are deductible business expenses whereas dividend
distributions are not deductible.
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4. Milton is the sole shareholder of Paradise Corp, which has been consistently profitable since its
incorporation and has accumulated E&P of $500,000. Paradise Corp has never paid a dividend. Milton is the
president of Paradise Corp and runs its operations, for which Milton receives a fixed salary that generally
comes to about 40% of Paradise Corp’s income each year. Starting in 2007, Paradise Corp made frequent
cash advances to Milton totaling $80,000 in 2007, $90,000 in 2009, and $130,000 in 2010. The advances are
recorded on Paradise Corp's books as "amounts due from Milton on open account" and are shown on
Paradise Corp's financial statements as "loans due from shareholder." Milton has never repaid any of these
advances, nor has Milton paid Paradise Corp any interest. The IRS claims that the advances should be
treated as dividends. Milton says they are loans. Who wins?
Whether Money Transferred to a Shareholder in Closely Held is a Loan of Dividend
Alterman Foods Inc. Case: There needed to be the intent to be treated as a loan and a key factor in this
intent is the “intent that the sums advanced would be repaid.”
Weigel Case: Additionally looking at all the objective factors that the courts have typically weighed in order
to determine whether a shareholder’s receipts from a corporation constitutes dividends rather than loans.
Case law has provided various tests to determine whether money transferred between a shareholder
and a corporation are loans or dividends. Most recently, Weigel v. Commissioner stated that the test is
an all facts and circumstances test and that it should include a review of the following factors:
1. The taxpayer’s degree of control over the corporation
 Milton is the sole shareholder, president, and runs all of its operations. He had
unfettered control in all aspects of Paradise Corp.
2. The existence of restrictions on the amount of disbursements
 Milton is the sole shareholder, president, and runs all of its operations. He had
unfettered control in all aspects of Paradise Corp.
3. The corporate earnings and dividends history
 Generally, a distribution by a corporate to its shareholders, to the extent of earnings
and profits, is a dividend, unless the distribution is within one of the exceptions of the
Code. Paradise Corp. has never declared a dividend.
4. The usage of customary loan documentation, such as promissory notes, security agreements or
mortgages
 Milton did not execute any notes to Paradise reflection his obligation to repay these
amounts. Additionally, Paradise was never provided a security interest against any of
Milton’s property
5. The ability of the shareholder to repay
 We don’t know the personal wealth of Milton. There is nothing in the record to support
Milton’s contention that he had the ability to repay the amounts in question.
6. The treatment of the disbursement on the corporate records and financial statements
 Paradise recorded the disbursements as loans due from shareholder.
7. The creation of legal obligations, such as payment of interest, repayment schedules, and
maturity dates
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 Taking into account the absence of any loan documentation, Milton failed to provide
that any definite maturity date existed for the loans.
8. The corporation’s attempt to enforce repayment AND
 There has been no attempt by Paradise to enforce repayment.
9. The shareholder’s intention or attempt to repay the loan.
 Repayment is strong evidence that a disbursement was intended to be a loan. There has
been no repayment in this case.
It is likely that Milton will lose this argument and that the advances will be treated as dividends.
Note that it is also possible that some of Milton’s salary could be deemed to be dividend, if the court
determined that the salary was excessive.
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Unit II.D—Dividends Received Deduction
I.
II.
III.
Dividends Received Deduction—§ 243(a)
 § 243(a)
o 100% DRD
- If corp receives “qualifying dividends” by member of same “affiliated group.”—§
243(a)(3).
 Affiliated group defined—§ 1504(a)(2)
 Parent must have at least 80% of ownership (value of subsidiary) and
80% of voting power.
 § 1.243-4(c) is the election to be considered an affiliated group.
o 80% DRD
- If corp receives dividend where it owns BEWTWEEN 80% and 20% of paying
corporation’s stock—§ 243(c).
o 70% DRD
- If corp receives dividend where it owns LESS than 20% of paying corp’s stock—§
243(a)(1).
Recharacterization Factors
 Timing
 Plan
 Source of Funds
 Business Purpose
Waterman
 Facts
o Waterman has a 700k basis and the stock is worth about 3.5 million. Sub distributes a 2.8 mil
note to Waterman. Waterman gives stock to Trucking and Waterman transfers the sub stock
to Trucking. Then an hour later T transfers the note to sub.
o The reason for this transaction is to take a 100% DRD from the note. The basis and sales
price were the same and no gain on the sale. Therefore, there was no tax on the sale, if the
transaction is accepted.
 Analysis
o Factors
- Timing:
 Everything occurred in 90 minutes.
 Time basically equals risk.
- Plan
- Source of funds
 Where did the cash come from?
 Another problem is that the money being paid on the note to W is through the
sub but is actually money from Trucking.
- Business Purpose
 Non-tax business purpose present?
o Court in this case says no business purpose, there was a plan, timing didn’t look good.
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o Court says that the transaction will not be excepted. They say that the stock went to
Trucking and paid 3.5 million to Waterman. Said that there should be a 2.8 million gain.
IV.
V.
VI.
Litton
 Facts
o Litton planned to sell stock to the public for cash. Stouffer distributed a note to Lipton
because the bankers told the parties to do it. After 6 month a buyer (Nestle) buys Stouffer.
 Issue:
o Whether Litton gets DRD on note.
 Analysis
o Timing
- 6 months between note and transaction
o Plan
- There was no tax avoidance plan.
o Source of Funds
- Nestle pays the funds, Stouffer actually could have paid the funds in its own right
though.
o Business Purpose
- They were going public/IPO.
 Court recognized the transaction
Rev. Rul. 75-493
 **General idea, you don’t want to buy stock in cash.
 Facts
o Cash goes from sub to parent, then sell sub to buyer.
 Analysis
o Timing
- Happened all together
o Plan
- Yes, but not to reduce tax.
o Source of funds
- Came from sub and it paid it all itself
o Business Purpose
- Yes, get the cash out.
 IRS concludes that the dividend should be respected. Tax the individual on the dividend and then
have a gain/loss from the sale.
Exclusion of Certain Dividends—§ 246(c)
 Create a 91 day window that is centered on the ex-dividend day.
o First figure out ex-dividend date. Then count 45 days back and forward. Creating a 91-day
window.
o Shareholder must hold the days at least 46 days (more than 45 days) during the 91-day
period.
 Congress was trying to avoid dividend stripping here. Its purpose is to put risk into the transaction.
 § 246(c)(3)(A) – the day of acquisition should not be counted in the ownership period.
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VII.
Corporate Shareholder's Basis in Stock Reduced by Nontaxed Portion of Extraordinary Dividends—§
1059
 § 246 is the first line of defense. If it does not apply you go to § 1059.
 Only applies to “extraordinary dividend”
 2 years before dividend announcement date.
o Announcement date is the date the corporation declares the dividend.
 Percentages to constitute extraordinary dividend.
o 5% on preferred
o 10% on common.
 Must hold for MORE than 2 years. So this means 2 years +.
 If extraordinary dividend AND stock held 2 years or less, then must reduce basis by the untaxed
portion.
Problems
1. LabRats Corp has owned 70% of the stock of Chase Co. for several years. LabRats Corp’s shares in Chase
Co. have a basis of $75 and are worth $200. LabRats Corp has located a potential buyer for its Chase Co.
stock, Davenport, Inc., but the two parties have not reached a final agreement. Through negotiations, the
transaction as structured contemplates that, immediately before selling its Chase Co. shares to Davenport,
Inc., LabRats Corp will cause Chase Co. to distribute a dividend to LabRats Corp of Chase Co.’s note in the
face amount, and with a value, of $100 (the minority shareholders of Chase Co. also receive a dividend of
Chase Co. notes). LabRats Corp then will sell its Chase Co. stock to Davenport, Inc. for $100 (the $200
value of Chase Co.'s shares having been reduced correspondingly by the creation of Chase Co.'s $100
liability). Davenport, Inc. will eventually contribute $100 to the capital of Chase Co., which Chase Co. will
use to pay the note it issued to LabRats Corp.
1) Chase Co. distributes a dividend (the note) to LabRats Co. equal to $100.
2) LabRats Corp. sells its stock of Chase Co. to Davenport Inc. for $100.
3) Davenport Inc. will give $100 of capital to Chase Co., and Chase Co. will use this capital to pay the
note.
a. If the IRS respects the form of these transactions, what is the total amount and character of LabRats
Corp’s taxable income as a result of these transactions?
What Tax Liability where 70% owner causes dividend to be paid in the form of a note from company
owned and then sells stock to a 3rd party for an amount that reflects a reduction of that note—If
respected
Dividends Received by Corporations:
§ 243: (a) General Rule – In the case of a corporation, there shall be allowed as a deduction an amount
equal to the following percentages of the amount received as dividends from a domestic corporation
which is subject to taxation under this chapter: (1) 70 percent, in the case of dividends other than
dividends described in paragraph (2) or (3); 100 percent, in the case of dividends received by small
38
business investment company operating under the Small Business Investment Act of 1958; and (3) 100
percent, in the case of qualifying dividends.
§ 243(a)(3) sends the reader to § 243(b) in order to determine what is a “qualifying dividend.” (Look at
code for this definition).  § 243(b) needs to have an “affiliated group” and this section sends the
reader to § 1504(a)(2) for the definition of an “affiliated group.”
o § 1504(a)(2): 80-percent voting and value test. – The ownership of sotck of any corporation
meets the requirements of this paragraph if it – A) possesses at least 80 percent of the total
voting power of the stock of such corporation, AND (B) has a value equal to at least 80 percent
of the total value of the stock of such corporation.
 Thus, there needs to be a parent corporation with the ownership threshold above of a
subsidiary in order for that parent-subsidiary relationship to qualify as an “affiliated
group.”
 Important: Need to make an election to be an “affiliated group,” it is not automatic.
 Treas. Reg. § 1.243-4(c): Guidelines and requirements to make the election
§ 243(c): Retention of 80-Percent Dividends Received Deduction for Dividends from 20-Percent Owned
Corporations – (1) In General – In the case of any dividend received from a 20-percent owned
corporation – (A) subsection (a)(1) of this section, and (B) subsections (a)(3) and (b)(2) of section 244,
shall be applied by substitution “80 percent” for “70 percent.” (2) 20-Percent Owned Corporation –
For purposes of this section the term “20-percent owned corporation” means any corporation if 20
percent or more of the stock of such corporation (by vote and value) is owned by the taxpayer. For
purposes of the preceding sentence, stock described in section 1504(a)(4) shall not be taken into
account.
Summary in Plain Language for DRD:
 0-19% vote and value  70 percent DRD
 20 – 79% vote and value  80 percent DRD
 80-100% vote and value  100 percent DRD
If the transaction is Respected
LabRats Corp. receives a § 301 distribution of $100. Under § 243(c), LabRat Corp. receives a
dividend received deduction (“DRD”) of 80% because it owns 20% of the stock of Chase Co.
LabRat Corp: § 301 distribution
$100 dividend – ($100*.8) = $20 * .35 = $7 tax
LabRat Corp.: Sale of Chase Co. stock to Davenport Inc.
§ 1001: R/E: A/R $100, A/B $75; RG = $25; tax liability = $25 capital gains * .35 = $8.75 tax
TOTAL TAX = $15.75
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Davenport has paid a total of $200 in this form ($100 capital and $100 purchase of stock).
b. In light of the cases you read for this class, how might the IRS argue that these transactions should be
recharacterized?
What Tax Liability where 70% owner causes dividend to be paid in the form of a note from company
owned and then sells stock to a 3rd party for an amount that reflects a reduction of that note—If
respected
Waterman Steamship Corp. Case:
All happened within approximately 2 hours.
(1) Waterman Steamship claims a 100% DRD on the note so zero tax liability.
(2) Sale of Stock, which the A/R is equal to the A/B so zero tax liability here also.
The Court re-characterizes this transaction looking at certain factors:
o Timing (90 minutes)
 Timing = Risk, and with only 90 minutes, there was very little risk
o Plan
 Tax Avoidance
o Source of the Funds
 To pay off note & to buy stock
 All of the funds in this case were coming from the Buyer
o Business Purpose Doctrine
 Need a non-tax business purpose
Court did not respect the transaction and re-characterized as only a sale of P-A stock for $3.5M,
resulting in a $2.8M gain, which will be taxed.
The IRS would argue it’s a lot like Waterman. There appears to be a plan. The source of the funds is
the buyer. There doesn’t appear to be a business purpose either. Therefore, likely would treat it all
as a purchase price. Really would just want to analyze this under the cases.
LabRat Corp.:
§ 1001: R/E: A/R $200, A/B $75; RG = $125; tax liability = $125 capital gains * .35 = $43.75 tax
TOTAL TAX = $43.75
2. On January 1, 2013, LabRats Corp purchases approximately 1% of the outstanding stock of Chase Co. for
$10,000. At the time, LabRats Corp had $1000 of capital gain from an unrelated transaction. On February 1,
2013, Chase Co. declares and pays a dividend, of which LabRats Corp’s share is $1000. LabRats Corp sells
its Chase Co. stock in the open market for $9000 on February 10, 2013.
a. Assume that neither §246(c) nor §1059 is in the Code. What advantage do these transactions offer to
LabRats Corp?
40
Corporation Buys Stock that Pays Dividend 1 month later, then Corp. Sells stock for a Loss
Labrats would have a $1,000 dividend but it will be a 70% DRD—§ 243 (owns less than 20% of the
voting and value of Chase Co.). Therefore, $300 dividends being taxed at 35%. $105 in tax from step
1.
The sale between LR and the Market. At the time of sale, there would be a $1,000 capital loss from
the sale ($10,000 basis - $9,000 sale). The $1,000 capital gain that is sitting around will be reduced by
the loss on the sale, offsetting the gain completely.
Paid tax of $305 but had not capital gain and avoided $350 of tax. So this is a net of $245 saved/made
on the transaction.
TOTAL TAX = $105 tax & No capital gain tax creates a $350 tax savings (1,000 CG * .35 = 350).
b. Do either §§246(c) or 1059 change that advantage, and if so, how?
Does § 246(c) or § 1059 apply to the above transaction?
§ 246(c) creates a Holding Period Requirement in order to be eligible for the Dividend Received Deduction.
In general – No deduction should be allowed under section 243, 244, or 245, in respect of any dividend on
any share of stock – (A) which is held by the taxpayer for 45 days or less during the 91-day period
beginning on the date which is 45 days before the date on which such share becomes ex-dividend with
respect to such dividend, or (B) to the extent that the taxpayer is under an obligation (whether pursuant to a
short sale or otherwise) to make related payments with respect to positions in substantially similar or
related property . . .
Ex-Dividend Date
|
45 days
|
45 days
|
|
91 days
|
Ex-Dividend Date: stock traded on the right without a dividend: Basically the day after the dividend is
declared.
Shareholder has to hold the stock for > 45 days in this 91-day window above.
§ 246(c)(3): Determination of Holding Periods – For purposes of this subsection, in determining the period
for which the taxpayer has held any share of stock – (A) the day of disposition, but not the day of
acquisition, shall be taken into account, and (B) paragraph (3) of section 1223 shall not apply.
§ 246(c) applies. It imposes a holding period requirement. Because the stock was purchased on
January 1 and sold on February 10. The stock was not held for 46 days. The ex-dividend date was
February 2nd—as long as it was owned February 1st you got the money.
12/19/12--------2/2/13----------3/19/13 This is the window. They only held the stock for 40 days (30
days in January (excluding the day of acquisition per § 246(c)(3)(A)) + 10 days of ownership in
February). So § 246(c) applies to prevent DRD treatment.
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TOTAL TAX = $350, no DRD
So per § 246, LR will have a 1k dividend, resulting in $350 tax. The sale will still be at a 1k loss. And
the loss will offset the capital gain. BUT this serves to neutralize the gain the stockholder would
otherwise realize on the transaction. The same rate applies to the dividend and the loss ($350 each).
§ 1059 apply?
If § 246(c) applies, then § 1059 WILL NOT APPLY!!
c. How would your answer to (b) change if the only change to the facts was that LabRats Corp sells its
Chase Co. stock on March 1st instead of February 10th?
What happens where the above transaction occurs and it is outside the scope of § 246(c), but § 1059
applies.
§ 246(c) no longer applies—If the sale occurs on March 1, 2013, Chase has held the stock for 59 days
(30J + 28F + 1M) so § 246(c) does not prevent the use of DRD.
BUT per § 1059 must go further.
§ 1059: Does it apply?
§ 1059—2 PART TEST: (If both met reduce basis by untaxed gain)
(1) Is it an extraordinary dividend? Yes—Extraordinary dividend (defined in § 1059(c)) is any
dividend that equals at least 10% of the taxpayer’s basis. In this case 10% of basis so equals the
statutory 10% and makes it an extraordinary dividend. Note: If preferred stock 5% is threshold.
Dividend = $1,000
10% of Adjusted Basis = .10 * $10,000 = $1,000
$1,000=$1,000, thus § 1059 applies.
(2) 2 year or less holding period: Yes
Dividend Announcement Date: 2/1/2013
2 years prior to 2/1/2013 = 2/1/11; therefore would have had to purchase the stock on 1/31/11 to have
greater than a 2 year holding period.
1kdiv/10k basis = 10%. The 2year+ period is not satisfied. Would have had to purchase the stock by
January 30, 2011.
§ 1059 applies because (1) and (2) are satisfied.
Therefore, § 1059(a)(1) and (2) say that you must reduce the basis by the amount of untaxed dividend.
$1,000 dividend – $700 DRD = $300 taxable portion, and $700 is nontaxed portion.
$10,000 basis - $700 nontaxed portion (§ 1059(a)(1): reduce basis by nontaxed portion) = $9,300 basis
Sale of Stock: § 1001: R/E: A/R $9,000, A/B $9.300; RL=$300 (this saves taxpayer $105 in tax from
this Capital Loss).
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1,000 Capital Gain from Unrelated Transaction - $300 Capital Loss from this transaction = $700
capital gain * .35 = $245 tax
TOTAL TAX = $245, but saved $105 in taxes from the capital loss.
This results in a neutral effect.—This statement seems strange, neutral as a result of the sale, but if §
1059 did not apply, then TP would get both the DRD and a capital loss to offset the $1,000 of capital
gain. So it appears it is only neutral as to the transaction.
d. How would your answer to (b) change if the only change to the facts was that the amount of the
dividend paid by Chase Co. was $800 instead of $1000?
Illustrates 10% threshold not applicable to § 246(c), only § 1059
First, § 246(c). Using February 10, 2013. Same issue as before and the DRD is not allowed. $240
taxed at dividend
What if March 1, 2013. Then can receive DRD deduction because the 45 day requirement is allowed.
BUT § 1059 at issue? $800 dividend in this case is less than the 10% requirement (800/10000 = 8%).
e. How would your answer to (b) change if the only change to the facts was that instead of purchasing
1% of Chase Co. for $10,000, LabRats Corp. purchased 50% of Chase Co. for $10,000?
This would change the DRD rate to 80% because ownership is between 20%-79%. The % ownership
does not matter for purposes of determining whether § 246(c) applies!!
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Unit III.A—Redemptions “Not Essentially Equivalent to a Dividend” and “Substantially
Disproportionate Redemptions”
I.
II.
III.
IV.
V.
Redemption defined—§ 317(b)
 For purposes of this part, stock shall be treated as redeemed by a corporation if the corporation
acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired
is cancelled, retired, or held as treasury stock.
Property defined—§ 317(a)
 For purposes of this part, the term “property” means money, securities, and any other property;
except that such term does not include stock in the corporation making the distribution (or rights to
acquire such stock.
o Excludes stock in the acquiring corporation
Redemptions—§ 302
 (a)—General Rule
o If a corporation redeems its stock (as defined in § 317(b)) and satisfies one of the § 312(b)
requirements, then such redemption shall be treated as a distribution in part or full payment
in exchange for the stock.
Not Essentially Equivalent to a Dividend—§ 302(b)(1): subjective test
 See Case Law that follows
 Factors in Determining whether “Meaningful Reduction” of s/hs “proportionate interest” occurs
o Right to Vote
o Right to participate in E&P
o Right to share in net assets on liquidation
- Rev. Rul. 85-106
Substantially Disproportionate Redemption of Stock—§ 302(b)(2): objective test
 3 requirements: Immediately after Redemption
o SH owns less than 50% of total vote
o SH ownership of voting stock less than 80% of ownership of voting stock before redemption
o SH ownership of common stock, by value, less than 80% of ownership of common stock, by
value, before redemption.
- Where 1 share = 1 vote, the answer in the second and third part will be the same.
 Two ways to calculate:
44
VI.
VII.
VIII.
IX.
X.
o 80% x ownership before. If the amount of ownership after is less than that number it is
satisfied
o Ownership % after/ ownership % before = X. If X <80%, then it is satisfied.
- Blank prefers this method.
Redemptions Treated as Distributions of Property—§ 302(d)
 If § 302(b) is not satisfied you will treat the transaction as a deemed distribution of property (defined
in § 317(a)), which will be taxed pursuant to § 301 distribution rules.
§ 312(n)(7)
 The part that is chargeable to E&P shall not be an amount in excess of the proportion
o How much of the redemption amount equal to
o It is the redemption % of E&P.
 You have to compare the % v. the actual amount distributed (or received?) by the company,
whichever is less will be subtracted.
 If you have CEP and AEP you would just add them together in making this determination. You
would reduce it by lesser of the two numbers above. Don’t focus on this (i.e. it won’t be tested).
 This section does not apply unless § 302(a) or § 303 apply.
o Thus it does not apply to § 301.
Corporate shareholder's basis in stock reduced by nontaxed portion of extraordinary dividends—§
1059(e)(1)(A)(ii)
 Causes § 1059(a) to apply where distribution is to corporation and not pro rata to other shareholders.
 Any amount treated as a dividend in regard to the distribution shall be treated as an extraordinary
dividend
o The threshold and duration of holding otherwise required under § 1059(a) do not apply.
o Also ignore the definition of an extraordinary dividend under §1059(c).
 This is to prevent a company from distributing E&P to corporations without being subject to capital
gains tax.
 This is an extra step. You still have to go through the § 301(c)(2) portion!!!
o MUST DO IT LAST, after all of the other adjustments.
Series of Redemptions—§ 302(b)(2)(D)
 Says the paragraph shall not apply with regards to a plan, the purpose of which is a series of
redemptions.
 This is Congress’s way of kicking the issue to the courts.
 The effect of this is to take § 302(b)(2) off of the table. However, § 302(b)(1) still is available.
 § 1.302-3(a)
o Whether you have a plan is a facts and circumstances test.
Step Transaction Doctrine
 This is judge made law and means that a judge may decide that it needs to take steps of a transaction
and combine them together to analyze the transaction in the aggregate.
 Ways to apply
o Binding Commitment Test
- We have two transactions and at the time of the first transaction there was a binding
commitment to enter into the second transaction.
- Look to facts or written contracts
45
XI.
- “prewired”
o Mutual Interdependence Test
- Two transactions and they will be stepped together as one if the first transaction
would be meaningless without the occurrence of the first one.
- Will have to look to other facts to make this determination.
o End Result Test
- There will be a series of transactions and the judge will look to other facts and if it
looks like the whole point of all of the transactions was to get to the end result, then
the court will integrate all of the transactions into one.
Cases and Rev. Rulings
 Substantially disproportionate redemption—§ 1.302-3
o Allows preferred stock to be treated as an exchange if it simultaneous with a substantially
disproportionate distribution.
o Also provides that § 302(b)(2) cannot be used where the redemption is only of nonvoting
preferred stock.
 United States v. Davis
o Davis owns stock in a corporation, 100% for tax purposes due to s 318 attribution rules. He
then loaned some money to the corporation in exchange for 1000 shares of preferred stock.
The stock is then redeemed.
o Court held it should be treated as a dividend. No meaningful deduction of shareholder’s
proportionate interest in the corporation. He owned 100% before and after the transaction.
 Rev. Rul. 85-106 (not assigned)
o Consider whether redemption reduces “meaningful reduction”:
- Right to vote
 This is the MOST important
- Right to participate in E&P
- Right to share in net assets on liquidation
 Rev. Rul. 76-364
o 4 shareholders. A starts out owning 27% and is reduced to 22%. The other shareholders go
from 24% to 25.9%.
o Reasoning:
- Before the transaction, A only needed one other shareholder to join up with him to
have 50%. Afterwards, he would have to have 3 people to have the majority of the
votes.
o Held:
- Meaningful reduction and therefore treated as a sale or exchange.
 Rev. Rul. 75-502
o Facts
- A had 57% before and 50% after. B went from 43% to 50%.
o Held:
- Meaningful reduction and therefore exchange treatment.
o Change of facts:
46


- What if there had been an additional party, C. This would be different because A still
has majority. Could still argue, but it would be more difficult because it would take 2
parties to equal the other 50%.
Rev. Rul. 78-401
o 90% to 60%
o No meaningful reduction because he still had day to day control of the corporation.
Therefore, treated as dividend.
Rev. Rul. 76-385
o Facts: dealing with publicly traded corporation. Reduction from .0001118% to .0001081%.
o Held: meaningful reduction. Dealing with minority shareholder. Any reduction in stock will
result in a reduction of voting, right to dividends, and right to share in net assets on
liquidation.
Problems
BusyCo is owned entirely by two individuals, Huckle and Billy (who are unrelated unless otherwise stated).
Huckle owns 1200 shares of BusyCo common stock (with a basis of $10 per share) and Billy owns 800 shares
of BusyCo common stock (with a basis of $40 per share). The current market value of BusyCo’s common stock
in the transactions below is $20 per share. BusyCo’s current earnings and profits for 2014, not including the
effects of any of the transactions described below, are $2,000.
What is the amount and character of gain or loss recognized by Huckle in the following alternative
transactions? For these we are assuming 1 vote per 1 share.
§ 302:
§ 302(a) – If a corporation redeems its stock and (1), (2), (3), (4), or (5) of § 302(b) applies, such
redemption shall be treated as a distribution in part of full payment in exchange for the stock. Sale or
exchange treatment.
If section 302(b) does not apply, then under § 302(d) the redemption is treated as a § 301 distribution.
47
***Key is all in § 302(b).***
§ 302(b):
§ 302(b)(1): subjective test: “not essentially equivalent to a dividend”
§ 302(b)(2): objective test: “substantially disproportionate redemption”
§ 302(b)(3): objective test: termination of shareholder’s interest
§302(b)(4): objective test: redemption from noncorporate S/H in partial liquidation.
***Only need one of these tests to pass to get to § 302(a)***
§ 302(b)(2) 3 part test:
1.) Immediately after the redemption the Shareholder owns less than 50% of the vote.
2.) The ratio of voting stock of the corporation owned by the shareholder immediately after the
redemption bears to all of the voting stock of the corporation at such time, is less than 80% of the
ratio which the voting stock of the corporation owned by the shareholder immediately before the
redemption bears to all of the voting stock of the corporation at such time (§ 302(b)(2)(C)(i)&(ii)).
3.) The same less than 80 percent requirement also applies to the value of the stock as well as the
voting stock.
1. Huckle sells 200 of his BusyCo shares to Billy for $4,000.
Simple Sale of Stock Between Shareholders
§ 317(b): Redemption of Stock – For purposes of this part, stock shall be treated as redeemed by a
corporation if the corporation acquires its stock from a shareholder in exchange for property, whether
or not the stock so acquired is cancelled, retired, or held as treasury.
This is not a redemption under § 317(b), therefore just a Realization Event under § 1001.
Huckle:
§ 1001: R/E: A/R $4,000, A/B $2,000; RG = $2,000; tax liability = $ capital gains * .20 = $400 tax
Total Tax = $400
BusyCo:
Gets a cost basis of $4,000 in the acquired stock (§ 1012(a)).
2. Huckle instead sells 600 shares back to BusyCo for $12,000.
Ownership requirements under § 302(b)(2)
§ 317(a) and (b) definitions for property and redemption satisfied.
Methodology for § 302(b)(2) (less than 50% and 80% Test (20% reduction))
 1.) Ownership:
o Before: (1200/2000) = 60%
o After: (600/1400) = 42.8%
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


2.) Less than 50% Vote  Yes, owns less than 50% of vote after redemption.
3.) Less than 80 percent test for vote and value  Yes, Before: 60%; After: 42.8; 42.8
[ownership after / 60 [ownership before]= 71.3%, which is less than 80% so Passed this test.
For the value, each common stock is entitled to 1 vote then the determination of the value test
will be the same result. If more vote to certain common stock, then need to calculate the less
than 80 percent test for the value.
4.) § 302(b) applies, therefore go to § 302(a), where there is sale or exchange treatment.
Huckle:
R/E: § 1001: AR: $12,000, AB: $6,000, RG: $6,000 capital gain @ 20% = $1,200 tax
TOTAL TAX = $1,200
Basis in remaining stock is still $10 per share [6000 basis / 600 remaining shares]
BusyCo:
Usually under § 312(a)(1): the CEP will be reduced by the distribution of money, however §312(a)(1)
does not apply to redemptions, and changes to CEP for redemptions is under § 312(n)(7):
Redemptions – If a corporation distributes amounts in a redemption to which section 302(a) or 303
applies, the part of such distribution which is properly chargeable to earnings and profits shall be an
amount which is not in excess of the ratable share of the earnings and profits of such corporation
accumulated after February 28, 1913, attributable to the stock so redeemed.
So for Redemptions § 312(n)(7) requires: Adjustments to E&P are made by reducing E&P by
the lesser of (1) ratable E&P [Redeemed/Total] for % OR (2) the actual distribution amount.
The stock redeemed was 600 shares out of 2000 shares. 600 / 2000 = 30%. Therefore, BusyCo’s
CEP = $2,000, and 30% * 2,000 = 600 E&P. CEP $2,000 – 600 = 1,400 = Final E&P
Final E&P = $1,400
3. Huckle instead sells 400 shares back to BusyCo for $8,000.
Redemption that Fails § 302(b)(2)  Use § 302(b)(1) “meaningful reductions”
For § 302(b)(1), it is a subjective test so need to look to Case law and Rev. Rul. to decided and support
the outcome.
 Davis Case: Davis owns 100% before and after and no “meaningful reduction” in control of
the corporation, therefore it is a dividend, and not a redemption.
o Main factor is the right to vote.
 Rev. Rul. 76-364: There are four shareholders, and A has 27% of the vote before the
redemption, and all the other shareholders owned 24%. After the redemption A owned 22%
of the shares, and the rest of the shareholders owned 25.9% each. This is a “meaningful
reduction” because A only need to team up with 1 shareholder to have a majority vote before
redemption, but afterwards A needs to team up with 2 shareholders to have majority vote.
49




Rev. Rul. 75-502: Before, A owned 57% of the Corp. and B owned 43% of the Corp. After, A
owned 50% and B owned 50%. This is a “meaningful reduction” because A no longer has
control of the Corp., and is now in equal control with B.
o Three Factors: provided 3 factors to consider: (1) shareholder’s right to vote and
exercise control; (2) shareholder’s right to participate in current earnings and
accumulated surplus; and (3) shareholder’s right to share in net assets in liquidation.
Rev. Rul. 78-401: A owned 90% before, and then owned 60% after. There were only two
shareholders. This is not a “meaningful reduction” because A still has control.
Rev. Rul. 76-385: Corporation is a public corporation. Shareholder A owns .00011188% of
the stock of this public Corp. before, and after A owns .0001081%. The IRS said this is a
“meaningful reduction” because A was a minority shareholder to begin with, and the IRS
said giving up a little bit works here. The main reason for this decision was that the Corp.
was a public corporation.
Rev. Rul. 77-426: IRS says taxpayer only owns non-voting preferred stock then when it is
redeemed it is treated as a “meaningful reduction” so qualifies under § 302(b)(1) and get
sale treatment under § 302(a).
START with the objective test under § 302(b)(2):
 1.) Ownership:
o Before: 1200/2000 = 60%
o After: 800/1600 = 50%
 2.) 50% Vote: NO  After redemption own 50% and not less than 50%.
 Therefore, fails § 302(b)(2)
SECOND, see if qualify under § 302(b)(1) “Not Essentially Equivalent to a Dividend”
Looking to Rev. Rul. 75-502, shareholder went from majority control to sharing control 50:50,
which is a “meaningful reduction.” Thus § 302(b)(1) is satisfied, and apply sale or exchange
treatment under § 302(a).
Huckle:
R/E § 1001: AR: $8,000, AB: $4,000; RG: $4,000 capital gain @ 20% = $800 tax
TOTAL TAX = $800
BusyCo:
§ 312(n)(7): 400 shares were redeemed: 400/2000 = 20%; CEP = $2,000 * .20 = $400; Final E&P =
$2,000 - $400 = $1,600
FINAL E&P = $1,600
Additional Fact Assumption (AEP and CEP):
AEP = $3,000 & CEP = $2,000
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Therefore reduce E&P by the lesser of the cash distributed or the ratable share. The ratable
share = 20% * $5,000 = $1,000. The cash distributed was $8,000 so reduce E&P by the ratable
share. $5,000-$1,000 = $4,000.
4. Huckle instead sells 200 shares back to BusyCo for $4,000.
Redemption that Fails § 302(b)(1),(2)  § 302(d) sends to § 301 AND Requires Tacking Basis
Treas. Reg. § 1.302-2(c): Basis Adjustment: In any case in which an amount received in redemption of a
stock is treated as a distribution of a dividend, proper adjustments of the basis in the remaining stock
will be made with respect to the stock redeemed. There are examples in this Reg., which illustrate it, but
I will illustrate it in the problem below.
START with the objective test under § 302(b)(2):
 1.) Ownership:
o Before: 1200/2000 = 60%
o After: 1000/1800 = 55%
 2.) Vote: NO  After redemption own 55%, which is not less than 50%.
SECOND, see if qualify under § 302(b)(1) “Not Essentially Equivalent to a Dividend”
Looking to Rev. Rul. 78-401, shareholder still held control of the corporation before and after the
redemption, which is not a “meaningful reduction.” Thus § 302(b)(1) is not satisfied and § 302(a)
does not apply. Therefore, treat the redemption as a § 301 deemed distribution under § 302(d).
§ 301 Distribution Analysis:
$4,000 Distribution; CEP = $2,000; Huckle’s original basis = $12,000
§ 301(c)(1): $2,000 Dividend @ 20% = $400 tax
§ 301(c)(2): $2,000 remaining distribution would constitute return of capital to the extent of basis.
BUT—An extra step to the analysis here, because have to solve the disappearing basis problem—
the disappearing basis problem is caused because shares are actually redeemed, but § 302(d)
requires treatment of the redemption under § 301. Therefore, to the extent that you have shares
deemed to be treated as § 301, that basis will be allocated to the remaining shares. Treas. Reg. §
1.302-2(c), ex. 1: 1,000 shares (not redeemed) * $10 per share = $10,000; 200 shares (redeemed
shares) * $10 per share = $2,000; Total Basis = $12,000 (this is the same basis as before), this is
called tacking the basis because you do not want his basis in the redeemed shares to disappear.
Return of Capital under § 301(c)(2) = $2,000; Remaining Basis: $12,000 total basis - $2,000 RofC =
$10,000.
TOTAL TAX = $400
Remaining Basis in the Stock = $10,000
Therefore, § 302(d) sends us § 301 and treats it as a deemed distribution. The distribution would be
determined under § 301(c). Because only $2,000 CEP exists, $2k would be a dividend per § 301(c)(1) = 4k
x (2k/4k) = 2k. This would result in $400 in tax at the 20% qualified dividend rate per § 316 and §
51
1(h)(11). The remaining $2,000 would constitute a reduction in basis per § 302(c)(2) and result in no
taxable income. The basis in the remaining shares would be increased the 2k per 1.302-2(c). 1000 shares
at $10 per share = $10,000 + $2,000 = $12,000. Then reduce by the deemed distribution of $2,000.
Leaving a $10,000 basis in the remaining shares.
a. What is the effect of the transaction on BusyCo’s earnings and profits?
This is the standard reduction of E&P from a distribution under § 312(a)(1), where the
distribution of property (cash) by a corporation with respect to its stock, the E&P of the
corporation shall be decreased by the sum of (1) the amount of money, . . .
CEP = $2,000 - $4,000 amount of money = $0
TOTAL E&P = $0
b. What if Huckle were a corporation rather than an individual?
Corporation receiving § 302(d)  § 301 deemed distribution, DRD Automatic—§ 1059, BUT Have to
REDUCE Basis By Untaxed Portion (DRD) per § 1059(e)(1)(A)(ii)
§ 1059(e): Special Rules for Certain Distributions: (1)(A) Redemptions: In the case of any redemption
of stock – flush language: any amount treated as a dividend with respect to such redemption shall be
treated as an extraordinary dividend to which paragraphs (1) and (2) of § 1059(a) apply without regard
to the period the taxpayer held such stock.
Plain Language: eliminates the holding period and threshold requirement, therefore the dividend is
automatically an extraordinary dividend. This is the new definition of an extraordinary dividend
compared to § 1059(c) so ignore § 1059(c) for redemptions. THIS IS THE LAST STEP AND IS NOT
INCLUDED IN THE RETURN OF CAPITAL DETERMINATION.
§ 301 distribution analysis:
(c)(1): Dividend: $2,000 – ($2,000 * .80 = $1,600: § 243) = $400 @ 35% = $140 tax.
(c)(2): $10,000 retained basis, $2,000 redeemed shares basis [1.302-2(c)]: Total basis = $12,000,
RofC = $2,000, Remaining Basis = $10,000 ($12,000 -$2,000)
BUT Additional Step: for the Remaining Basis under § 1059(a), pursuant to § 1059(e)(1)(A)(ii):
$1,600 non-taxed portion of the dividend, therefore $10,000 remaining basis - $1,600 non-taxed
portion = $8,400
TOTAL TAX = $140
Remaining Basis in the Stock = $8,400
5. Suppose that shortly after the transaction in Problem 2 above, Billy also sold 200 shares back to BusyCo
for $4,000?
Two Redemptions in equal Amounts, One Shortly After the Other—Step Transaction
52
If NOT STEPPED TOGETHER:
$1,400 total voting stock after Problem 2.
Start with the objective test under § 302(b)(2):
 1.) Ownership:
o Before: 800/1400 = 57%
o After: 600/1200 = 50%
 2.) Vote: NO  After redemption own 50%, which is not less than 50%.
Now, see if qualify under § 302(b)(1) “Not Essentially Equivalent to a Dividend”
Looking to Rev. Rul. 75-502, shareholder went from majority control to sharing control 50:50,
which is a “meaningful reduction.” Thus § 302(b)(1) is satisfied, and apply sale or exchange
treatment under § 302(a).
§ 1001: AR: $4,000, AB: $8,000 ($200 shares * $40 per share), RL: ($4,000)
Additionally, be aware that § 302(b)(2)(D) applies to a Series of Redemptions: Need to check the
consequences to Huckle from Problem 2.
§ 302(b)(2)(D): Series of Redemptions: This paragraph shall not apply to any redemption made
pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution
which (in the aggregate) is not substantially disproportionate with respect to the shareholder.
 “Pursuant to a plan”: Judges decide what to do under facts & circumstances: STEP
TRANSACTION DOCTRINE: is not the IRC, but judges apply this doctrine into case law.
 1.) Binding Commitment Test: If time H sold stock to BusyCo, and a commitment
also that B would also sell to BusyCo a few days later  then these steps are
stepped together. Look for a written agreement.
 2.) Mutual Interdependence Test: stepped together as one if the 1st transaction
would be meaningless without the 2nd transaction.
 3.) End Result Test: Series of transactions if it looks like the whole point was to
get to an end result than everything will be integrated together  Timing is key
here.
 Treas. Reg. § 1.302-3(a): Section 302(b)(2) provides for the treatment of amount
received in redemption of stock as an amount received in an exchange for such stock if –
(1) Immediately after the redemption the shareholder owns less than 50 percent of the
total combined voting power of all class of stock as provided in section 302(b)(2)(B), (2)
The redemption is a substantially disproportionate redemption within the meaning of
section 302(b)(2)(C), and (3) The redemption is not pursuant to a plan described in
section 302(b)(2)(D).
 Subsection 302(b)(2)(D) provides that a redemption will not be treated as
substantially disproportionate if made pursuant to a plan the purpose or effect of
53
which is a series of redemptions which result in the aggregate in a distribution
which is not substantially disproportionate. Whether or not such a plan exists
will be determined from all the facts and circumstances.
If § 302(b)(2)(D) applies (i.e. the transaction was pursuant to a plan and meets a judicial stepdoctrine test):
Huckle:
o Before: 1200 / 2000  60%
o After: 600 / 1200  50%; Here the total number of shares is lowered from 1400 to 1200
because Billy’s redemption is stepped together with Huckle’s redemption.
o Now, fail the § 302(d)(2) test because don’t have less than 50% after the redemption.
However, Huckle still qualifies for § 302(a) sale treatment under § 302(b)(1), and will get
the same tax consequences just can’t get it through § 302(b)(2)—sale or exchange
treatment.
R/E: § 1001: AR: $12,000, AB: $6,000, RG: $6,000 capital gain @ 20% = $1,200 tax
TOTAL TAX = $1,200
Basis in remaining stock is still $10 per share.
Billy would not receive § 302(a) sale or exchange treatment because his ownership increased after
the redemption.
His ownership before was 40% (800/2000)
His ownership after was 50% (600/1200)
Therefore, § 302(d) would boot him into § 301 distribution treatment.
6. Suppose that BusyCo also has 400 outstanding shares of nonvoting preferred stock, of which Huckle
owns 200 shares. BusyCo redeems 600 shares of the common and all of the preferred held by Huckle.
Simultaneous Redemption of Preferred Stock with § 302(b)(2) Common Stock Redemption
Piggy Backing Rule: Treas. Reg. § 1.302-3(a): Section 302(b)(2) only applies to a redemption of voting
stock or to a redemption of both voting stock and other stock. Section 302(b)(2) does not apply to the
redemption solely of nonvoting stock (common or preferred). However, if a redemption is treated as an
exchange to a particular shareholder under the terms of section 302(b)(2), such section will apply to the
simultaneous redemption of nonvoting preferred stock (which is not section 306 stock) owned by such
shareholder and such redemption will also be treated as an exchange.
Basically, if a redemption is treated as an exchange under § 302(b)(2), such section will apply
to the simultaneous redemption of nonvoting preferred stock owned by such shareholder and
such redemption will also be treated as an exchange
Assume: Pay $2,000 for the common & $2,000 for the preferred.
54
Here, the 600 shares of the common stock are considered a substantially disproportionate
redemption of stock under § 302(b)(2) so have sale treatment under § 302(a). Therefore, under
Treas. Reg. § 1.302-3(a), sale treatment will apply to the simultaneous redemption of the
nonvoting preferred shares.
7. Suppose Huckle owned no common stock, ONLY the 200 shares of nonvoting preferred, and BusyCo
redeems 80 of Huckle’s preferred shares?
Redemption of Only Nonvoting Preferred Stock
Rev. Rul. 77-426: Redemption of any amount of stock that is nonvoting, non-convertible, and limited
and preferred as to dividends and inn liquidation represents a meaningful reduction of the shareholder’s
proportionate interest in the corporation if the shareholder does not own stock of any other class, either
directly or indirectly. Therefore, the redemption in this case qualifies as not essentially equivalent to a
dividend. Takeaway: If a shareholder owns only nonvoting preferred stock and some of it is
redeemed, it will satisfy § 302(b)(1) and be a meaningful reduction. Also can’t be convertible.
Under Treas. Reg. § 1.302-3(a), § 302(b)(2) does not apply to the redemption of solely nonvoting
stock (preferred or common). Nothing to piggy back on here!!, so no SUbsantially
disproportionate analysis necessary.
Does this qualify for § 302(a) under § 302(b)(1)?
Rev Rul. 77-426, this is a meaningful reduction so satisfy § 302(b)(1) and get sale treatment under
§ 302(a).
55
Unit III.B—Attribution and Complete Terminations
I.
II.
III.
IV.
Termination of Shareholders Interest—§ 302(b)(3)
 Sale or exchange treatment if the redemption is of all of the stock of the shareholder.
Constructive Ownership of Stock—§ 302(c)
 Tells us to look to § 318 constructive ownership/attribution rules.
Waiver of Family Attribution—§ 302(c)(2)
 Applies only to § 302(b)(3) and says § 318(a)(1) will not apply if 3 requirements are met:
o No interest in the corporation after the distribution other than as a creditor;
o Does not acquire any prohibited interest within 10 years from the date of the redemption
transaction; AND
o The previous shareholder must agree to tell the IRS if he ever gets a prohibited interest.
 This is limited to family attribution.
 § 302(b)(2)(B)(i)
o If any of the redeemed stock is acquired in the past 10 years by a related party, then
o Flush language says that it applies if there was a tax avoidance purpose then the waiver is not
avoidable.
 Ex. (which is Ex. 2 from 1.302-2(c))
o H and W each own 50% of Corp. All of H’s stock is redeemed.
o The remaining basis in H’s stock would be taxed to W’s stock.
o This creates potential for abuse.
o Proposed regs pending to resolve this potential for abuse.
 Proposed Regs 1.302-5 (the scope of this is limited to a § 302(b)(3) complete redemption situation).
o (a)(3)
- The redeemed shareholder will be allowed to use the excess basis as a loss under the
inclusion date of 1.302-5(b)
o (b)—definitions
- Deferred loss
- Inclusion date
Constructive ownership/attribution—§ 318
 **Blank suggests analyzing without attribution first and then adding the attribution shares.
 (a)(1)—Family attribution
o Includes spouse, children, grandchildren, and parents.
o Remember siblings are not considered related under § 318(a)(1)(A).
 (a)(2)—Entity Attribution—FROM—“upstream attributions”
o Corporation if own 50% or more than 50% attribute proportionately
- “upstream attributions
 (a)(3)—Entity Attribution—TO—“downstream attributions”
 (a)(4)—Options
o If any person has an option to acquire stock, such stock shall be considered as owned by such
person. For purposes of this paragraph, an option to acquire such an option, and each one of a
series of such options, shall be considered as an option to acquire such stock.
o Options = stock
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
o § 318(a)(5)(D) says that if you are dealing stock is attributable per (a)(1) and (a)(4), (a)(4)
will trump.
(a)(5)
o (B) stock constructively owned by one family member by reason of (a)(1) shall not be
applied in making another family a constructive owner under (a)(1).
o Ex.
- Father son and daughter each own 33 shares. Corp redeems all shares from daughter.
- Before redemption 33+33 = 66 shares
- After redemption 33 total. Not actual 33 constructive.
a. Father has 33 actual and 33 constructive from son = 66. BUT when
attributing to daughter, can’t have two (a)(1) transactions back to back.
i. Ie no reattribution vie (a)(1)
Problems
BusyCo is owned entirely by two individuals, Huckle and Billy (who are unrelated unless otherwise stated).
Huckle owns 1200 shares of BusyCo common stock (with a basis of $10 per share) and Billy owns 800 shares
of BusyCo common stock (with a basis of $40 per share). The current market value of BusyCo’s common stock
in the transactions below is $20 per share. BusyCo’s current earnings and profits for 2014, not including the
effects of any of the transactions described below, are $2,000.
**Blank Suggests doing the ownership test before applying attribution rules
§ 302(b)(3): Termination of Shareholder’s Interest: Subsection (a) shall apply if the redemption is in complete
redemption of all of the stock of the corporation owned by the shareholder.
§ 302(c): Constructive Ownership of Stock: (1) In General – Except as provided in paragraph (2) of this
subsection, section 318(a)(1) shall apply in determining the ownership of stock for purposes of this section.
Turn on § 318 for purposes of figuring out if § 302(b) safe harbors apply.
§ 318(a): Look to the Code for this section because it is rather technical.
§ 318(a)(5): Operating Rules:
(A) In General – Except as provided in subparagraphs (B) and (C), stock constructively owned by a person by
reason of the application of paragraph (1), (2), (3) or (4), shall, for purposes of applying paragraphs (1), (2),
(3), and (4), be considered as actually owned by such person.
(B) Members of Family – Stock constructively owned by an individual by reason of the application of
paragraph (1) shall not be considered as owned by him for purposes of again applying paragraph (1) in
order to make another the constructive owner of such stock. Plain Language: Prevents double attribution of
attributing a son’s shares to the father and then those shares being attributed to the father’s daughter (aka the
son’s sister which is not allowed under § 318(a)(1)).
(C) Partnerships, Estates, Trusts, and Corporations – Stock constructively owned by a partnership, estate, trust,
or corporation by reason of the application of paragraph (3) shall not be considered as owned by it for
purposes of applying paragraph (2) in order to make another the constructive owner of such stock. Plain
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Language: Stock owned by partnership, etc. by “Downstream Attribution” (§ 318(a)(3)) shall not be considered
as owned for purposes of “Upstream Attribution” (§ 318(a)(2)).
(D) Option Rule in lieu of Family Rule – For purposes of this paragraph, if stock may be considered as
owned by an individual under paragraph (1) or (4), it shall be considered owned by him under paragraph (4).
1. Huckle sells 600 BusyCo shares to BusyCo for $12,000. What is the amount and character of gain or loss
recognized by Huckle if Huckle and Billy are related in the following alternative ways?
a. Billy is Huckle’s brother.
Attribution/Constructive Ownership—§ 318(a)(1)—Family Members Doesn’t Include Siblings
§ 318(a)(1); Members of Family – An individual shall be considered as owning the stock owned,
directly or indirectly, by or for – (i) his spouse (other than a spouse who is legally separated from
the individual under a decree of divorce or separate maintenance), and (ii) his children,
grandchildren, and parents.
§ 318(a)(1)—Does not include the sibling relationship here!!!! Therefore same result as before.
Before: 1200/2000 = 60%; After: 600/1400 = 43%; 43%[After]/60%[Before] = 71.67% < 80%
and after the redemption have less than 50% control, therefore qualifies under § 302(b)(2)
substantially disproportionate redemption of stock, and is treated as a sale under § 302(a).
Huckle:
R/E: § 1001: AR: $12,000, AB: $6,000, RG: $6,000 capital gain @ 20% = $1,200 tax
TOTAL TAX = $1,200
Basis in remaining stock is still $10 per share [6000 basis / 600 remaining shares]
Busy Co.
The stock redeemed was 600 shares out of 2000 shares. 600 / 2000 = 30%. Therefore,
BusyCo’s CEP = $2,000, and 30% * 2,000 = 600 E&P. CEP $2,000 – 600 = 1,400 = Final E&P
Final E&P = $1,400
b. Billy is a corporation in which Huckle owns one half of the stock.
Attribution from Corporation to Shareholder
§ 318(a)(2)(C): Attribution from Corporations – If 50 percent or more in value of the stock in a
corporation is owned, directly or indirectly, by or for any person, such person shall be considered as
owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which
the value of the stock which such person so owns bears to the value of all the stock in such
corporation. PROPORTIONALITY. This is called “Upstream Attribution.”
Huckle:
58
Before: (1,200 + 400 upstream attribution [Because Huckle owns 50% of BillyCo, Huckle will
own the stock of BillyCo in the same proportion; 50% of 800 shares owned by BillyCo of
BusyCo] = 1,600 / 2000  80%
After: (600 + 400) / 1400  71%
§ 302(b)(2) After the redemption, ownership is not less than 50% so does not apply.
§ 302(b)(1) also does not apply because not a “meaningful reduction” because still have control
before and after redemption.
Treat as § 301 distribution under § 302(d):
§ 301(c)(1): Dividend: $2,000 @ 20% = $ 400 tax
§ 301(c)(2): $6,000 (600 shares x $10) remaining shares + $6,000 redeemed shares [§ 1.302-2(c)
tacking]= $12,000 total basis; RofC = $2,000 ($4,000 basis - $2,000 dividend), Remaining Basis
= $10,000
TOTAL TAX = $400
Remaining Basis in the Stock = $10,000
BusyCo:
E&P = $2,000 CEP - $4,000 distribution (§ 312(a)) = 0
TOTAL E&P = $0
c. Billy is Huckle’s equal partner in a partnership.
Attribution/Constructive Ownership Equal Partners (Can go in and out of P’ship)
§ 318(a)(3)(A): if it applies, everything that the partner owns is attributed to the partnership. NO
PROPORTIONALITY: Downstream Attribution.
§ 318(a)(2)(A): stock owned by partnership is proportionally owned by the partners.
PROPORTIONALITY: Upstream Attribution.
Here, § 318(a)(5)(C) is activated and the stock of BusyCo that is attributed to the partnership
owned by Huckle and Billy (“Downstream Attribution”) is not reattributed to Huckle
(“Upstream Attribution”). § 318(a)(5)(C) prevents (3)  (2) attribution.
Before: 1,200/2000 = 60%; After: 600 / 1400 = 42%. Therefore, § 302(b)(2) applies because
70% (42%/60%)<80%, and Huckle owns less than 50% in BusyCo after the redemption. Sale
treatment under § 302(a).
So start with the beginning ownership. 1200/2000 before and 600/1400 after.
d. Billy and Huckle are siblings and their father has an option to purchase Billy’s stock.
Option to Purchase Stock Treated as Owned—§ 318(a)(4)
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§ 318(a)(4): Options – If any person has an option to acquire stock, such stock shall be considered
as owned by such person. For purposes of this paragraph, an option to acquire such an option, and
each one of a series of such options, shall be considered as an option to acquire such stock.
The 800 stock that their father has option to purchase from Billy is considered owned by the
Father under § 318(a)(1).
The stock owned by the Father is attributable to Huckle under § 318(a)(1)(ii).
Before: (1200 + 800 under § 318(a)(4)) / 2000 = 100%; After: (600+800)/1400 = 100%.
Therefore do not qualify under § 302(b)(1) or (2), and will be treated as a § 301 distribution
under § 302(d).
2. As above, Huckle owns 1200 shares and Billy owns 800 shares of BusyCo’s common stock. What results to
Huckle under the following alternatives?
a. BusyCo redeems all of Huckle’s stock for $24,000 cash.
Redemption of All of a Shareholder’s Stock—Termination of Interest—§ 302(b)(3)
§ 302(b)(3)—Termination of Shareholder’s Interest: Subsection (a) shall apply if the redemption is
in complete redemption of all of the stock of the corporation owned by the shareholder.
Before: 1200 / 2000  60%; After 0/800  0% after redemption so complete termination
under § 302(b)(3) so sale/exchange treatment under § 302(a).
b. BusyCo redeems all of Huckle’s stock for $24,000 in cash, but Billy is Huckle’s father.
Termination of Interest where Family Member Retains Stock—Possible §302(c) Waiver
Although Huckle got rid of all of his stock, which would reduce his ownership from 100% to
0%, he would constructively own the stock his father owned through § 318(a)(1), as turned on
by § 302(c).
Before: (1200 + 800 under § 318(a)(1)) / 200 100%
After: 800/800  100% This would be the norm if § 318(a)(1) attribution rules were turned
under § 302(c), however, there is also a special rule in § 302(c)(2) that applies only for §
302(b)(3).
Without Waiver, still owns all and would fail § 302(b), causing § 301 treatment.
BUT see below.
§ 302(c)(2): (A) in the case of a distribution described in subsection (b)(3), section 318(a)(1) shall
not apply if – (i) immediately after the distribution the distributee has no interest in the
corporation (including an interest as an officer, director, or employee), other than an interest as a
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creditor, (ii) the distributee does not acquire any such interest (other than stock acquired by bequest
of inheritance) within 10 years from the date of such distribution, AND (iii) the distributee, at such
time and in such manner as the Secretary by regulations prescribes, files an agreement to notify the
Secretary of any acquisition described in clause (ii) and to retain such records as may be necessary
for the application of this paragraph.
(B) Subparagraph (A) of this paragraph shall not apply if – (i) any portion of the stock redeemed
was acquired, directly or indirectly, within the 10-year period ending on the date of the distribution
by the distributee from a person the ownership of whose stock would (at the time of distribution) be
attributable to the distributee under § 318(a), or (ii) any person owns (at the time of the distribution)
stock the ownership of which is attributable to the distributee under § 318(a) and such person
acquired stock in the corporation, directly or indirectly, from the distributee within the 10-year
period ending on the date of the distribution, unless such stock so acquired from the distributee is
redeemed in the same transaction. The preceding sentence shall not apply if the acquisition did not
have as one of its principal purposes the avoidance of Federal income tax.
Simple language: 3 requirements under § 302(c)(2): TURNS OFF § 318(a)(1), and only turns
off § 318(a)(1) and not the other attribution rules!!!
• 1.) No interest in the corporation after the redemption except as a creditor (No “Prohibited
Interest”);
• 2.) For 10 years, AND
• 3.) Agree to notify the IRS if you get a prohibited interest
If Huckle can take advantage of § 302(c)(2), then § 318(a)(1) is turned off and no attribution
from his Father: Before: 1200 / 2000  60%; After: 0/800  0% after redemption so complete
termination under § 302(b)(3) so sale treatment under § 302(a).
c. Same as Question 2(b), except that immediately after the redemption, Huckle continues to serve as a
paid “consultant” to BusyCo.
Prohibited Interest under Waiver of Family Attribution—Paid Consultant prohibited.
Lynch v. Comm’r: Consultant is a prohibited interest!!!!!!!— The facts in this example are similar
to Lynch v. Commissioner. In Lynch, the appellate court rejected the Tax Court’s interpretation of
section 302(c)(2)(A)(i), a section of the waiver of attribution of family-owned shares provision. The
court held that a taxpayer who provides post-redemption services, either as an employee or an
independent contractor, holds a prohibited interest in the corporation because he is not a creditor.
The Lynch court found that a taxpayer who entered into a consulting position with the redeeming
corporation was an independent contractor who cannot find shelter in the safe harbor of section
302(c)(2)(A)(i).
Thus, because a consultant is a prohibited interest § 318(a)(1) is still turned on for the
application of § 302(b)(3).
Before: (1200+800)/2000  100%
After: 800/800  100%
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Treat as a § 301 distribution under § 302(d).
§ 301 distribution analysis: $24,000 Distribution
(c)(1): $2,000 Dividend (b/c only 2000 E&P) @ 20% = $400 tax
(c)(2): $12,000 basis in original stock  $0 basis because of $12,000 RofC.
(c)(3): $10,000 gain from the sale or exchange of property @ 20% = $2,000 tax
TOTAL TAX = $400 + $2,000 = $2,400
Remaining Basis in the Stock = $0
Assumption: If there was $3,000 in leftover basis after the RofC, then the leftover basis will be
added to Billy’s stock basis (Treas. Reg. § 1.302-2(c), Ex. 2).
BUT Need to Analyze under Proposed Regulations § 1.302-5 because this will become law.
Prop. Reg. § 1.302-5(a)(3)(i): Remaining basis treated as a loss to Huckle. Huckle can take this loss
on the “inclusion date.”
• Prop. Reg. § 1.302-5(b)(4): (i) Definition. The term “inclusion date” means the earlier of-(A) The first date on which the redeemed shareholder would satisfy the criteria of section
302(b)(1), (2), or (3), if the facts and circumstances that exist at the end of such day had existed
immediately after the redemption (Plain Language: when Billy sells enough stock to qualify Huckle
for the criteria of § 302(b)(1), (2), or (3)); or
(B) The first date on which all classes of stock of the redeeming corporation become worthless
within the meaning of section 165(g).
Solely for purposes of this paragraph, if the assets of the redeeming corporation (or its successor)
are acquired by another corporation in a transaction described in section 381(a), the inclusion date
for the redeemed shareholder is determined by treating all of the facts and circumstances that exist
at the end of the day that includes the section 381 transaction (including the acquisition of the assets
of the redeeming corporation or its successor) as existing immediately after the redemption. A
successor for this purpose means a corporation that acquires the assets of the redeeming
corporation in a transaction to which section 381(a) applies.
Vs.
Treas. Reg. § 1.302-2(c) where the remaining basis is shifted to the other related shareholder’s
stock, which has a potential for loss shifting / basis shifting.
Application of the Proposed Regulations:
****Assume BusyCo has CEP = $30M, and then same other facts as (c). ****
§ 301 distribution analysis: $24,000 distribution:
(c)(1): $24,000 Dividend @ 20% = $4,800 tax
(c)(2): No RofC so there is a remaining basis of $12,000. This is treated as a “deferred” loss
under Prop. Reg. § 1.302-5(a)(3)(i) and 1.302-(b)(4), and this loss is deferred until the inclusion
62
date., inclusion date is likely when Billy sells back enough stock to satisfy Huckle’s loss, then
Huckle can take the loss. This generally will occur at the time Billy sells all of his stock.
Total Tax = $4,800
- Luke “holds on to” the deferred loss
a. Gets to claim the loss on the “inclusion date”
i. Has to wait essentially until Sebastian sells some of his stock in
Organa
- Here, Luke has 12k deffered loss
a. Say Sebastian sells all 800 back to Organa for cash
i. Imagine “smacking them (the transactions) all together” – now,
Luke has no control because Sebastian has none either – this is
when the loss could be recognized
Vs.
Treas. Reg. § 1.302-2(c): the remaining $12,000 basis would simply be added to Billy’s stock.
- This creates a planning opportunity, because if Billy has a lot of gains, this could
give him basis and thus a bigger loss
a. See Notice 2001-45
i. As a result of this, the New Reg was Proposed (Reg 1.302-5
d. Same as Question 2(b), except that Huckle purchased his stock in BusyCo for cash from Billy two
years prior to the redemption by BusyCo.
Stock redeemed purchase from Family Member < 10 years prior to Redemption
Huckle goes from 1200/2000 to 0/800.
§ 318(a)(1) still is turned on because § 302(c)(2)(A) [Family Attribution Waiver] does not turn
it off in this case due to § 302(c)(2)(B) [10-year look back]. § 302(c)(2)(B) turns off §
302(c)(2)(A).
§ 302(c)(2)(B)(i) creates a “10 year Look Back Rule.” This rule is if any redeemed stock was
acquired 10 years before the redemption from a person whose ownership of the stock would be
attributable to the distributee under § 318(a), then 302(c)(2) (A) safge harbor cant apply.
However, this does not apply if the acquisition by the distributee did not have a “principal
purpose of the avoidance of Federal income tax.”
Therefore, § 301 distribution analysis.
§ 301 distribution analysis: $24,000 Distribution
(c)(1): $2,000 Dividend @ 20% = $400 tax
(c)(2): $12,000 basis in original stock  $0 basis because of $12,000 RofC.
(c)(3): $10,000 gain from the sale or exchange of property @ 20% = $2,000 tax
TOTAL TAX = $400 + $2,000 = $2,400
Remaining Basis in the Stock = $0
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Under Prop Reg.
- IF HE HAD any basis left over (i.e. there was more E&P/ no basis reduction
under 301(c)(2)), couldn’t shift it over to Sebastian./related s/h
a. Would be a deferred loss until inclusion date
i. This provision stops the “game” by taking the waiver (302(c)(2))
away
- Vs
- Under current law
a. If HE HAD ANY BASIS (here, he does not) it would be added to
Sebastians stock
e. Same as Question 2(d), except that since Huckle’s purchase of the shares from Billy, he and his
father have become bitter enemies.
Metzger Case: Bitter enemies are only relevant for the tax avoidance plan for facts &
circumstances. Court believed that the Commissioner was correct in refusing to take family
discord into account in applying the attribution rules .Tax Court had said that it might be relevant
– IRS hated this. By time it got to 5th Cir, 5th Cir said no –bad blood doesn’t matter.
But, bad blood doesn’t matter for the law!!!!
Therefore, same result as in Question 2(d) for the law, but may matter for the facts &
circumstances for the tax avoidance plan (see, e.g. 302(c)(2)(B)(last pragraoph/sentence)
R: 302(c)(2)(B) – applies only if the principal purpose was to avoid taxes
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Unit III.C—Partial Liquidations and Bootstrap Acquisitions
I.
II.
III.
General
 This is different than the other § 302(b) subsections. It focuses on what happens at the corporate
level.
 Where this really comes into play the most is § 355—spinoffs.
 Ex. Shareholder owns a corporation that makes peanut butter and jelly. Corporation decides to stop
making jelly. Corporation distributes all of the assets from the jelly business to the shareholder in
exchange for the s/hs stock.
o This is just a § 317 redemption. So how should it be treated.
o Should be treated as a partial liquidation.
Redemption from Noncorporate Shareholder in Partial Liquidation—§ 302(b)(4)
 Shall apply to a distribution if such distribution is—
o (A) in redemption of stock held by a shareholder who is not a corporation, and
o (B) in partial liquidation of the distributing corporation.
Partial Liquidation Defined—§ 302(e)
 Distribution Must Not Be Essentially Equivalent to a Dividend (determined at Corp Level and
determined in line with (e)(2)):
o Distributing must cease to conduct QTB or distribute of assets of QTB; AND
o Distributing must be engaged in QTB immediately after distribution.
- QTB = actively conducted through 5-yr period
o Must be pursuant to a PLAN
- Must happen within the taxable year of a plan or the next year.
- How will this be determined?
 You will look through a paper trail to see if the transaction was pursuant to a
plan.
 § 302(e)(2) – says what is “not essentially equivalent to a div” in this context
o Distributing corp must cease to conduct a QTB or distribute the assets of a QTB; AND
o Distributing corp must be engaged in (another/ a different) QTB immediately after the
distribution
 Qualified trade or business—§ 302(e)(3)
o 5 year business (actively conducted for the last 5 years) AND
o Not acquired in a taxable (probably cash) transaction within those last 5 years.
o **The 5 year period is explicit. Case law will not be able to get around it.
Problems
Electric Co is equally owned by Hector, Francine, who are both individuals, and Rebus Co, which is a
corporation under Delaware law. Electric Co operates three businesses – auto-manufacturing, lending and
power tool production. Electric Co has operated the auto-manufacturing and lending businesses for 10 years
each. In September 2014, Electric Co decides to stop the auto-manufacturing business and distribute the assets
of this business pro rata to each of its three shareholders in exchange for one third of each shareholder’s stock.
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§ 302(b)(4): Redemption form a Noncorporate Shareholder in Partial Liquidation – Subsection (a) shall apply
to a distribution if such disitribution is – (A) in redemption of stock held by a shareholder who is not a
corporation, AND (B) in partial liquidation of the distributing corporation.
Steps:
1.) Is it a § 317 redemption?
2.) § 302(b)(4)
a. Go to § 302(e)(1):Partial Liquidation Defined: distribution shall be treated as in partial
liquidation of a corporation if i. (A) the distribution is not essentially equivalent to a dividend (determined at the
corporate level rather than the shareholder level!!!!), AND
ii. (B) the distribution is pursuant to a plan and occurs within the taxable year in which the
plan is adopted or within the succeeding taxable year.
b. The essentially equivalent to a dividend is at the corporate level here, which is different from §
302(b)(1) where it is at the shareholder level!!!
c. OBJECTIVE TEST: Go to § 302(e)(2): Termination of a business – The distributions which meet
the requirements of paragraph 1(A) shall include a distribution which meets the requirements of
subparagraphs (A) and (B) of this paragraph:
i. (A) The distribution is attributable to the distributing corporation ceasing to conduct, or
consists of the assets of, a qualified trade or business, AND
ii. (B) Immediately after the distribution, the distributing corporation is actively engaged
in the conduct of a qualified trade or business.
iii. Go to § 302(e)(3) to determine what a qualified trade or business is: means any trade or
business which –
1. (A) was actively conducted throughout the 5-year period ending on the date of the
redemption, AND
(B) was not acquired by the corporation within such period in a transaction in which gain or loss was
recognized in whole or in part (not acquired in a taxable transaction is the simple language).
1. Will the distribution by Electric Co qualify as a sale or exchange with respect to Hector, Francine and Rebus Co
under §302(b)(4)? What more do you need to know?
Partial Liquidation under § 302(b)(4)—not applicable for corporate shareholders
Rebus Corporation:
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It will not qualify for sale or exchange under § 302(b)(4) because § 302(b)(4) only applies to noncorporate
SHs and Rebus Corporation is a corporate SH.
Treat as a distribution under 301 because do not get sale treatment under § 302(a) unless qualify for any
of the other tests.
Don’t have these numbers, but just assume: $1000 Assets - $800 DRD = $200 @ 35% = $70 tax. However,
need to treat the dividend as an extraordinary dividend under § 1059(e)(1)(A)(i), and the $800 nontaxable
portion would reduce Rebus’s basis in Electric Co. by $800.
§ 1059(e)(1)(A)(i): Redemptions – in the case of any redemption of stock – (i) which is part of a partial
liquidation (within the meaning of section 302(e)) of the redeeming corporation . . . any amount treated as a
dividend with respect to such redemption shall be treated as an extraordinary dividend to which paragraphs
(1) and (2) of subsection (a) apply without regard to the period of the taxpayer held such stock.
•It is still a partial liquidation even though doesn’t qualify for § 302(b)(4) because it still meets the
definition of partial liquation under § 302(e).
***Note that under § 1059 this transaction is still treated as a partial liquidation, corp. just doesn’t get
sale or exchange treatment under § 302(b)(4). Therefore, the basis in Electric co would be reduced by
$800.
- i.e. since this is still a partial liquidation, 1059(e) applies, even though the corp
doesn’t get sales treatment under 302(b)(4)
Hector & Francine: (These are noncorporate SHs so run through § 302(b)(4) to see if it applies:
§ 302(e) defines Partial Liquidation: (e)(2): Termination of Business: (A) Electric Co. is distributing
assets of a “qualified trade or business.” Determine if it is a “qualified trade or business”  § 302(e)(3):
Electric Co. has to run the auto-manufacturing business for 10 years so it meets the 5-year requirement
of actively conducting business, and we are assuming it was not acquired in a taxable transaction during
this 5-year period. Then go back to § 302(e)(2)(B), and check that Electric Co. is still actively engaged in
the conduct of a QTB immediately after the distribution, so need to figure out if the Power Tool
Production Business is a QTB, which we are assuming it is based on the facts provided. Note: IF power
corporation had not been around for 5 years, only have to maintain one business.
Sale Treatment under § 302(a).
§ 302(b)(4) will never apply unless the distributing corporation is operating two or more QTBs.
Electric Co.:
Will have to recognize gain under § 311(b) if the assets are appreciated assets. Would recognize gains but
NOT losses.
E&P will also be decreased by BOTH the § 302(a) and §301 distributions. § 301 deductions to E&P will
take place first.
E&P
- Here, is a partial liquidation
67
a. Thus, under 311(b), electric co will have to recognize any GAIN under
(b), but not any Losses (per 311(a))
- 312
a.
2. Same facts as above, except assume that Electric Co acquired the auto-manufacturing business three years ago
for cash. Does this new fact change your answer to Question 1?
302(e)(3), the definition of a QTB is being tested here. There was an acquisition of the automanufacturing inside this 5-year period. Was there gain or loss recognized in whole or in part during this
acquisition? If Yes  not a QTB; If No  Is a QTB. Thus QTB -- § 302(a) sale or exchange. If no QTB,
§ 301 treatment.
- As long as electric obtained it in a transaction in which gain was recognized, is a
Qt/b
Whqt about RRebus Co?
- 1059(e)(1)(A) – DOESN’T APPLY if the auto bus isn’t a QTB (because then the
distribution couldn’t be a “partial liquidation”)– because not part of a partial
liquidation and is a pro-rata distribution
a. I. dowesnt apply (see above)
b. Ii. Here, is pro rata, so doesn’t apply
- For 1059 to apply, have to know their basis, etc…
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Unit III.D—Redemptions by Related Corporations
I.
II.
III.
In General
 Ex. Bill owns two corporations, M and G. Bill sells all of his stock in M to G (acquiring co) and G
pays $200B to Bill. This is a brother-sister transaction.
o This is not a redemption under § 317(b). This is because G is not acquiring G’s own stock.
o § 302(a) also cannot apply because it is not G’s own stock.
o Independent of § 304, this transaction looks just like a sale to a 3rd party.
o BUT if he sells it to G, because he has control of both businesses he is just selling all of his
stock. This would leave Bill owning all of G, which would own all of M. Putting stock from
one pocket into the other but giving him $200B at capital gains. Really seems to be more of
a distribution to him that should be taxed under § 301.
o What is the problem with this? Giving sale or exchange rate when switching money from
one pocket to the other. It has no economic significance since he still controls after the
transaction.
o What if § 304 does apply?
- Then the transaction will be treated as a deemed redemption of the stock of the
corporation of the acquiring stock.
- Bill will be treated as selling stock in G to G (stock in the acquiring corporation to the
acquiring corp.).
- We then look to § 302(a) and look to the § 302(b) safe harbors with respect to the
ISSUING CORPORATION (do the sale/exchange analysis w/re to the change in
ownership %s for this (issuing) corp).
- We have to keep track of the amount of ownership in M before and after the
transaction—§ 304(b).
Redemption Through Use of Related Corporation—§ 304
 One or more persons in control of 2 corps.
o § 304(c) defines control.
- 50% vote or value
- § 318 attribution applies (substitute 5% for 50%)
 One corp acquires stock in other corp from controlling person
 For property.
o § 317(a) defines property for this Part! Both § 317 and 304 are under the same part. Doesn’t
include stock in the corp making the distribution.
 (a)(1) one or more persons are in control of each of two corporations.
 Function
o Such property shall be treated (deemed transaction) as a distribution in a redemption of the
stock of the corporation acquiring stock.
 (b)(1) the 50% limitation of § 318(c)(2) and (c)(3) does not apply when analyzing § 302(b) as
triggered by § 304.
Control—§ 304(C)
 50% or more of total combined voting power OR 50% total value of BOTH corporations.
 At what time is the control measured?
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IV.
o § 304(c)
o 1.304-2(a)
- Measure control before the transfer!!
 See also 1.304-5(b)
 § 304(c)(3) turns § 318 constructive ownership rules on. These rules are limited to determining §
304 control (i.e. it will not be used under the § 302(b) attribution analysis).
o For CONTROL purposes of § 318(a)(2)(C), substitute 5% for 50%.
o § 1.304-2
- Where person in control (as determined by statute—50% control test) of two
corporations and sells the stock in one to the other, then such property shall be
treated as received in redemption of stock in the acquiring company.
 Stock received by corp. shall be treated as contribution to capital (basis
determined under § 162(a).
 Transferor’s basis in stock of acquiring corporation shall be increased by basis
of stock surrendered by him.
- Amount received by transferor shall be treated under § 302(d) (i.e. § 301), unless
transferor is able to satisfy § 302(a) (i.e one of the requirements under § 302(b)).
 However, in applying § 302(b), determination of ownership will be in
relation to ownership in issuing corporation (not acquiring corporation).
o However, when applying the attribution rules under § 318(a), the
ownership will be in relation to the acquiring corporation.
 In determining control under § 302(b), § 318(a) shall be applied without
regard to the 50% limitation in § 302(a)(2)(C) and (a)(3)(C).
 When the transaction fails § 302(d) the flush language of § 304(a) will control..
o The flush language provides such property shall be treated as a distribution in redemption of
the stock of the corporation acquiring such stock. To the extent that such distribution is
treated as a distribution to which section 301 applies, the transferor and the acquiring
corporation shall be treated in the same manner as if the transferor had transferred the stock
so acquired to the acquiring corporation in exchange for stock of the acquiring corporation in
a transaction to which section 351(a) applies, and then the acquiring corporation had
redeemed the stock it was treated as issuing in such transaction.
- Quick overview of § 351.
 If you control a corporation immediately after and contribute property in
exchange for stock, you won’t be required to pay tax at that time.
 In this transaction, the shareholder will take a basis in the stock that is equal to
the basis it had in the property contributed.
 The corporation also takes the shareholder’s basis in the machine—this is §
362(a).
o Pretend that control person transfers issuing stock in exchange for a acquiring stock in a §
351 transaction.
 Always ask whether 304 applies!!
3 Fact Patterns and Outcomes
 (1) Redemption through Use of Related Corporation § 304 with § 302
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

(2) Redemption through Use of Related Corporation § 304, but § 302(b) fails, so § 301
(3) Redemption through Use of Related Corporation that fails § 304
Problems
Harry, an individual, owns 100% (100 shares) of Bones Corp common stock with an aggregate basis of $200.
Each share of Bones Corp. common stock is worth $4. Harry also owns 50% (50 shares) of Figg Corp common
stock with an aggregate basis of $100. Each share of Figg Corp common stock is worth $5.71. Each of Bones
Corp and Figg Corp has $100 of current earnings and profits.
Redemptions by Related Corporations are not a redemption under § 317(b) because the Acquiring Corp. is not
acquiring its own stock in exchange for property. Therefore, we are now in the realm of § 304 (this section is a
beast!).
§ 304(a)(1):
 (A): One or more persons are in control of each of two corporations, AND
 (B): in return for property, one of the corporations acquires stock in the other corporation from the
person so in control.
o Property is the definition of property under § 317(a).
o Control: § 304(c): at least 50% vote OR value of all classes of stock.
 Different than the definition of control for § 302(b)(2) where need vote and value.
 When do we measure control? § 1.304-2(a): Before the redemption.
§ 304(c)(3): Turns on § 318(a)!!!
 For § 318(a)(2)(c): by substituting “5 percent” for “50 percent”
o ONLY USE THIS IN DETERMINING CONTROL – NOT SALE/EXCHANGE
TREATMENT
If § 304 does not apply, it would just be a normal § 1001 sale or exchange.
Vs.
If § 304 applies, treated as a redemption of the acquiring corporation stock.
 Pretend that controlling shareholder is selling acquiring corp.’s stock in exchange for property or
money.
 Then § 302 will apply to this pretend redemption and use the same § 302 analysis to determine if § 301
distribution or § 302(a) sale or exchange treatment is used.
For § 302(b) analysis, LOOK TO CHANGE IN OWNERSHIP IN THE ISSUING CORPORATION!!!! (§
304(b)).
1. Harry sells all 100 of his Bones Corp shares to Figg Corp for $400 in cash. What tax result to Harry, Bones
Corp and Figg Corp?
71
Redemption through Use of Related Corporation/Brother-Sister Redemptions—§ 304(a) with Sale or
Exchange Treatment—passes § 302(b)
**This transaction is not a redemption under § 317(b). This is because Harry is not acquiring
Harry’s own stock.
**Additionally, § 302(a) cannot apply because it is not Harry’s own stock.
**NOTE: Attribution Rules are going to come into play
Does § 304 apply?
Yes.
§ 304(a)(1)(A): Harry owns at least 50% vote of both Bones Corp. and Figg Corp.
§ 304(b)(1)(B): In return for property (here cash) [ § 317(a) definition], Figg Corp. acquires stock in
**We pretend (the statute does not tell us how this transaction will take place and, therefore, we just
accept that it is considered being transferred for Figg stock—not the same as the analysis in problem
(2)) that Figg is redeeming Fig stock per § 304(b).
§ 302(b) analysis:
§ 302(b)(2): The analysis is done through Harry’s ownership in Bones corp stock (the issuing
corporation) under § 304(b).
Before: (100 shares/100 shares) = 100%  After: [(0 shares directly owned + (.50 * 100 = 50 under
§ 318(a)(2)(C))) / 100 shares] = 50%  Not less than 50% after the redemption so § 302(b) doesn’t
apply. Note: the total share (the denominator is not reduced in this redemption) FAILED § 302(b)(2).
Sidenote: Under § 304(b): § 318(a)(2)(C) and (a)(3)(C) shall be applied without regard to the 50%
limitation when applying § 302(b), meaning if you own less than 50% you would still be attributed
proportionate ownership.
Another: § 304(c) special attribution rule is not turned on here, it is only relevant for § 304 control.
§ 302(b)(1): PASSED: Rev. Rul. 75-502 (can only be 2 SHs for this Rev. Rul. to apply): Harry’s
ownership in Bones Corp. went from 100% to 50%, and Harry no longer has full control over Bones
Corp.
Treat as a sale or exchange under § 302(a).  The proper lingo is “§ 304(a) Transaction with Sale or
Exchange Treatment.”
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Bones Corp.: (Issuing)
No tax consequences. Just has a new owner, which is Figg Corp. now.
Figg Corp.: (Acquiring)
Figg bought Bones stock for $400 so Figg gets a cost basis in Bones stock. Basis in Bones Corp. stock =
cost basis under § 1012 = $400. This basis can actually be found in § 1.304-2(a), but it is § 1012 basis.
E&P doesn’t change because it just a pretend redemption and not a real one so § 312(n)(7) does not
apply.
Harry:
§ 302(a) sale or exchange treatment: AR: $400, AB: $200 (§ 1.304-2(a): Harry’s basis in pretend Figg
stock is his basis in the Bones stock); RG = $200 capital gain @ 20% = $40 tax.
Total Tax Liability = $40
Harry’s basis in Real Figg Corp = $100, it is unchanged. No basis has gone missing.
2. Instead, assume that Harry owns 70% (70 shares) of Figg Corp with an aggregate basis of $140 and sells all
100 of his Bones Corp stock to Figg Corp for $400 in cash. What tax result to Harry, Bones Corp and Figg
Corp?
Redemption through Use of Related Corporation—§ 304(a) with §301 treatment (Fails § 302(b))
§ 304 Apply?
§ 304(a)(1)(A): Harry owns at least 50% vote of both Bones Corp. and Figg Corp.
§ 304(b)(1)(B): In return for property (here cash) [§ 317(a) definition], Figg Corp. acquires stock in
Bones Corp. from Harry so in control.
Such property shall be treated as a distribution in redemption of the stock of the acquiring corp. (Figg
Corp).
§ 302(b) analysis:
§ 302(b)(2): The analysis is done through Harry’s ownership in Bones corp stock (the issuing
corporation) under § 304(b).
Before: (100 shares/100 shares) = 100%  After: [(0 shares directly owned + (.70 * 100 = 70 under
§ 318(a)(2)(C))) / 100 shares] = 70%  Not less than 50% after the redemption so § 302(b) doesn’t
apply. FAILED § 302(b)(2).
Sidenote: Under § 304(b): § 318(a)(2)(C) and (a)(3)(C) shall be applied without regard to the 50%
limitation when applying § 302(b).
§ 302(b)(1): FAILED: Rev. Rul. 78-401: No Meaningful reduction because in the Rev. Rul. ownership
went from 90% to 60% and was ruled no meaningful reduction.
§ 302(a) does not apply so, treat as a § 301 distribution under § 302(d).
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Harry:
§ 304(b)(2): the dividend shall be made as if the property were distributed – (A) by the acquiring
corporation to the extent of its E&P, and (B) then by the issuing corporation to the extent of its E&P.
 Dividend comes out of Acquiring Corp. E&P THEN out of Issuing Corp E&P
*Pretend that Harry transfers Bones stock in exchange for a Figg stock in § 351 transaction. This
results in a 70 share distribution of Figg stock ($400 [Purchase Price for Bones’ stock/$5.71 [Figg’s
stock value per share]). So Harry gave 100 shares of Bones stock in exchange for the same value of
Figg stock, 70 shares.—§304(a)(1)
At this point Harry has 70 shares of actual Figg stock and 70 pretend shares of Figg stock. He has
two blocks of Figg stock. After this treat Figg as immediately redeeming the pretend Figg stock for
$400, which is treated as a § 301 distribution to Harry.
Harry’s basis in the 70 pretend Figg stock that was redeemed is his basis in the Bone’s stock [$200],
and he has a $140 basis in his 70 real Figg stock.
§ 301 Distribution Analysis: Distribution $400; Figg Corp CEP = $100; Bones Corp CEP = $100
(c)(1): Dividend: $100 out of Figg E&P + $100 Bones Corp E&P = $200 * .20 = $40 tax
(c)(2): $200 Non-Dividend 
Harry’s Basis of Figg Corp. = $140 (real Figg Stock original basis)
H’s Basis in Bones Corp (which is also the basis in pretend Figg Stock)
Prop. Reg. § 1.304-2(a)(4): Basis of redeemed shares. To the extent that section 301(c)(2) applies to the
redemption of the common stock of the acquiring corporation issued in the deemed section 351 ex-change,
the amount distributed in such redemption shall be applied to reduce the adjusted basis of each share of
common stock directly held or deemed held by the transferor on a pro rata, share-by-share basis.
Pretend Basis: $200 – $100 (allocate the remaining non-dividend among the basis) = $100
Real Basis: $140 - $100 (allocate the remaining non-dividend among the basis) = $40.
The FMV is split equally 50/50 because there are 70 pretend shares with a FMV of $400 (70 x $5.71),
and 70 real Figg shares with a FMV of $400 (70 x $5.71). Then the pretend shares go away, and we
are left with the real 70 shares, and the remaining basis is allocated to 35 shares and 35 shares.
There are 70 shares of real Figg stock that Harry owns, and therefore these shares are split into two:
35 shares and 35 shares, and $100 of basis is allocated to 35 shares, and $40 of basis is allocated to the
other $35 shares—§ 1.304-2(a)(4).
Basis in Two Blocks of Figg Stock
35 shares
$100 Basis
35 shares
$40 Basis
The Regulations aren’t current with the statute so practitioners use the Proposed Regulations that
match the statute under § 304(a)(1), which the statute provides for a pretend § 351(a) transaction,
then a pretend redemption.
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Figg Corp.: (Acquiring)
CEP = $100 - $200 (the portion of cash distribution under § 312(a)) = $0.
Figg Corp.’s basis in Bones Corp. = $200, carryover basis from H’s basis in Bones Corp.  This
comes from the pretend § 351 that is then decided under § 362(a).
Bones Corp: (Issuing)
CEP = $100 - $200 (the portion of cash distribution under § 312(a)) = $0.
Additional Explanation from Dink:
Harry is treated as receiving a dividend of $200 ($100 from the current E&P of Figg and then $100 of
the current and accumulated E&P of Bones). Section 301(c)(1). Harry is taxed at the 20% rate on this
dividend and pays $40.
Under section 301(c)(2), we are supposed to decrease the basis of Harry’s stock by the portion that is
not a dividend. However, Harry is selling pretend stock of Figg.
Harry’s basis in the pretend Figg stock is the $200 basis of his Bones Stock which was sold to Figg.
This is similar to the section 351 fiction.
The Prop. Treas. Reg. states “the transferor’s basis in the common stock of the acquiring corporation
deemed issued to the transferor in the deemed section 351 transaction is equal to the transferor’s
basis in the stock of the issuing corporation it surrendered.”
Harry also has this real Figg stock with a basis of $140. This is the 70% of the Figg stock that Harry
owns with the $140 basis.
We have $200 from the deemed distribution remaining of non-dividend distribution.
The proposed regulations now give a new method that we have to use. We have to allocate the basis
according to the FMV of the 2 blocks of stock Harry holds.
We first have to total the FMV of the real stock held by the transferor and the total FMV of the
pretend stock held by the transferor.
The FMV of the real Figg stock is $400 and the FMV of the pretend stock is $400.
Under 1.304-2(a)(4), the remaining $200 of the distribution will be applied to and reduce the basis of
each share of Figg Corp. stock held by Harry allocated ratably. Harry owns 70 shares in each block of
real and pretend stock, so each block gets 50% of the remaining $200 distribution.
We are going to reduce the 2 blocks by $100 each. The pretend stock will be reduced to $100 basis
(Harry’s basis in the pretend Figg stock is the $200 basis of his Bones stock according to section 351),
and the real Figg stock (70 shares with $140 basis) will be reduced by $100 to $40 basis.
75
Harry has 70 real shares of Figg. The proposed regulations tell us to take those 70 shares and divide
them into 2 blocks, 35 shares each. In one of the blocks, Harry will have a basis of $100 and in the
other block Harry will have a basis of $40. Harry will be required to keep track of each.
3. Instead, assume that Harry owns 45% (45 shares) of Figg Corp stock with an aggregate basis of $90 and
sells all 100 of his Bones Corp stock to Figg Corp for $400 in cash. What tax result to Harry, Bones Corp
and Figg Corp?
Redemption through Use of Related Corporation where § 304 Does not Apply—§1001 Sale/Exchange
§ 304(a)(1)(A): Harry owns 45% of Figg Corp. so Harry only “controls” 1 corporation (can’t control
Figg/acquiring corp before or after the sale), and § 304(a) does not apply. So it is just a § 1001 sale.
Harry:
§ 1001: RE: AR = $400, AB=$200; G = $200 * .20 = $40 tax
TOTAL TAX = $40
Figg Corp.:
§ 1012 cost basis for Bone stock = $400
Bones:
No tax consequences.
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Unit IV.A—Stock Dividends
I.
II.
Distributions of Stock and Stock Rights—§ 305(a)—General Rule No TAX
 Gross income does not include the amount of any distribution of the stock of a corporation made by
such corporation to its shareholders with respect to its stock.
o Must be the distributing corporation’s own stock.
o Consequences to corporation where § 305(a) applies
 § 311(a)(1)—no gain or loss shall be recognized on distribution of stock. § 311(b)
does not apply to distribution of corporation’s own stock
 § 312(d)—distribution to distributee shall not be considered distribution of E&P if the
distribution was not subject to tax in the hands of the distributee under § 305(a).
Exceptions to general Rule—§305(b)—Distributions in Lieu of Money
 Exceptions: does the expansion cause the stockholder to be entitled to more of the company (more of
the economic pie)? If so, the stock distribution will be treated as a distribution, taxable under § 301.
Therefore, (a)—the general rule—will not apply. Keep in mind that multiple may apply at the same
time.
o (b)(1)—option for stock or property
 If at the election of any of the shareholders (whether exercised before or after the
declaration thereof), payable either—
 In its stock, or
 In property
o (b)(2)—disproportionate distributions
 If the distribution (or a series of distributions of which such distribution is one) has
the result of—
 The receipt of property by some shareholders, and
 An increase in the proportionate interests of other shareholders in the assets or
earnings and profits of the corporation.
 Put simply, need:
 Distribution of property and (“companion property”)
o Note that dividends can satisfy this. Even if they do not occur
simultaneously with the increase in shareholder interest.
 1.305-3(d)(1) and -3(e) ex. 4.
 Proportionate increase in the interest in assets or E&P (profit).
o (b)(3)—distributions of common and preferred stock
 If the distribution (or a series of distributions of which such distribution is one) has
the result of—
 The receipt of preferred stock by some common shareholders, and
 The receipt of common stock by other common shareholders.
 What is the result?
 Treat as § 301 distribution to both the recipients of common and preferred.
o (b)(4)—Distributions on Preferred Stock
 If the distribution is with respect to preferred stock, other than an increase in the
conversion ratio of convertible preferred stock made solely to take account of a stock
77
III.
dividend or stock split with respect to the stock into which such convertible stock is
convertible.
 Here the preferred shareholder’s piece of the pie is growing. Whenever anything is
given to preferred stockholders, § 301 will apply. Unless the exception applies.
o (b)(5)—Distributions of Convertible Preferred Stock
 If the distribution is of convertible preferred stock, unless it is established to the
satisfaction of the Secretary that such distribution will not have the result described in
paragraph (2).
 Distribution of convertible preferred stock will be § 301 distribution. Because all
people would be receiving convertible, some may convert which would increase their
share if others did not.
 Reg. 1.305-6(a)(2) addresses this issue.
o Whether conversion rights must be exercised within a certain amount
of time, etc.
Certain Transactions Treated as Distributions—§ 305(c)
 Certain Transactions Treated as Distributions
o Deemed stock dividend if…
 Specified act occurs AND
 Increase in proportionate interest in assets OR earning and profits of at least one
shareholder.
o Result: Treat as a distribution with respect to any shareholder whose interest was increased.
The pretend stock distribution must then be run through § 305(b) to see if it will be taxable.
§ 302(b)(2) is the most common exception for this. Therefore, § 301 will control.
 Ex. Shareholder A and B. B sells half of his stock for cash to the corporation. This would result in
A’s share of the corporation increasing.
o Will we pretend that A is getting stock.
 This is important and something I did not take from reading the statute.
 § 1.305-3(b)(3)
o This reg says if the receipt of property is the result of an isolated redemption of shares, §
305(c) will not apply.
 § 1.305-3(e)
o Provides further illustration. One shot redemptions are okay. A series of them every six
months would be worse and be subject to § 305(c).
o Without the regulations every redemption that fails § 302 would potentially be subject to §
305(c).
o Ex. 8 (not tested on)
 Tells how to calculate the pretend shares received by the non-redeemed shareholder.
If the number between profits and assets were different in the following equation, the
bigger number would be used.
 X = (number of shares owned by non-redeemed shareholder before the redemption +
Y) / Total shares outstanding before redemption + Y). X is the ownership post
redemption
 Ex.
78
o .6 = (180 + Y) / (360 + Y)
o Y = 90
o 45 stock.
IV.
V.
VI.
Allocation of Basis—§ 307
 If a shareholder in a corporation receives its stock or rights to acquire its stock (referred to in this
subsection as “new stock”) in a distribution to which section 305(A) applies, then the basis of such
new stock and of the stock with respect to which it is distributed (referred to in this section as “old
stock”), respectively, shall, in the shareholder’s hands, be determined by allocating between the old
stock and the new stock the adjusted basis of the old stock. Such allocation shall be made under
regulations prescribed by the Secretary.
o Formula = old basis x (new common FMV/total FMV)
o Reg. 1.307-1 provides more guidance.
 § 1223(4)
o The holding period of the new stock is the holding period of the old Stock.
Eisner v. Macomber
 Standard Oil makes a 50% stock distribution.
 Holding
o Not taxable.
 Reasoning and analysis
o Basically says that you need to have an accession to wealth before it to be taxable.
Therefore, stock dividends are not taxable
Koshland v. Helvering
 Two types of stock outstanding—nonvoting preferred and common. The corporation distributes
common stock to the nonvoting preferred owners.
 This should be treated differently because it is very different from Eisner. The preferred stockholder
gains more of the business in these transactions.
 Holding
o Common stock distributions on preferred stock are taxable.
Problems
Frog Corp. is a Subchapter C corporation with significant current and accumulated earnings and profits.
1. Assume that Frog Corp. has two classes of stock outstanding, common and non-convertible preferred. The
preferred shares are entitled to a cumulative annual dividend of $6 per share, payable before any dividends
may be paid on the common shares. Describe the federal income tax consequences if Frog Corp. distributes:
Common Stock Dividend—§ 305(a) General Rule
Frog Corp.:
§ 305(a) Turned On!
§ 311(a): No gain or loss shall be recognized to a corporation on the distribution with respect to its stock of its
stock.
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§ 311(b): Doesn’t apply to Corporation’s own stock because “property” under § 317(a) does not include stock
in the corporation making the distribution.
E&P: § 312(d): The distribution shall not be considered a distribution of the E&P of any corporation – (B) if the
distribution was not subject to tax in the hands of such distributee by reason of § 305(a).
Andrew:
§ 307(a): Basis: Need to allocate the basis between the old stock and the new stock when § 305(a) applies.
 The Formula on how to allocate is in § 1.307-1: The date of the distribution in each case shall be the
date the stock or the rights are distributed to the stockholder and not the record date. Allocate based
on the proportion of the FMV values of each on the date of distribution.
o Old Basis * (FMV New Shares/FMV Total Shares) = Basis of New Shares
o 1,000 Old Basis * ($90 New Shares/$990 Total Shares) = $90.91
o The new common shares have a basis of $90.91
 The holding period of new stock shall be equal to the holding period of the old stock
under § 1223(4).
o The old common shares is just the $1,000 old basis - $90.91 New Share Basis = $909.09.
a. one share of common on each ten shares of common outstanding, the common shareholders having
the option, however, to receive cash in lieu of stock.
Distributions in Lieu of Money—§ 305(b)(1) exception to § 305(a)—Common Stock Dividend
Option to Receive Cash in Lieu of Stock.
§ 305(b)(1):
o Have Shareholders who decide to take the cash: Treat as a § 301 Distribution.
o Have Shareholders that choose stock:
o New Common:
 Treat as a § 301 Distribution under § 305(b)(1). The FMV of the new shares is
the amount distributed under § 301(b). Technically, § 1.305-1(b) is the authority:
FMV of such stock or rights on the date of the distribution is the amount of
the distribution for § 301 distribution.
 Ask Blank about this – shouldn’t the rule at 1.305-1(b)(2) apply since
this is an “in lieu of cash” stock div? (that rule states that the amount
of the distribution would be the amount of money the s/h electing to
receive stock could have elected to receive instead)???
 Basis: § 301(d): the basis of the property received in a distribution to which
subsection (a) applies shall be the FMV of the property. Basis = FMV of
Property
 ***No allocation needed because § 307 only applies when § 305(a) is
turned on!
o SO: Old Common: No change to the basis!
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Frog:
§ 311(a): No gain or loss recognized.
E&P/312(d): § 1.312-1(d): In the case of a distribution of stock or rights to acquire stock a portion
of which is includible in income by reason of section 305(b), the earnings and profits shall be
reduced by the FMV of such portion. No reduction shall be made if a distribution of stock or rights
to acquire stock is not includible in income under the provisions of section 305. Reduce E&P by
FMV of distributed shares in a taxable stock distribution (under 305(b) and 301).
**§ 1.305-2(a): For § 305(b)(1), it does not matter if SHs elect to take cash instead of stock, vice
versa, it just matters that the option is there!!!! All distributions will be treated as a
distribution of property to which section 301 applies.
b. one share of common on each share of non-convertible preferred stock outstanding.
Stock Dividend—Distributions on Preferred Stock—§ 302(b)(4)
The common shares are being distributed to the nonvoting preferred stock SHs.
§ 305(b)(4):
o Distribution with respect to preferred stock.
o Treat as a § 301 distribution, and TURNED OFF § 305(a) – so, no allocation of basis
between the old and “new” shares.
o § 1.305-5(a): The distinguishing feature of “preferred stock” for the purposes of section
305(b)(4) is not its privileged position (generally associated with specified dividend and
liquidation priorities) as such, but that such privileged position is limited and that such stock
does not” participate in corporate growth” to any significant extent.  This definition is a little
different than the general definition of preferred stock, and is a facts and circumstances test.
***Any way around this outcome? Could argue that it isn’t actually preferred stock, since it is
preferred (not limited) in its participation in the corps growth (gets the first 6 of dividends, on
cumulative basis). Would argue it was just another class of common stock. Reg. 1.305-5. The
treasury is looking to whether it is limited on dividends and liquidation and you don’t
participate materially in corporate growth. However, this argument likely would fail given
our facts. Calling it preferred is a bad step.
2. Now assume that Frog Corp. has two classes of common outstanding, 90 shares of Class A and 180 shares
of Class B. Describe the federal income tax consequences if Frog Corp. distributes:
a. cash on the Class A common and Class B common on the Class B common.
Stock Dividend—Disproportionate Distributions—§ 305(b)(2)—2 Classes of Common/Cash to One and
Stock to the Other
The Class B slice of pie will get bigger.
§ 305(b)(2):
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o 1.) Receipt of property by some SHs  Yes, Class A Common SHs received CASH.
o 2.) Increase in proportionate interests in the assets or E&P of the Frog Corp.  Yes, Class
B Common SHs interest increased.
o Therefore, under § 302(b)(2), ALL SHs are taxed as a § 301 distribution – EVEN the
CLASS A s/hs who elected to receive cash (their s. 301 amt of distribution is the amt of cash
recieved)???
b. cash in redemption of one-third of the Class B common on a pro rata basis. Assume, alternatively,
that:
Classified as a redemption under § 317(b).
If § 305(c) is triggered, then treated as a pretend stock dividend (aka deemed stock dividend)
to SHs who have increase in E&P or assets. Need to pretend Class A SHs are receiving a
deemed stock dividend.
i. The Frog Corp. shares are owned by two individuals, Arnold and Adrianne, as follows:
Arnold
Adrianne
Class A Shares
45
45
Class B Shares
90
90
Pro Rata Cash Redemption—Certain Transactions Treated as § 301 Distribution—§ 305(c)
If § 305(c) applies it will treat the Class A shareholders as having a deemed stock
dividend.
Step 1: IS THERE A REDEMPTION? Same analysis under § 302:
o Arnold:
o Before: [(45+90=135)/(90+180=270)] = 50%
o After: [(45+60 = 105) / (90+120=210)] = 50%
o FAILED all the test under § 302(b), so no sale or exchange treatment under
§ 302(a), and treat as § 301 distribution under § 302(d).
Step 2: DOES § 305(C) GET TURNED ON?
o SHs: Both treated the same here because same amount redeemed for each SH:
o 1.) Redemption which is treated as a distribution to which § 301 applies 
Yes, PASSED
o 2.) Proportionate Interest Increased  NO, FAILED because Both SHs
owns 50% before and 50% after.
o Therefore, never have to enter § 305 because § 305(c) was not turned on!!!
SO would just have a § 301 deemed distribution because pro rata cash redemption fails
§ 302(b), which would have § 302(d) send us to § 301 to determine consequences.
§ 305(c) Requires:
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

(1)Specified act occurs AND
o Change in conversion ratio
o Change in redemption price
o Difference between redemption price and issue price OR
o Redemption which is treated as a distribution to which § 301 applies
(2)Increase in proportionate interest in assets OR earning and profits of at least
one shareholder.
ii. Arnold holds 90 shares of Class A common and Adrianne holds 180 shares Class B common.
Class A and Class B each have 1 vote per share and participate equally in dividends (the
difference between the two classes of stock is that Class A shares assets with Class B in
liquidation in the ratio of 2:1).
Redemption of Stock Treated as Deemed Stock Dividend—§ 305(c) Turned On
Arnold
Adrianne
Class A
90
0
Class B
0
180
Step 1: IS THERE A REDEMPTION? Same analysis under § 302:
o Adrianne
o Before: [(0+180=180)/(90+180=270)] = 66%
o After: [(0+120 = 120) / (90+120=210)] = 57%
o FAILED all the tests under § 302(b), so no sale or exchange treatment
under § 302(a), and treat as § 301 distribution under § 302(d).
Step 2: DOES § 305(c) GET TURNED ON?
o 1.) Redemption which is treated as a distribution to which § 301 applies  Yes,
PASSED
o 2.) Proportionate Interest Increased  Yes, PASSED because Arnold’s interests in
E&P increased from before to after.
Arnold
Adrienne
Class A
Before: 90/270
33%
After: 90/210
43%
10% Increase
Class B
180/270
120/210
o Now, § 305(c) is TURNED ON!! Treated as a deemed stock dividend for Arnold.
o NOTE: Just need an increase in the interests of E&P OR Assets for § 305(c) second
requirement to be met. Arnold already met the E&P increase requirement, but he
also would have met the Assets increase as well.
o Multiplied Assets by 2, relative to the Class A 2:1 liquidation ratio, relative to
the Class B Stock.
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Class A
Class B
Arnold
Before: 180/360
After: 180/300
50%
40%
Adrianne
50%
60%
180/360
120/300
Step 3: § 305(c) IS TURNED ON! So Deemed Stock Dividend. Tax Treatment?
o There is now Pretend Class A Stock, will it be taxed or not?
o Treated as a pretend stock dividend (aka deemed stock dividend) to SHs
(Arnold) who have increase in E&P or assets. Need to pretend Class A SHs
(Arnold) are receiving a deemed stock dividend.
o 1.) Run it through the § 305(b) Exceptions
 § 305(b)(2): PASSED: Applies because (A) Adrianne is getting
property, and (B) Arnold’s increased interest in E&P.
 Turn off § 305(a).
 Tax has to be paid!!! Treated as a § 301 distribution—§ 302(b).
 JUST KNOWING THAT THERE WILL BE TAX PAID IS
AS FAR AS WE HAVE TO GO ON THE EXAM, BUT
BELOW IS THE FURTHER ANALYSIS ON HOW MUCH
TAX WILL BE PAID, ETC.!!!
o § 1.305-3(e), Ex. 8
 x = (# shares before redemption of non-redeemed SH + y)/(total # shares
outstanding before the redemption + y)
 x is the ownership post-redemption to the non-redeemed SH
 .6 = (180+y)/(360+y)
 y = 90 additional assets, which is equivalent to 45 shares of stock in this
problem because 2:1. These are the additional shares that are to be
distributed to Arnold in the deemed stock dividend and 45 shares * FMV
of the shares = the Value of the § 301 Distribution to Arnold.
o § 1.305-3(b)(3): In addition, a distribution of property incident to an “isolated
redemption” of stock will not cause section 305(b)(2) to apply even though the
redemption distribution is treated as a distribution of property to which section
301 applies. § 1.305-3(e), Ex. 10 illustrates this perfectly!
 One time redemption is OK, and § 305(c) will not apply!
 Series of redemption is not isolated so § 305(c) can apply.
3. Now assume that Frog Corp. has 100 shares of common and 50 shares of convertible preferred outstanding.
The preferred is entitled to an annual non-cumulative dividend of $6 per share and converts to the common
on a 2:1 ratio (i.e., each share of preferred is convertible into two common shares, such that, if all preferred
shares were converted, the 50 preferred would convert to 100 common). Describe the federal income tax
consequences if Frog Corp.:
a. distributes cash on the preferred.
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Cash Distribution on Preferred Stock  Simple § 301 Cash Distribution
The distribution of cash on the preferred is a § 301 distribution because the shareholder is just
receiving cash.
b. distributes 1 share of common on each share of common outstanding. Assume that the preferred
contains no anti-dilution feature (i.e., no adjustment to the conversion ratio to reflect issuance of
common shares).
Common and Convertible Preferred Outstanding—Stock distributed on Common and $6 dividend to
preferred Every year—§ 305(d)(1)
The common SHs will get a bigger piece of the pie because no adjustment to the x2 common
for CPS shareholders.
§ 305(d)(1): Rights to acquire stock – For purposes of this section, the term “stock” includes
rights to acquire such stock.
§ 1.305-3(b)(5): In determining whether a distribution or a series of distributions has the result of
a disproportionate distribution, there shall be treated as outstanding stock of the distributing
corporation (i) any right to acquire such stock (whether or not exercisable during the taxable
year), and (ii) any security convertible into stock of the distributing corporation (whether or not
convertible during the taxable year).
Common Share of
Total Shares
Convertible Preferred
Share of Total
With § 305(d)(1) / § 1.305-3(b)(5)
Outstanding Stock
After Stock Dividend
100/200 = 50%, the 200
200/300 = 67%, there
is made up of 100
are now 200 common
common, and 100
shares because
pretend from CPS rights distributed 1 share of
(50x2).
common for each
[Common Shares
common share (so
Owned/Outstanding
distributed 100
Common Shares]
common shares) + 100
100/ 200 = 50%, rights to 100/300 = 33%
acquire stock as
common stock
Therefore, the preferred shares’ ownership goes down.
§ 305(b) analysis:
§ 305(b)(2): Passed:
 “property” does not include corporation’s own stock  is the $6 dividend enough for
property? So there must also be “companion property”
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

o The preferred shareholders are entitled to a $6 per share dividend every year.
o § 1.305-3(d)(1), -3(e), Ex. 4: It is hard to find this exactly in these Regulations, but
reading into it, the $6 dividend is enough for property!!!
o Passed this part!
o Note: the stock and dividend do not have to happen at the same time.
Proportionate interest of other shareholders increase? Passed.
Therefore, § 305(b)(2) applies, and § Turn off § 305(a), treat as a § 301 distribution.
86
Unit IV.B—Dispositions of Tainted Stock
I.
II.
General Example
 Hazel and frank receive preferred stock and then sell it to insurance.
o On distribution, none of § 305(b) would apply, therefore § 305(a) would make this a tax free
distribution of stock.
o A § 307 allocation of basis would take place. 100 shares of common with $100 basis must
be allocated to 100 shares preferred. FMV of common = $4 and preferred = $1. 100 x
100/500 = $20 basis in preferred stock. This leaves an $80 basis in the common stock.
o On sale of preferred stock he would have an $80 gain at 20% tax = $16.
 The abuse: this transaction allowed Frank to spread basis from common stock to preferred stock and
immediately use the basis.
o If this had been a cash distribution then it would have just been treated as a § 301
distribution. $160 E&P so $80 would be dividend, resulting in $16 tax.
o The remainder would reduce basis to $80.
o So what is the difference? In this situation, nothing. BUT if E&P were higher, then the entire
amount would be taxed as dividend.
Dispositions of Certain (Tainted) Stock—§ 306
 Basic idea is that when shareholder gets preferred stock in a pro rata stock distribution and as a result
§ 305(a) applies, we will not tax that stock. However, the stock will be tainted as 306 stock. When
it is sold or redeemed it will be treated specially.
 § 306(a)(1)—SALE
o AR = OI to extent of PRO RATA portion of issuing corp’s E&P at time SH received § 306
stock—§ 306(a)(1)(A);
 This at the qualified dividend rate (20%)—§ 306(a)(1)(D).
o AR MINUS
 Amount treated as ordinary income AND (plus)
 Shareholder’s adjusted basis in § 306 stock
 = gain from the sale of stock—306(a)(1)(B).
o Losses are not recognized—306(a)(1)(C).
 § 306(a)(2)—REDEMPTION
o AR = § 301 distribution
 § 306(A)(2)/ Reg. § 1.306-1(c)
o Timing:
 Look to E&P of issue corp in the year of redemption (can use all available E&P, not
just ratable share).
 Exceptions—§ 306(b)—remember these don’t take away the taint, they only take away the negative
impact
o (b)(1)——disposition totally terminates SH’s interest
o (b)(2)—disposition is incomplete liquidation of corporation
o (b)(3)—disposition is in a nonrecognition transaction
o (b)(4)—tax avoidance not a principal purpose
 This is a fact specific discussion.
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


§ 306(c) defines – must meet one of the paragraphs, we are only concerned with (A).
o § 306(c)(1)(A)—
 Stock (other than commons stock issued with respect to common stock) which was
distributed to the shareholder selling or otherwise disposing of such stock if, b reason
of § 305(a), any part of such distribution as not includible in the gross income of the
shareholder.
 Requirements
 Preferred stock
 § 305(a) applies
 Sell/dispose
Things that are not § 306 stock:
o § 306(c)(2)—exception for where there are no earnings and profits at the distribution of stock
was made.
Exceptions—§ 306(b)—remember these don’t take away the taint, they only take away the negative
impact
o (b)(1)—disposition totally terminates SH’s interest
o (b)(2)—disposition is incomplete liquidation of corporation
o (b)(3)—disposition is in a nonrecognition transaction
o (b)(4)—tax avoidance not a principal purpose
 This is a fact specific discussion.
Problems
Hazel and Frank (unrelated individuals) organized Octavian Corp in 1997, each contributing $100 and
each receiving 100 shares of common stock. In June 2001, Octavian Corp declared a dividend payable in
preferred stock, one share of preferred for each share of common outstanding. The preferred stock's value at the
date of distribution was $1 per share ($100 each for Hazel and Frank); the value of the common stock after the
distribution was $4 per share ($400 each for Hazel and Frank).
On January 1, 2001, Octavian Corp had accumulated earnings and profits of $130 and current earnings
and profits of $30. On January 1, 2007, Octavian Corp had accumulated earnings and profits of $280 and
current earnings and profits of $20.
What are the tax consequences of the following dispositions, applying the federal tax law as in effect in
2014?
Rationale/Policy for § 306: The stock dividend of preferred shares would fall under § 305(a) because it does
not meet any of the exceptions under § 305(b). Therefore, need to allocate Frank’s basis under § 307. $100
shares of common @ FMV = $4 per share, and 100 shares of preferred @ $1 per share. The original basis of
$100 * ($100/$500) = $20 of basis for the new shares of preferred, and $80 of basis ($100-$20) for the old
common shares. Then, SH turns around and sells the preferred shares to a 3rd party for $100 cash. The SH
can use the $20 basis to not be taxed on the full $100 received resulting in an $80 realized gain on the sale
88
instead of $100 realized gain. This was believed to be abusive so Congress enacted § 306 to stop this from
happening.
 § 306: the preferred stock will become “§ 306 stock,” and the disposition of “§ 306 stock” will have
special tax treatment.
§ 306(c)(1): the term “section 306 stock” means stock which meets the requirements of subparagraph (A), (B),
or (C) of this paragraph.
 § 306(c)(1)(A): Distributed to Seller: Stock (other than common stock issued with respect to common
stock) which was distributed to the SH selling or otherwise disposing of such stock if, by reason of
section 305(a), any part of such distribution was not includible in the gross income of the shareholder.
o Requirements for (A): (1) Needs to be preferred stock (2) § 305(a) stock, AND sale or
disposition  if all 3 of these requirements are met then have “§ 306 stock.”
§ 306(c)(2): EXCEPTION WHERE NO EARNINGS & PROFITS: the term “§ 306 stock” does not include any
stock no part of the distribution of which would have been a dividend at the time of the distribution if money
had been distributed in lieu of stock.
 Simple language: Corp. that has no E&P at time of stock distribution can’t be § 306 stock. TAKES
AWAY THE TAINT OF THE STOCK.
o Congress did this because it is not abusive because with no E&P the chance of abuse is very
limited.
§ 306(a)(1): Dispositions other than Redemptions: (SALE)
§ 306(a) does not apply if . . .
 Disposition totally terminates SH’s interest (§ 306(b)(1))
 Disposition is in complete liquidation of corporation (§ 306(b)(2))
 Disposition is in a nonrecognition transaction (§ 306(b)(3))
 Tax Avoidance not a principal purpose (§ 306(b)(4))
1. In December 2007, Hazel sells all of her preferred stock to Jason, an unrelated individual, for $85; and in
June 2008, Hazel sells all of her common stock to Wayne, an unrelated individual, for $500.
Preferred on Common Stock Dividend, § 306 Tainted Preferred Sold, then Common Sold
Methodology: § 306(b) will turn off § 306(a) if any of the exceptions under § 306(b) apply. If no
exception applies, then ask if redemption. No, so go to § 306(a)(1)(A). If yes, then go to § 306(a)(2).
89
Step 1: Determine if there is § 306 stock under § 306(c)(1)(A)?
Did Hazel not include the preferred stock in her GI under § 305(a)?  Yes, it didn’t qualify under
any of the exceptions under § 305(b), therefore § 305(a) applies to the preferred stock. § 306(c)(1)(A)
doesn’t deal with common stock issued with respect to common stock; only deals with preferred
stock; so if it was only common stock being sold then § 306 doesn’t apply.
Step 2: Tax Consequences?
1.) Hazel sells her preferred stock to Jason, an unrelated individual Dec. 2007:
o $100 common shares @ $4 per share and $100 preferred stock @ $1 per share.
 Because § 305(a) applies to the preferred stock, have to allocate the basis under §
307.
 $100 original basis * ($100 [preferred value/$500 [total value]) = $20 basis for
preferred stock, and then (100-20=80) so $80 basis for common stock.
o § 306(a)(1)(A): Have to look at E&P @ time of the preferred distribution (June 2001).
 2001 Total E&P = $160 (made up of $130 AEP, $30 CEP)
 Ratable share of E&P allocated to the distribution: $100 distribution * ($160
E&P / $200 total distribution) = $80. The $80 is treated as Ordinary Income,
but taxed at 20% (however, will be characterized the same way as a qualified
dividend income) under § 306(a)(1)(D). $80 * 20% = $16 TAX
o § 306(a)(1)(B): Determining the Amount Realized from the sale to Jason?
 Formula: AR MINUS (Ordinary Income + Adjusted Basis in § 306 stock): $85 –
($80 + $20) = RL ($15): No loss is recognized under § 306(a)(1)(C).
o FINAL RESULT: $16 tax on sale of preferred stock + $15 unrecognized loss. What
happens to the unrecognized loss?
 The loss will adjust the basis of the common stock under § 1.306-1(b)(2), Ex. 2
 The loss that is not able to be recognized is added back to the basis of the
common stock 80+15=$95. This per 1.306-1(B)(2) ex. 2. $95 Basis in
Common Stock.
2.) Hazel sells her common stock to Frank for $500 in June 2008:
 The sale to Frank will just be a realization event under § 1001, but have to use the new
basis for the common stock of $95, which we calculated above.
o AR $500, AB $ 95; RG $405 @ 20% = $81 tax
o TOTAL TAX LIABILITY = $81
 § 306(c)(1)(A) doesn’t apply because common stock, and is originally held stock.
3.) Octavian:
 No E&P adjustment under § 1.306-1(b)(1)!!!!
o § 1306-1(b)(1): No reduction of earnings and profits results from any disposition of
stock other than a redemption.
4.) Frank:
 No Tax Consequences, except a basis in purchased common stock is the cost basis under §
1012 = $500.
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How would this answer change if no E&P existed at the time of the distribution?
The stock would not have been § 306 stock to begin with because there is an exception in § 306(c)(2),
exception where no E&P at the time of distribution.
2. Same as (1), except that the sales to Jason and Wayne take place in reverse order (i.e., Hazel sells all of her
common stock to Wayne for $500 in December 2007, and then Hazel sells all of her preferred stock to Jason
for $85 in June 2008).
Preferred on Common Stock Dividend, § 306 Tainted Common Sold, then Preferred Sold—Taint
Lifted—§306(b)(1)(A)
Step 1: Determine if there is § 306 stock under § 306(c)(1)(A)?
Did Hazel not include the preferred stock in her GI under § 305(a)?  Yes, it didn’t qualify under any of
the exceptions under § 305(b), therefore § 305(a) applies to the preferred stock. § 306(c)(1)(A) doesn’t deal
with common stock issued with respect to common stock; only deals with preferred stock; so if it was only
common stock being sold then § 306 doesn’t apply.
Step 2: Tax Consequences?
1.) Hazel sells her $500 common stock to Frank:
 The sale to Frank will just be a realization event under § 1001, but have to use the allocated
basis for the common stock of $80 determined in previous problem under § 307.
o AR $500, AB $ 80; RG $420 @ 20% = $84 tax
o TOTAL TAX LIABILITY = $84
 § 306(c)(1)(A) doesn’t apply because common stock, and is originally held stock so not § 306
stock.
2.) Hazel sells her preferred stock to Jason, an unrelated individual:
o § 306(b): § 306(b)(1)(A) applies so it turns off § 306(a):
 § 306(b)(1) – TERMINATION OF SHAREHOLDER’S INTEREST, ETC. – (A) Not in
Redemption – If the disposition – (i) is not a redemption; (ii) is not, directly or indirectly,
to a person the ownership of whose stock would (under § 318(a)) be attributable to the
shareholder; AND (iii) terminates the entire stock interest of the shareholder in the
corporation (and for purposes of this clause, section § 318(a) shall apply).
 Hazel interest in Octavian Corp is terminated when she sells her remaining
preferred stock to Jason, an unrelated individual.
 Treat as a Realization Event under § 1001: AR $85, AB $20; RG $65 @ 20% = $13
tax
 TOTAL TAX LIABILITY = $13
3.) Octavian:
 No tax consequences
4.) Frank:
 No Tax Consequences, except a basis in purchased common stock is the cost basis under §
1012 = $500.
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**The purpose of § 306(a) is to prevent the shareholder from owning both common stock and
holding cash. In this instant, that is not at issue.
3. In June 2007, Octavian Corp redeems all of Hazel’s preferred for $85.
Preferred on Common Stock Dividend, § 306 Tainted, Preferred Stock REDEEMED
Methodology:
1.) Is it § 306 stock under § 306(c)(1)(A)?
2.) If so, look at the exceptions under § 306(b)?
 If no exception applies, THEN
3.) Is it a redemption under § 317(b)? If yes look at § 306(a)(2)—If redeemed:
 The amount realized shall be treated as a distribution of property to which § 301 applies
(treat as a § 301 distribution).
Hazel:
Can use all E&P in the year of the redemption [NOTE: this is a different timing for E&P than §
306(a)(1)(A)(2), which would focus on E&P at the time of the distribution]; not just the ratable share
of the E&P (as the analysis is for § 306(a)(1)) for applying the § 301 distribution analysis!!!!!
§ 301 Analysis: $85 distribution; CEP $20; AEP $280
(c)(1): $85 dividend ($20 from CEP and $65 from AEP) * .20 = $17 tax.
TOTAL TAX LIABILITY = $17
What happens to basis in preferred shares? $20 basis  Add it to the basis of the common stock =
$20+$80 = $100 basis in common shares. The authority for this is under § 1.302-2(c): in any case in
which an amount received in redemption of stock is treated as a distribution of a dividend, proper
adjustment of the basis of the remaining stock will be made with respect to the stock redeemed.
Octavian:
§ 312(a)(1):
AEP: $280 - $65 = $215
CEP: $20 - $20 = $0
Additional Hypo:
1.) Assume 2007 E&P = $300 and 2008 E&P = $1 in Problem 3?  Nothing changes because only
look to current E&P in the year of the redemption when dealing with redemptions. BUT if there
had been $1 dollar in the year distributed, that would be sufficient to cause it to fail the E&P safe
harbor of § 306(c)(2)
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Unit V.A—Liquidations in General
I.
II.
III.
Three Sale Possibilities
 Sale Followed by Liquidation
 Liquidation Followed by Sale
 Sale of Stock
Shareholder Treatment
 § 331(a)—Amounts received by a shareholder in a distribution in complete liquidation of a
corporation shall be treated as in full payment in exchange for the stock.
o Seller gets sale or exchange treatment  taking us into § 1001.
o AR will be FMV of property distributed less any liabilities that the shareholder assumes.
o The gain is AR – shareholders outside basis.
- Rev. Rul. 59-228
o § 331(b) says that § 301 shall not apply to any distribution of property in complete
liquidation.
 § 346(a)—defines “in complete liquidation”
o A distribution qualifies if it is “one of a series of distributions in redemption of all of the
stock of the corporation pursuant to a plan.”
- i.e. the business shuts down – if it exists at all, it is only because it is winding down –
so, could be considered liquidating even though it still exists
 § 334(a)—basis of property received in liquidations
o If property is received in a distribution in complete liquidation, and if gain or loss is
recognized on receipt of such property, then the basis of the property in the hands of the
distributee shall be the FMV of such property at the time of the distribution.
 § 6901
o Makes the corporation’s tax liability from the distribution a liability to the
shareholder/transferee.
Corporation Treatment
 § 336(a)
o Gain or loss shall be recognized to a liquidating corporation on the distribution of property in
complete liquidation as if such property were sold to the distributee at its fair market value.
- Note: this is different than § 311(a) or (b) relating to partial liquidations where loss is
disallowed.
 § 336(d)(1)—No loss recognized in certain distributions to related persons
o Non pro rata and related party (w/in meaning of § 267)
- If so, loss disappears.
o Disqualified property and goes to related person
- Disqualified property is property received under § 351 during the 5-year period
ending on the date of distribution.
 § 336(d)(2)—Special Rule for Certain Property Acquired in Certain Carryover Basis Transactions
o IF:
- § 351 property
- Built in loss
93
IV.
V.
- Corporations acquisition of the property was part of a plan to trigger the loss
- **note it does not regard related persons
o Then the statute says that you will reduce the AB by the amount the basis exceeds the FMV.
Effectively, reduce the basis to the FMV at the time of the distribution—reread this language,
seems to be some language that I got wrong (there are some timing issues going on)
o Therefore, there is no loss, but the way of doing so is to reduce the basis
 If § 336(d)(1) and (d)(2) apply, the related parties will have it denied under § 336(d)(1), and the nonrelated parties will have the loss disallowed under § (d)(2).
Transferred Assets—§ 6901: Tax liability goes to shareholder!
 This provision makes the recipient responsible for the tax liabilities of the liquidating corporation.
Gain or Loss Recognized on Property Distributed in Complete Liquidation—§ 336
 EXCEPTIONS
o § 336(d)(1)—No loss recognized in certain distributions to related persons
o § 336(d)(2)—Special rule for certain property acquired in certain carryover basis transactions
Problems
Olympus Co. owns a single asset, a rental apartment building that it has owned since 1998. The building
has a fair market value of $1,000, subject to a mortgage liability of $400. Olympus Co.’s adjusted basis for this
property is $300. All of Olympus Co’s stock is owned by Piper, an individual, whose basis in her Olympus Co.
stock is $100. Olympus Co. has $200 of current earnings and profits, uses the cash method of accounting and
reports on a calendar year basis. All of Olympus Co.’s income is taxed at a marginal federal income tax rate of
35%.
In the following problems, state the amount of realized and recognized gain or loss to the parties.
What requires more work: Sale of stock of the corporation or the sale of the assets?
 Selling Stock is much more complicated for tax lawyers, but easier for corporate lawyers.
 Vice versa for the Sale of Assets
Three Sale Possibilities:
1.) Sale of assets Followed by a Liquidation
2.) Liquidation Followed by Sale of assets
3.) Sale of Stock
§ 346(a): COMPLETE LIQUIDATION: For purposes of this subchapter, a distribution shall be treated as in
complete liquidation of a corporation if the distribution is one of a series of distributions in redemption of all of
the stock of the corporation pursuant to a plan.
§ 331: GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS: § 331 (a) Distributions in
Complete Liquidation Treated as Exchanges – Amounts received by a shareholder in a distribution in complete
94
liquidation of a corporation shall be treated as in full payment in exchange for stock. § 331(b): Nonapplication
of Section 301 – Section 301 shall not apply to any distribution of property in complete liquidation.
 Sale or Exchange Treamtent under § 331.
o Amount Realized: FMV of the assets received MINUS liabilities assumed by the shareholder.
 Liabilities assumed authority is Rev. Rul. 59-228
o Adjusted Basis: Shareholder’s basis in the stock also can be referred to as the Outside Basis.
§ 334: BASIS OF PROPERTY RECEIVED IN LIQUIDATIONS: § 334(a): If property is received in a
distribution in complete liquidation, and if gain or loss is recognized of such property, then the basis of the
property in the hands of the distributee shall be the FMV of such property at the time of distribution.
§ 336: GAIN OR LOSS RECOGNIZED ON PROPERTY DISTRIBUTED IN COMPLETE LIQUIDATION: §
336(a): General Rule – Except as otherwise provided in this section of section 337, gain or loss shall be
recognized to a liquidating corporation on the distribution of property in complete liquidation as if such
property were sold to the distributee at its FMV. § 336(b): Treatment of Liabilities – the FMV of such property
shall be treated as not less than the amount of such liability.
§ 336(d): Limitations on Recognition of Loss: 2 BIG ONES WE WILL LOOK AT:
 1.) § 336(d)(1): No Loss Recognition: § 336(d)(1)(A): RELATED PERSONS: No loss shall be
recognized to a liquidating corporation on the distribution of any property to a related person (within
the meaning of section 267) if – (i) such distribution is not pro rata, OR (ii) such property is
disqualified property.
o Disqualified Property: § 336(d)(1)(B): Property acquired by the liquidating corporation to
which section § 351 applied during the 5-year period ending on the date of the distribution.
 2.) § 336(d)(2): “Anti-Stuffing Rule”: NEVER MENTIONS RELATED PERSONS
o 3 Requirements Need to be Met under § 336(d)(2)(B):
 1. Property received in a § 351 transaction (§ 336(d)(2)(B)(I)).
 2. Property was contributed with a Built-In Loss (§ 336(d)(2)(B)(II), AND
 3. Plan to trigger the loss (§ 336(d)(2)(B)(II))
o If these 3 Requirements are met, then under § 336(d)(2)(A)(i)&(ii), need to reduce the
liquidating corporation’s basis (but no below zero) in this Built-In Loss Property.
 (i) Reduce by the adjusted basis of such property immediately after its acquisition by such
corporation, over
 (ii) the FMV of such property as of such time.
 Example: Building has a basis of $3,000 and FMV = $1,000? Reduce basis by
($3,000-$1,000)= $2,000. Reduce the Basis of the Built-In Loss Property by
$2,000 to have a basis of $1,000.
 § 336(d)(1) and § 336(d)(2) both do the same thing by disallowing the loss, but § 336(d)(1) is used for
Related Persons, and § 336(d)(2) never mentions related persons so applies to unrelated persons.
 § 6901—Transferred Assets: Tax liability goes to shareholder!
o This provision makes the recipient responsible for the tax liabilities of the liquidating
corporation.
95
1. Valdez Corp. (an unrelated corporation) acquires the rental apartment building from Olympus Co. in the
following alternative ways:
a. Olympus Co. adopts a plan of liquidation in 2007, sells the property to Valdez Corp. in December
2007 for $600 in cash (with Valdez Corp. taking the property subject to the mortgage); Olympus Co.
then distributes the cash to Piper in complete liquidation in 2008.
Corporation Adopts Plan of Liquidation, Sells Assets, Distributes Cash to Shareholders (No § 336)—
Shareholder in Gain Position
Olympus Co.: (Liquidating Corp.)
**Good Idea to start at the Corporation Level First!
Sale to Valdez Corp.: § 1001: AR: $600 cash + $400 Assumption of Liability, AB $300; RG
$700 @ 35% = $245 tax in 2007
TOTAL TAX LIABILITY = $245
*§ 336 does not apply to Olympus Co. here because Olympus Co. is just distributing cash!
Piper: (Shareholder)
§ 331(a) applies, therefore, treated as full payment in exchange for stock. § 331(c) treat the sale
as the same tax consequences of § 1001.  AR $355 (this is the cash leftover after paying tax:
$600 - $245 [Federal tax Liability] = $355), AB $100, RG $255 @ 20% = $51 tax
TOTAL TAX LIABILITY = $51
Valdez Corp.: (3rd Party Purchaser)
§ 1012 cost basis in the rental building = $1,000
Note: Who pays the $245 tax? Assume Olympus Corp. pays the tax, which is why the cash
received is $355 instead of $600. This is actually set forth in § 6091.
Note: this transaction also looks like a § 302(b)(3) complete termination. So be careful with
how it should be treated.
b. Olympus Co. adopts a plan of complete liquidation in 2007 and distributes the property to Piper “in
kind” pursuant to this plan in December 2007. In 2008, Piper negotiates a sale of the property to
96
Valdez Corp. for $600 in cash with Valdez Corp. taking the property subject to the mortgage; the
sale closes in 2008.
Corporation Adopts Plan of Liquidation, Distributes Assets to Shareholders, Shareholder Sells Assets (§
336 applies)—Shareholder in Gain Position
“In-kind” means actual property and not cash.
Olympus Co.: (Liquidating Corp)
*Good Idea to start at the Corporation Level First!
§ 336—Gain or Loss on Recognized on Property Distributed in Complete Liquidation—treat
as if property were sold to distributee at its FMV: applies here: AR: $1,000, AB $300, RG $700
@35% = $245 tax
TOTAL TAX LIABILITY = $245
Piper: (Shareholder)
1.) § 331: Selling his stock to Olympus: AR: $1,000 FMV - $400 liability - $245 [Federal tax] =
$355, AB $100, RG $255 capital gain @ 20% = $51 tax in 2007.
TOTAL TAX LIABILITY = $51
§ 6901(a)&(b): Tax liabilities that become liability of other people? As sole SH, Piper is
responsible for the tax of Olympus Co.. This is assuming that Olympus Co. is no more, and
this is why $245 is subtracted from the Amount Realized above.
2.) Sale of property to Valdez Corp: § 1001: AR $600 cash + 400 liability, AB $1,000, RG $0 =
$0 Tax in 2008
TOTAL TAX LIABILITY = $0
Valdez Corp.: (3rd Party Purchaser)
§ 1012 cost basis in the rental building = $1,000
The only difference between (a) and (b) in this Problem is TIMING. This is not a big difference
though!
c. Piper sells her stock in Olympus Co. to Valdez Corp. in December 2007 for $600 in cash.
Sale of Stock to 3rd Party—Shareholder in Gain Position
This is just a simple § 1001 sale of stock.
Piper:
§ 1001: AR: $600, AB $100, RG $500 @ 20% = $100 tax
TOTAL TAX LIABILITY = $100
Valdez Corp.:
97
§ 1012 cost basis in the rental building = $600
There is $245 of tax built-in to the property because if the corp sells the building after the sale,
will have gain on the diff between the 1k FMV and its 300 basis, therefore Valdez shouldnt
have paid $600 for the stock – the corp contained a “Ticking Tax Bomb” because the corp’s
basis in the building is still the same, and didn’t get stepped up to cost (because the corp’s
stock gets the Cost basis, not the asset)– This is important for deal structuring!
2. If Piper’s basis in her Olympus Co. stock was $800, instead of $100, how would the tax results in the above
transactions change?
a. Olympus has the same treatment.
Corporation Adopts Plan of Liquidation, Sells Assets, Distributes Cash to Shareholders (No § 336)—
Shareholder in Loss Position
Piper:
§ 331(a): AR $355[1k minus 400 (liab assumed/mtg) minus 245 (corp tax liab assumed), AB
$800, RL ($445), the loss is recognized under § 331(a).
Recognize loss and gain under § 331(a)!! So Loss of $445.
b. Olympus has the same treatment
Corporation Adopts Plan of Liquidation, Distributes Assets to Shareholders, Shareholder Sells Assets (§
336 applies)—Shareholder in Loss Position
Piper:
§ 331(a): AR $1,000-$400-$245=$355, AB $800, RL ($445), loss is recognized under § 331(a).
c. The loss would be allowed. The simple sale controlled by § 1001 would result in an amount realized
of $600 and Piper’s basis is $800. This would be a LTCL of $200 for Piper.
Sale of Stock to 3rd Party—Shareholder in Loss Position
Piper: § 331 does not apply:
§ 1001: AR $600, AB $800, RL ($200)
Hypo
What if building had basis of 3000 and FMV of 1000 and distributed it to Piper – i.e. could the
corp realize the loss?
Could the Olympus recognize the loss of $2000? See 336(d)(1 and 2)
Base rule under § 336(a) says gain or loss shall be recognized.
BUT 2 limitations:
98



§ 336(d)(1) no loss recognized to the distring corp on distributions to related persons if
distrib not pro-rata or the distributiong is of “disqualified prop” (prop acquired in a
351 transaction os “as a contribution to capital”)
(d)(2) special rule for determining amount of loss w/re to prop acquired in carryover
basis transactions
§ 336(c) liquidations which are part of a reorg
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BEGIN CORPORATE TAX II
Unit V.B—Parent-Subsidiary Liquidations
I.
II.
III.
Reverse Treatment from Normal Liquidations
 § 332(a) reverses § 331
o Parent
 § 337(a) reverses § 336
o Sub
 § 334(b) reverses § 334(a)
o Basis
Requirements for Complete Liquidation of Sub—§ 332(b)
 Parent must own AT LEAST 80% of vote & value of Sub
 Continuously until the liquidation is completed.
 § 332—Complete Liquidations of Subsidiaries(Parent)
o § 332(a): General Rule – No gain or loss shall be recognized on the receipt of a corporation
of property distributed in complete liquidation of another corporation.
- Reverses § 331 effect
o § 332(b): Liquidations to Which Section Applies – For purpose of this section, a distribution
shall be considered to be in complete liquidation only if – (1) the corporation receiving such
property was on the date of the adoption of the plan of liquidation, and has continued to be
at all times until the receipt of property, the owner of stock (in such other corporation)
meeting the requirements of § 1504(a)(2); AND either (2) or (3) (look to Code for exact
language).
- § 1504(a)(2): at least 80% of total vote AND total value of the stock of the
corporation.
- Basically two requirement under § 332(b): 1) Parent must own at least 80% of vote
and value of subsidiary, and 2) ownership has to be continuous until the liquidation is
completed.
o Basis—§ 334(b) gives parent subs basis and other stuff. E&P also transfers/inherits tax
attributes.
o Holding period also tacks under § 1223
 § 337: NONRECOGNITION FOR PROPERTY DISTRIBUTED TO PARENT IN COMPLETE
LIQUIDATION OF SUBSIDIARY.
o § 337(a): In General – No gain or loss shall be recognized to the liquidating corporation on
the distribution to the 80-percent distributee of any property in a complete liquidation to
which section 332 applies.
Tax Consequences if § 332 Triggered
 Parent Corp
o No gain or loss under § 332(a)
o Basis in property received from subsidiary is a transferred/carryover basis under § 334(b)
o Tax attributes from subsidiary are incurred by Parent corporation under § 381 – includes
E&P, NOLs, Etc. etc.
100

IV.
Subsidiary Corporation
o No gain or loss under § 337(a)
§ 336(d)(3)
 In the case of any liquidation to which section 332 applies, NO LOSS shall be recognized to the
liquidating corporation on ANY distribution in such liquidation. The preceding sentence shall apply
to any distribution to the 80% distributee only if subsection (a) or (b)(1) of section 337 applies to
such distribution.
o If § 332 is triggered, no loss is allowed on distribution to the majority or minority owner.
- Why?
 Prevent the possibility of clustering loss property and distributing it all to one
owner and the gain property to the other.
Problems
Capone Corp. is the sole shareholder of Earhart Corp. Capone Corp.’s basis in its Earhart Corp. stock is
$100. Earhart Corp owns only one asset, rental property, which it has owned since 1999, with a gross market
value of $1,000, and which is subject to a mortgage liability of $400. Earhart Corp.’s adjusted basis in this
property is $300.
On January 21, 2009, Earhart Corp. adopts a plan of complete liquidation and distributes its property to
Capone Corp. “in kind” pursuant to this plan in December of 2009.
In 2010, Capone Corp. negotiates a sale of the property to another corporation, Daley Corp, for $1,000
($600 in cash with Daley Corp. taking subject to the mortgage). The sale closes in 2010 as well.
Corporation Owned 100% by Another Corporation Liquidates, Distributes Property
Earhart Corp. (Controlled Corp):
§ 337(a)  does § 332 apply? If it does, then no gain or loss should be recognized to the liquidating
corporation on the distribution to the “80-percent distributee.”
 Capone Corp. owns 100% if Earhart Corp. so it qualifies and no gain or loss shall be recognized
to Earhart Corp. (liquidating sub) on the property distribution. This is because the 80% vote and
value test of §1504(a)(2) is satisfied since he had the AT LEAST 80% ownership the entire time
(until completion).
Capone Corp. (100% Owner/Corp s/h):
 § 332(a): No gain or loss recognized on the receipt of the building under § 332(a).
 Capone’s basis in the building (the property) is the transferred basis under § 334(b)  the basis in
the hands of Earhart Corp. = $300, therefore the basis in the hands of Capone Corp. = $300.
 The holding period of the building is tacked under § 1223.
 If Earhart Corp. has E&P, Capone takes over the E&P under § 381(a) & (c).
o R/381: Tax Attributes of Sub Carryover to the parent as well: § 381(a) applies when § 332
applies, or when certain § 361 reorgs occur.
101



See 381(c)(2) special E&P rule about what to do when the liquidated sub/corp had a
DEFICIT in E&P (can only be used to offset E&P accumulated (by the acquiring
corp/parent) AFTER the transfer/liquidation).
Parent’s Basis in the Sub’s Stock: Capone’s basis in Earhart Corp. just disappears because
Earhart no longer exists for tax purposes. Neither the Code nor regs do anything to prevent this.
Sale to Daley Corp. Realization Event under § 1001
o AR: $600 cash + $400 liability relieved = $1,000, AB: $300 (Earhart’s Basis), RG: $700
@35% = $245 tax.
o TOTAL TAX LIABILITY = $245
1. Without getting into the numbers, how, in principle, would your answer change if Capone Corp. owned only
80% of Earhart Corp., and the other 20% was owned by unrelated Cherub Corp., such that, in liquidation,
Capone Corp. and Cherub Corp. receive undivided 80% and 20% interests in the property, in each case
subject to a pro-rata share of the liability?
Liquidation Where Minority Shareholder is Present 80/20 Ownership Ratio
Capone Corp. (Majority Owner—80%): Still qualifies as an “80-percent distributee,” therefore apply
§ 332. Earhart Corp. gets § 337 treatment for 80% of the property.
 § 1.332-5: Upon the liquidation of a corporation in pursuance of a plan of complete liquidation,
the gain or loss of minority shareholders shall be determined without regard to section 332, since
it does not apply to the part of distributions in liquidation received by minority shareholders.
 R: Allocate Basis and FMV among the 2 parts of the property according to % of ownership in
the corp: In this problem 80% & 20% interests in one piece of prop.
o Basis of the property = $300, FMV of the property = $1,000
 Basis: $300 * .80 = $240 basis to Capone Corp.
 $300 *.20 = $60 basis to minority shareholder (Cherub).
 FMV: $1,000 * .80 = $800 FMV to Capone Corp. and
 $200 FMV to minority shareholder (Cherub).
 No gain or loss is recognized to Earhart Corporation on the $800 portion of property
distributed to the parent since under 332 and 337 no one recognized any gain/loss
 Capone gets a basis in the property of $240.
Cherub (Minority Shareholder—20%):
 Because § 332 does not apply to the distribution to the minority shareholder (20%), the gain or
loss to the minority shareholder shall be determined without regard to § 332 per § 1.332-5 (i.e.
treat it as a 331 distribution)Therefore, § 331 applies to Cherub so Cherub will have a gain or
loss—treat as if sold its stock at FMV
o [FMV OF CHERUB’S STOCK] – [Cherub/S/HS BASIS IN THE STOCK]= gain, taxed
at applicable Cap Gain rate
 Basis in the building = 60
102

§ 336 will apply to Earhart/Sub: AR $200 (§ 336(a), prop/building sold at the applicable %
(20) of total FMV (1000) allocated to the minority s.hs 20% interest in the corp)), AB (IN THE
PROP distributed) $60, RG $140 @ 35% = $49 tax
What happens if this is loss property that is being distributed?
- No gain or loss to the 80% company. No loss on the distribution to Capone.
- W/re to the sub/liquiating corp, (EARHART), NO LOSS RECOGNIZED on the
distribution to the parent (337) OR to the the minority s/h (per 336(d)(3)
- W/re to Cherub, 331 applies – gain or loss will be recognized
2. If Earhart Corp., held its property at a loss, would it make sense for Earhart Corp., to liquidate in kind?
Liquidation Where Property Held by Liquidating Corp in Loss Position
Note: Depreciable assets: Professor Blank is referring to property that has a Basis > FMV.
It doesn’t make sense to liquidate here because want to take the loss from this depreciated asset. Since
332 and 337 apply, the loss wouldn’t be recognized if the distribution is subject to the two sections.
Liquidation will give Earhart Corp. NO LOSS.
 To Trigger the loss: 1.) Have Capone become NOT a “80% distributee” OR 2.) Have Earhart
directly sell the building to Daley.
“Busting the Statute:”/ ways to fuck around with the requirements to get/avoid non-rec treatment
***DIDN’T READ THESE CASES***
 Granite Trust Case: Facts: Before, the Parent owned 100% of the subsidiary, but sold 20.5% of the
stock of the subsidiary to a 3rd party in order for the Parent to own 79.5% of the subsidiary. Holding:
Court said the transfer was motivated by tax consequences, but the selling of the stock to not qualify for
§ 332 is still allowed – referred to as “busting the statute” (it is a term of art). ALLOWED TO
PURPOSEFULLY FAIL THE REQUIREMENTS OF A STATUTE, SUCH AS § 332.
 George L. Riggs, Inc. Case: Facts: At the time of declaration of the liquidation, Parent corporation
owned 79.5% of the subsidiary, and after the declaration of the liquidation, Parent corporation owned
80% of the subsidiary. Holding: Basically, you are allowed to declare the liquidation at the time the
Parent does not have § 1504(a)(2) ownership, then after the declaration of the liquidation, the Parent
can get control.  This still “busts the statute”. These are ways that are allowed to bust the statute.
 Another way: Complete liquidation has to occur in 3 years, so can leave assets in the liquidating
corporation and distribute those assets in 4 years to purposefully “bust the statute.” The 3-year
requirement is under § 332(b)(3).
 BASICALLY SECTION 332 IS AN EFFECTIVELY ELECTIVE STATUTE!!!
Analysis if there was a minority shareholder (aka Cherub) when there was built-in loss property?
 Cherub (Minority Shareholder—20%):
o § 331 applies.
 Earhart Corp. (Controlled Corporation:
103
o § 336 applies.
 § 336(d)(3): Special Rule in Case of Liquidation to Which Section 332 Applies:
Simplified Language: In the case of any liquidation to which section 332 applies, no
loss shall be recognized to the liquidating corporation on any such liquidation . . . 
complete liquidation where § 332 applies, then TURN OFF LOSS recognition
EVEN IF MINORITY SHAREHOLDER.
 Policy: Potential abuse of only distributing loss to minority shareholder and
gain to “80-perecent distributee.” § 332(d)(3) will prevent this potential
abuse.
 Most likely will not happen though because if there is a built-in loss will try
to “bust the statute” of § 332 in order to recognize the loss as discussed
above.
Ex. What if basis were $1k and FMV $300 for the property that Earhart had. In this, assuming that
Capone owned all of the stock. The result would be the same, except Capone would have a basis of
$1k in the property. No loss would be recognized in Earhart’s hands. The loss would have to be
taken on the sale at a later point in time.
104
Unit V.C—Section 338 Elections
I.
§ 338 Election
 § 338(a): If purchasing corporation makes an election under this section, then, in the case of any
qualified stock purchase, the target corporation – (1) shall be treated as having sold all of its assets
at the close of the acquisition date at fair market value in a single transaction, and (2) shall be treated
as a new corporation which purchased all of the assets referred to in paragraph (1) as of the
beginning of the day after the acquisition date.
o LOTS OF PRETENDS OCCUR!!
o This treats the stock acquisition as an asset acquisition, but more complex than this!!!
 Qualified Stock Purchase—§ 338(d)(3)
o “means any transaction or series of transactions in which stock (meeting the requirements of
section 1504(a)(2)) of 1 corporation is acquired by another corporation by purchase during
the 12-month acquisition period.”
- § 1504(a)(2): 80% voting and value test: at least 80% of the total voting power of the
stock, AND value equal to at least 80% of the total value of the stock
- “12-month acquisition period” (§ 338(h)(1))
 Means the 12-month period beginning with the date of the first acquisition by
purchase of stock included in a qualified stock purchase
 “acquisition date” (§ 338(h)(2))
o means the first day on which there is a qualified stock purchase
with respect to the stock of such corporation.
 ***Corporate Purchaser***
 Election within 8.5 months after the acquisition date
o Once we have a QSP, election has to be made within 8.5 months (15th day) after the
acquisition date occurs. (§ 338(g)(1))
o An election once made is irrevocable (§ 338(g)(3))
 Example of purchase under § 338(h)(3)—Purchase Satisfied?
o Oct 2010: 5%
o Jan 2011: 40%
o Apr 2011: 25%
o Jun 2011: 5%
o Dec 2011: 10%
o Total of 85%, but is it a qualified stock purchase under § 338(d)(3)
- Depends on how you slice it. If start on Oct 2010, it will fail. If you start on Jan
2011, it will qualify.
- Here, from Oct. 2010-Oct. 2011, there is only 5% + 40% + 25% + 5% = 75%, which
is less than 80% so no QSP.
- From Jan. 2011-Jan. 2012: 40% + 25%+ 5% + 10% = 80%, which is exactly 80% so
have a QSP.
 Thus, the acquisition date will be Dec. 2011 (the exact date if we had it), and
the 12-month acquisition period starts on the acquisition date and goes back
12-months.
105
II.
§ 338(g) Election
 When made—except as otherwise provided in regulations, an election under this section shall be
made in not later than the 15th day of the 9th month beginning after the month in which the
acquisition date occurs
 Election made by purchaser—unilateral transaction.
 **Generally not useful because it requires trigger of income.
 § 338(g)(3): The election is irrevocable
o You can plead that it should be changed but it is very difficult.
 Process:
o Step 1: stock sale by capone (of Earhart /target shares) to daley
o Step 2: earhart treated as selling all assets to new corp/unrelated person. Earhart will have
gain or loss on this transfer
- We will treat the amount received as whatever the FMV is.
- This gain will be triggered and tax liability paid by purchaser.
o Step 3: then treated as selling it all back
- Earhart will take a FMV basis.
o Who will be responsible for the taxable liability?
- The purchaser (Daley)
o **no impact on seller.
III.
§ 338(h)(10) Elections
 Elective Recognition of Gain or Loss by Target Corporation, Together with Nonrecognition of Gain
or Loss on Stock Sold by Selling Consolidated Group—“(h)(10) election”
o Seller Consolidated Group
- One tax return for everyone in a consolidated group.
 You have to make a special election to file a consolidate tax return AND
 Normally, need to make an election to become a consolidated group.
 However, § 338(h)(10) flush language says do not need to file a
consolidated tax return to be a member of the selling consolidated
group for § 338(h)(10) election. § 1.338(h)(10)-1(c)—election to
become a consolidated group does not need to be made.
THEREFORE, ALL WE NEED IS THE 80% [§1504] VOTE
AND VALUE, which is considered an “affiliated group.
106
o Requirements:
- (1) Seller and target that are part of same affiliated group
- (2) Joint election made by seller and buyer
IV.
Kimbell Diamond
 Facts
o Buyer buys a target, which holds an asset. The target holds the asset with a very high basis.
Basis of $1,000 and FMV of $500.
o Buyer pays $500 for the target stock.
o Then the target liquidates and distributes to the buyer. This would be under 337 and 332. No
tax on distribution and there will be a carryover basis of $1000.
 IRS stepped in and said this transaction should not be allowed because it was really only done to get
the high basis in the property
 Court held that we should just treat the buyer as just buying assets.
 § 338 created to resolve situations like this.
Problems
In 2010, Capone Corp. sells all of its Earhart Corp. stock to Daley Corp. for $600, and Daley Corp.
continues to operate Earhart Corp. as a subsidiary. Assume for Questions (1) through (4) below that Capone
Corp. is unwilling to participate in an election under § 338(h)(10).
In a straight up sale, from Capone to Daley, what problems? Trapped gain in the corporation – a
“ticking tax timebomb” – there is a 700 dollar gain (1000 FMV over 300 basis in the building) in Earhart
– in the sale of stock directly to Daley, the besis in the building stays the same. So, Daley should have paid
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less money than FMV (600 cash plus he assumed 400 mtg) because he would have to pay tax on that gain
to sell the building.
- He should have paid something between 355 and 600 (1000 FMV – 400 Mtg
assumption – 245 tax on the 700 dollar gain he would have if he sold the building
= 355.
1. Was Daley Corp. wise in accepting the deal on these terms? If not, what might Daley Corp. find
objectionable about it?
Probably not, built-gain tax of $245. Should have paid $355 based on the liability from the mortgage
and the tax.
Daley was not wise in accepting this deal because there is built-in gain in the building that Earhart
owns, which will eventually be taxed to Daley, therefore there is a tax liability (245 tax on 700 of gain)
because no step up to cost basis (w/re to the building) – note that not getting cost basis (which would
be higher since the prop is appreciated) also means less depreciation tax deductions.
2. If Daley Corp. convinces Capone Corp. to accept $355 for the Earhart Corp. stock, would that take care of
Daley Corp.’s objections in (1)? If not, what problem remains from Daley Corp.’s perspective?
Fixes the tax liability issue because Daley is now paying less for Earhart Corp. to take into
consideration built-in gain, which will be a tax liability in the future. BUT the basis problem still
exists. Not a whole lot of depreciation/tax deductions at $300.
3. Would a § 338 election cure the problem in (2)? If so, why might Daley Corp. not make the § 338 election?
§ 338(g) Election Consequences
Two things to think about. The advantage the company would receive from being able to take the
deduction and also the amount of tax being triggered at the time of the election.
A § 338 election would allow Daley to step up its basis in the property. The drawback is that Daley
will own Earhart at the time the gain is triggered as a result of the election/sale.
Tax Consequences:
Capone (Seller)
 Just selling stock.
o § 1001: gain or loss on the sale of stock.
Earhart Corp. (Target)
 Step 1:
o Sells building in pretend transaction to an unrelated person on the acquisition date.
Earhart recognizes gain or loss on this pretend transaction.
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

Step 2:
o Pretend buys the building back, and Earhart Corp. is treated as new corporation. No gain
or loss to the Unrelated Person because FMV = Basis.
o New Earhart Corp. now has a basis in the assets that have been stepped-up to FMV (cost
basis § 1012). THE WHOLE PURPOSE OF A 338 ELECTION IS TO GET A STEPPED
UP-BASIS IN THE ASSETS.
Cost Associated with the § 338 election:
o Daley Corp. is indirectly responsible for the tax liability that arose to Earhart Corp. in Step
1.
o § 338(g) elections do not get used that much because triggers tax earlier.
4. If Daley Corp. would find a § 338 election unattractive on these facts, what other facts would make it
attractive?
If Earhart Corp. has gain & loss property, then can offset one another at the Earhart level, which is
an attractive aspect of a § 338(g) election.
If it is loss property, then under § 338(h)(9), Daley Corp. can’t use the losses of Earhart Corp. to
offset Daley Corp.’s gains.
 § 338(h)(9): Target should not be treated as an affiliated group except for § 338(h)(10). Therefore,
can’t offset Daley’s loss with Earhart’s gains, vice versa, or other tax attributes in a § 338(g) election.
5. Revert to the basic model, in which Capone Corp. wishes to sell and Daley Corp. wishes to purchase 100%
of the stock of Earhart Corp.
a. If Daley Corp. buys all of the Earhart Corp stock at once, would Daley Corp. and Capone Corp. be
eligible to join in an election under § 338(h)(10)?
§ 338(h)(10) Election
Assuming they jointly make the election and it occurs within the 8.5 month time period it
should be possible.
Steps:
1: Earhart (Target) treated as being a member of Capone (Seller) consolidated/affiliated
group.
2: Daley needs to buy 80% of stock for a QSP.
3: Earhart treated as selling all of its assets in a single transaction, at the close of the
acquisition date. Treat target as engaging in sale when it was owned by Capone. §
1.338(h)(10)-1(d). This is the opposite of what happened in (g) election.
o Old Earhart (Target) sells the building then, liquidates, and the cash is distributed, The
distribution is treated as going to Capone. Section 332 is why there is no tax.
4: New Target treated as a member of Daley Corp and treated as buying all of the assets from
an unrelated person  same as § 338(g) election.
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Tax consequences
Capone (Seller):
Step 1: No consequences—§ 338(h)(10) flush language, no gain or loss will be treated as
recognized on the sale of the stock. This really is saying treat it as an asset. No gain on the sale
of stock. Basis disappears.
o Don’t recognize the sale of Earhart Corp stock to Daley Corp  Different from §
338(g) election
Step 2: Old Earhart Corp. triggers gain or loss on the sale of the assets to the Unrelated
Person, but Old Earhart and Capone are an affiliated group so this is Capone’s tax liability.
Tax Attributes of Old Earhart are kept by Capone.
New Earhart Corp:
Step 3: Buys back the assets from unrelated person, and gets a stepped-up basis in the assets
(cost basis under § 1012)
Daley (Purchaser):
Daley bought stock from Capone. The statute tells us to ignore the stock sale by Capone;
however, the statute limits the nonrecognition to members of the selling consolidated group.
Because Daley paid money for the stock he will get the cost basis in the stock purchased (cost
basis under § 1012)
Why do this?
o Capone can deduct any losses it may have from the gain triggered in Earhart
corporation as a result of the election.
o Maybe Capone bought Earhart a long time ago and has a low basis in the stock, which
has since appreciated. As a result, Capone could avoid that gain because the basis in
stock does not come into play in this transaction.
o Purchaser demands it
b. Would you expect Daley Corp. to be willing to pay Capone Corp. $600 if Capone Corp. were willing
to join Daley Corp. in a § 338(h)(10) election?
Is $600 a good price? Need to determine tax consequences to see if it is fair.
Capone:
 Step 1: $500 gain on sale of Earhart stock to Daley Corp, which is not recognized under §
338(h)(10) flush language.
 Step 2: Old Earhart Corp. deemed to sell the building to Unrelated Person:
o AR: $1,000
o AB: $300
o RG: $700 @ 35% = $245 tax  Capone’s tax liability (If Capone had a loss in this
year it would be ok with the gain)
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New Earhart Corp:
 Step 3: Buys back the assets from unrelated person, and gets a stepped-up basis in the
assets (cost basis under § 1012), which is $1,000. **Therefore, there would be no gain on a
subsequent sale because basis is FMV)
Daley Corp.:
 Basis in the New Earhart Corp. Stock is the amount Daley paid for the stock from Capone
(cost basis under § 1012), which is $600.
 Daley pays $600 for the stock for a building that is subject to a mortgage liability ($1000$400). Daley would be willing to engage in this because Capone took on the tax liability.
When New Earhart Corp. sells the building, there will be no tax because the basis is now FMV
(unless the building appreciates in value).
Therefore, $600 is a fair price for Daley because Daley doesn’t bear any tax liability.
c. If, absent the § 338(h)(10) election, Capone Corp. could not convince Daley Corp. to pay more than
$355 for Earhart Corp., would you expect Capone Corp. to be willing to join in a § 338(h)(10)
election in order to conclude the sale of the Earhart Corp. stock, provided that Daley Corp. pays
$600 for the stock?
If Daley pays $600, which triggers a $245 tax liability, which is paid by Capone. Therefore,
Capone is receiving $355, and Capone gets the tax attributes of Old Earhart Corp. under the §
338(h)(10) election. Additionally, Capone has no gain on the sale of stock to Daley Corp. under
§ 338(h)(10) election. Compared to a no § 338(h)(10) election, where Capone will be taxed on
the sale of the stock so Capone would receive $355, and has an AB of $100, resulting in a
Realized Gain of $255, which is then taxed. Therefore, Capone would be willing to join the §
338(h)(10) election.
Although initially these two options look similar, there are some differences. The losses that
could be offset could make a difference.
d. If Daley Corp. buys all of the Earhart Corp. stock for $600, what would be the effect of a §
338(h)(10) election?
If Daley bought Earhart for $600 and an (h)(10) election was made, see (b) above.
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Unit VI.A—Incorporation of Assets—§ 351
I.
§ 351(a)—Transfer to Corporation Controlled by Transferor: No Gain or Loss IF:
 (1) Property is transferred to corp.
o Cash is property, equipment, and building
 Cash—Rev. Rul. 69-357
 Equipment—American Banton
 Accounts Receivables (Hempt Brothers Case: Court reads the interpretation of
“property” very broadly to include payment for past services as property for § 351.
o § 1.351-1(a)(1)(i): Stock or securities issued for services rendered or to be rendered to or for
the benefit of the issuing corporation will not be treated as having been issued in return for
property.
o NOTE: § 317(a) definition is NOT controlling
o § 351(d) excludes:
 Services
 Indebtedness of the transferee corporation which is not evidenced by a security; and
 Interest on indebtedness of the transferee corporation which accrued on or after the
beginning of the transferor’s holding period for the debt.
 (2) By one or more persons
o § 1.351-1(a)(2)
 (3) Solely for stock
 (4) “Control” immediately after the transaction
o § 368(c) defines control
 “Control” is § 368(c) Control:
 Ownership of stock possessing at least 80 percent of the total combined
voting power of all classes of stock entitled to vote, AND
 At least 80% of the total number of shares of all other classes of stock of the
corporation.
 § 368(c) is older than § 1504(a)(2), and § 1504(a)(2) is the more modern,
easier approach.
 Sidenote: § 318 (Constructive Ownership) is not turned on under § 351.
 The control can be made up of more than 1 person (i.e. 4 people) who will be treated
as a collective group for control purposes (§ 1.351-1(a)(2)).
 **This really is just a deferral
 § 1.351-1(a)(1)(ii)
o Proportion of “relatively small value” compared to Rocky’s value of stock for services and
o Purpose of the cash contribution was to validate the § 351 transaction, then it will not be
allowed.
 § 1.351-1(a)(1)
o The phrase “immediately after the exchange” does not necessarily require simultaneous
exchanges by two or more persons, but comprehends a situation where the rights of the
parties have been previously defined and the execution of the agreement proceeds with an
expedition consistent with orderly procedure.
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II.
III.
IV.
 This is vague
 BUT immediately does not mean a second.
Rev. Proc. 77-37
 Gov’t says that in a § 351 transaction TP must show that property must equal at least 10% of the
stock for services.
 This is not the law, it is just what the gov’t has said.
BOOT—§ 351(b)
 The realized gain limits the amount of gain that can be recognized on the transaction.
 § 358(a)(1) (plus the (d) liability portion)
o Start with SH’s basis in property MINUS
o FMV of boot received PLUS
o Gain recognized by SH MINUS
o (d) Liabilities assumed by Corp =
o SH’s basis in stock
Assumption of Liability—§ 357
 § 358(a) says the assumption of liability = Debt Relief - $
o You ignore the liability for any purpose other than determining the shareholder BASIS.
 § 357(b)—Tax Avoidance Purpose
o If the primary purpose was tax avoidance then the liability assumption will be treated as boot.
o OR if no actual purpose, then assumption is that will be treated as boot.
o Will treat ALL liabilities assumed as BOOT
 § 357(c)—will apply whenever the liability is greater than the basis in the property contributed. If
this is the case, then the excess will be treated as gain on the sale of stock.
o Character is § 1.357-2(a)—character of whatever item was contributed to the corporation.
o Does not treat liabilities assumed as boot.
o Treats the excess as gain.
- “such excess shall be considered as a gain from the sale or exchange of a capital asset
or of property which is not a capital asset, as the case may be.”
o **ANY TIME that § 357(c) applies, you will have a $0 basis!!
o EXCEPTIONS:
- § 357(c)(3)—certain liabilities excluded
 If the liability would give rise to a deduction, then the amount of the liability
shall be excluded shall be ignored for purposes of § 357(c). Meaning the
assumption of liability is ignored.
 Ex.
 Dosa cart bought for $20. Owes $30 salary. Wants to incorporate.
Contributes the cart ($20 basis) and the $30 liability.
 Generally, under s 357(c) this would create § 357(c) gain of $10.
 Would look to § 358 to adjust basis in the property. This would
require a reduction in the basis by the amount of liabilities assumed.
 § 357(c)(3) effect? The salary would be deductible. So this
subsection tells us to ignore the liability assumption. This recreates §
357(a).
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 § 358(d)(2) creates an exception to the general rule of assumption of
liabilities and states that the general rules shall not apply to the amount
of any liability excluded under § 357(c)(3).
1. So this makes no adjustment necessary.
V.
VI.
VII.
VIII.
IX.
Quick Overview of § 357
 (a)—assumption of liability not boot
 (b)—if tax avoidance purpose:
o Debt assumption = boot
 (c)—if liabilities assumed > basis:
o Excess = gain from sale/exchange
Basis to Corporation—§ 362(a)
 Transferee basis will be the basis of the property in the transferors hands, increased by any gain
recognized by the transferor on the transfer.
o carryover basis + any gain recognized
Special Rule for When General Liability Assumption Rule in (d) Does Not Apply—§ 358(h)
 Tell us that we will reduce basis by the liability even though it would be deductible in the hands of
the transferor
Miscellaneous code
 § 1012
 § 1032
o no gain or loss to corporation in exchange for stock—corporations can deal in its own stock.
o Sends us to § 362.
- Says if property was acquired by a corporation in connection with a transaction to a §
351 transaction, the basis will be the basis in the contributor, increased by certain
things.
 § 1223(1)
o Holding period tacks for person who makes contribution of property.
 § 362(e)(2)
o Limits basis on loss property to FMV in § 351 transactions.
Tax shelter
 No business purpose
 Also, have a 3rd party who is willing to help.
 Huge loss that helps to offset the game.
o No economic loss
 Secrecy
 Money-back guarantee
 Keep in mind the reportable transactions.
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X.
XI.
XII.
Hempt Brothers
 Court reads the definition of property very broadly, even payment for past services can be treated as
property for the purposes of § 351.
Black and Decker Corp.
 Facts
o Company had $500m gain that it wanted to avoid. It had health care liabilities that would
ultimately create deduction/losses. Its accounting firm had the idea to create a subsidiary that
would take the $ 500m worth of liabilities and $501m cash and in exchange, the company
would receive stock in the sub.
o An employee would then create a trust and transfer all of the health sub stock held by B&D
into the trust for $1m.
 Law and Analysis
o This looks just like a § 351 transaction.
o § 351(a) says we don’t have to worry about the liabilities, so no gain or losses on the receipt
of the stock.
- § 357(a) says the assumption shall not be treated as money or property. This allows
no tax.
o B&D basis on the stock would be
- § 358(a)(1)
 $501m - $0 (boot) + $0 (gain) - $500 (liabilities) = $1m basis. BUT this
ignores § 358(d)(2)
- § 358(d)(2)
 Says don’t deduct out the liabilities if under § 357(c)(3).
 This likely would be a deductible liability under § 357(c)(3)—liability where
you would get a tax deduction.
- SO the basis would actually be $501 – 0 + 0 -$0 (here we aren’t deducting the
liability because the basis
 Resulting in Basis of $501m
o Therefore, on the sale of the assets to the trust, B&D would realize a $500 million loss,
which would offset the $500m gain, achieving the tax objective.
o THAT is if the transaction is respected.
o The IRS rejected this argument.
- § 357(c)(3) is out of context here even though
Notice 2001-17—“listed transaction”
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

The IRS calls the B&D transaction an abusive transaction.
The IRS says it will challenge this type of transaction and names it as a listed transaction, meaning
that the TP must file a special form saying that they are entering into this type of transaction. This
can result in a penalty.
Also discusses § 358(h), which was created to prevent this basis reduction.
So in the B&D transaction, the consequence of § 358(h) is that B&D’s basis in the stock of the
health sub would be reduced by the liabilities assumed, resulting in a $1m basis and thus preventing
the recognition of a loss on the sale of the health sub stock to the trust.


Problems
Rocky, Flynn, Ty, and Gunther, four individual unrelated cash-method taxpayers, have decided to join together
to form Shake Corp., an engineering consulting firm and an accrual method taxpayer. Rocky, Flynn, Ty, and
Gunther will each receive 25 shares of Shake Corp. stock and will each transfer the following property to Shake
Corp. (000's have been omitted from each dollar amount):
Transferor
Property
Rocky
Trade Account
Receivable
Equipment
Building
Cash
Flynn
Ty
Gunther
Transferor’s Adjusted
Basis
$0
Fair Market Value
$10
$35
$25
$25
$25
$25
$25
1. Determine the tax consequences of these transfers to Rocky, Flynn, Ty, Gunther and Shake Corp (including
realization and recognition of any gain or loss on the exchange, and the basis and holding period of the Shake
Corp. stock or property received).
Simple § 351 Application—Contribution of Property in Exchange for Corp Stock
Everyone is contributing property.
One or more persons § 1.351-1(a)(2)
Control § 368(c) factors are met—80% of vote and 80% of each class. § 318 attribution not applicable
because it has to be turned on, which it is not.
Does § 351 apply?
 (1) Property?
o Cash: Yes
o Equipment: Yes
o Building: Yes
o Accounts Receivable: Yes
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


(2) 1 or more persons? Yes
(3) Solely for stock? Yes
(4) Control?
o Yes, R, F, Ty, and G have 100% control of Shake Corp. immediately after the contribution,
which meets § 368(c) control.
§ 358(a)(1) (plus the (d) liability portion)
 Start with SH’s basis in property MINUS
 FMV of boot received PLUS
 Gain recognized by SH MINUS
 (d) Liabilities assumed by Corp =
 SH’s basis in stock
Gunther
§ 351: provides for nonrecognition on the contribution.
§ 358(a)(1): provides that the person contributing the property receives a basis in stock equivalent to the
basis of property contributed.
Shake with Gunther
§ 1032: No gain or loss on distribution of stock
§ 362(a): Basis the same in the hands of the transferor + amount of gain recognized to the transferor on
such transfer. Shake’s basis will be $25
Flynn
AR: $25; AB: $10; RG: $15, but he does not recognize any gain per § 351(a).
Will take a basis in Shake stock equivalent to his basis in the contributed property, $10 per § 358(a)
Shake with Flynn
§ 1032 no gain or loss to corporation in exchange for stock—corporations can deal in its own stock.
§ 362(a)(1): provides Shake with a $10 transferred basis in the equipment. § 1223(1) gives Shake tacked
holding period in the equipment.
**Upon sale of stock and equipment there would be tax to both Flynn and Shake.
Ty
AR: $25; AB: $35; RL: $10 However, the $10 realized loss is not recognized under § 351(a)
Receives stock with a basis of $35, same basis as in building under § 358(a)
Shake with Ty
No gain or loss under § 1032(a)
§ 362(e)(2)(A) — Shake will take a basis in the building of $25. Its basis is limited to the FMV. This is to
avoid the double loss that otherwise would be allowed.
§ 362(e), exception to step the basis down to FMV.
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
§ 362(e)(2): Limitation on Transfer of Built-In Losses in Section 351 Transactions: if the
property transferred by a transferor has a built-in loss, then the transferor’s basis of property
so transferred shall not exceed the FMV of such property immediately after such transaction.
Rocky
AR: $25, AB: $0, RG $25 not recognized under § 351—Accounts receivable receives §351 treatment like
any other property.
Hempt Case: Ignore the Assignment of Income Doctrine for § 351. This allowed Rocky to get taxed at capital
gain rates now instead of A/R, which have been ordinary income for past services rendered. (this is a positive
aspect of the § 351 contribution for the SH.)
Basis in stock of $0 in the stock—a transferred basis from the a/r under § 358(a)
Shake with Rocky
Shake also will have a $0 basis in the a/r under § 362(a)(1)
All of the Shareholders get a holding period in the Shake Corp. Stock as they had in their property that is
tacked under § 1223(2). Under § 1223(2), get the same holding period if used the same basis in whole or in
part in his hands as it would have in the hands of the transferor.
2. Same as Question (1), except that Rocky received his 25 shares of Shake Corp. stock in exchange for services
Rocky will perform for Shake Corp.
Contribution of Services in Exchange for Stock—§ 351(d) disallows § 351 Treatment
Under § 351(d), Services are not considered property. The rationale behind this is that services are taxed
as ordinary income, and Rocky wouldn’t be taxes at all on the receipt of stock and get capital gains
treatment when he sells the stock—trying to prevent disguised salary payments.
Therefore, Rocky has $25 ordinary income.
Property transferors are now F,T, and G (not R). Do they have control? No, they don’t have § 368(c)
control because they only have 75% ownership.
Tax Consequences to Other Shareholders as a Result of Failing § 351
Ty
No § 351 Transaction because control fails. Assume that the shares have FMV of the property
transferred. AR: $25, AB: 35, RL: $10, and it is recognized. This will be recognized under § 1001.
Actually helps Ty because he gets to recognize loss so there is some incentive for TPs who contribute loss
property to want the § 351 transaction to bust.
Gunther
No § 351. Cash for stock so this is just a purchase which will result in no gain or loss because cash is
being used.
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Flynn
No § 351. Flynn will recognize AR: $25, AB: 10, RG: $15, and it is recognized in a § 1001 exchange (25-10).
Shake
Shake will still be able to use § 1032 and have no gain or loss because it is receiving money and property
in exchange for Shake stock.
Basis will be FMV in the property received
Shake Corp. cannot take a basis in the services performed by Rocky and cannot have a holding period.
Shake Corp. will have a basis of $25 in the remaining shareholders’ properties contributed.
3. Same as Question (1), except that Rocky received 5 shares of Shake Corp. stock in exchange for $5 in cash,
and the other 20 shares in exchange for services Rocky will perform for Shake Corp.
Part Cash Contribution/Part Service
§ 1.351-1(a)(1)(ii): If primary purpose was to qualify the transfer under § 351, and the property is “relatively
small value” vs. value of stock in exchange for services, then there is a problem!!!
 “Relatively Small Value”: Rev. Proc. 77-37: property contribution has to equal at least 10% of
the stock received for services. This is not the law, just the IRS’ view so if want a ruling from the
IRS then need to represent this threshold. Basically, can’t contribute a peppercorn.
 In our problem, have $5 property contribution, and $20 stock for services  $5/$20 = 25%
so it passes the 10% threshold.
§ 1.351-1(a)(2), Ex. 3: PART SERVICES & PART PROPERTY: Once Rocky passes the 10% threshold, all of
the stock received is considered for control. Treasury is generous here. ONLY IF MEET 10% THRESHOLD.
Rocky
Contributes 20 services and $5 cash.
§ 1.351-1(a)(1)(ii): If primary purpose was to qualify the transfer under § 351, and the property is “relatively
small value” vs. value of stock in exchange for services, then there is a problem!!!
 “Relatively Small Value”: Rev. Proc. 77-37: property contribution has to equal at least 10% of
the stock received for services. This is not the law, just the IRS’ view so if want a ruling from the
IRS then need to represent this threshold. Basically, can’t contribute a peppercorn.
 In our problem, have $5 property contribution, and $20 stock for services  $5/$20 = 25%
so it passes the 10% threshold.
§ 1.351-1(a)(2), Ex. 3: PART SERVICES & PART PROPERTY: Once Rocky passes the 10% threshold, ALL of
the stock received is considered for control. Treasury is generous here. ONLY IF MEET 10% THRESHOLD.
Rocky’s 25 shares can count towards control for the § 351 transaction, so now there is 100% control of
the corporation immediately after, and the § 351 transaction applies.
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Stock (services)
Ordinary Income (compensation) outside of § 351 so $20 ordinary income. His basis in this stock = $20
because he will pay tax on the $20 f ordinary income.
Stock (property)
No tax because § 351 applies, and basis in cash = $5 so the basis in the stock = $5 under § 358(a). If the
property was not cash, it would still be under § 351.
Shake
Gets $5 cash + $20 worth of services.
Shake can take a tax deduction for the services paid to Rocky per §162
Results would be the same as in Problem (1) for Flynn, Ty, and Gunther.
4. Same as Question (1), except that Rocky sold his Shake Corp. stock to his friend Dina a week after the
transfer to Shake Corp.
Contribution of Property Qualifying for § 351, Followed By Sale of Stock Received One Week Later
The whole issue here is whether the “immediately after” requirement has been met.
§ 1.351-1(a)(1)— The phrase “immediately after the exchange” does not necessarily require simultaneous
exchanges by two or more persons, but comprehends a situation where the rights of the parties have been
previously defined and the execution of the agreement proceeds with an expedition consistent with
orderly procedure. Define the rights of the parties (i.e., draw out the plan). This is largely resolved by
IRS/court.
o Plain Language: It doesn’t have to be all at once to be one transaction, the parties will draft and
agreement saying it is one transaction.
IRS likely would think that 1 week seems suspicious. Really goes back to step-transaction test. They
would look at the doctrines: Binding Commitment Test (binding commitement to sell to Dina before §352
transaction even happened), End Result (if the court says the whole point was to make Dina a owner, so
they would ignore Rocky completely and only count the other people who contributed property which
would result in them failing the control test), Mutual Interdependence (can’t do one step without the
other so they will be integrated).
This seems like a binding commitment and would probably fail the test, resulting in being treated as one
transaction.
Is there a solution? Make Dina a property owner right away instead of Rocky. There are other
possibilities just have to discuss with client.
Takeaway: “Immediately” is very vague, and doesn’t mean a second after. A week is problematic, one
month or two months is arguable, a year is probably fine absent any written agreement.
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5. Flynn transfers his property, the equipment, to Shake Corp. and receives 10 shares of stock and $15 in cash
from Shake Corp.
Contribution of Property and Receive Stock AND Cash—“Solely”/Boot
Issue is “solely” language in § 351(a).
§ 351(b): If other property or money is received in addition to stock, then – (1) gain (if any) to such recipient
shall be recognized, but not in excess of – (A) the amount of money received, plus (B) the FMV of such other
property received; and (2) no loss to such recipient shall be recognized.
 Basic Rule: Gain will be recognized up to the boot, but loss will not be recognized. This is the
“relaxed solely voting” requirement.
 § 351 is still turned on!!!
Tax Consequences
Flynn
Qualifies under § 351(a) if not for the other than “solely for stock” requirement so boot gain shall be
recognized under § 351(b). What is the gain? AR: $25, AB: $10 = RG $15, this is the gain, and is
recognized up to the amount of boot, which is the $15 in cash. Therefore, the full $15 gain is recognized.
Call this gain “boot gain” just to keep the gains from getting confused. The boot gain will be capital gain,
which will be long term or short term depending how long held the equipment for.
Drill the point home: Assume: AR: $25, AB: $22, RG: $3; the boot gain is $3 because the cap is still $15
from the cash.
Flynn’s basis in the Shake Stock: § 358(a): $10 [starting basis] - $15 [boot received] + $15 [boot gain] =
$10 basis.
Shake
Basis: Basis in the Equipment: § 362(a)(1): Basis in transferor’s hands + gain recognized by Flynn = $10
+ $15 = $25.
6. Same as Question (1), but Flynn’s equipment has a FMV of $35 and is subject to a $10 mortgage. Flynn
incurred the debt several years prior to the incorporation for valid business reasons.
Contribution of Property that Is Encumbered by Debt
§ 357(a): the liability (debt relief) should not be treated as boot for purposes of § 351. It does not takeaway
the tax-free treatment of § 351.
***2 Big Exceptions to § 357(a):***
 (1) § 357(b)(1): TAX AVOIDANCE: If the principal purpose of the taxpayer with respect to the
assumption described in section 357(a) – (A) was a purpose to avoid Federal income tax on the
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
exchange, or (B) if not such purpose, was not a bona fide business purpose, then flush language:
such assumption shall for purposes of § 351 or § 361 be considered as money received by the taxpayer
on the exchange.
o Liability  CASH BOOT
o § 357(b)(2): The taxpayer has the burden of proof, which is the clear preponderance of
evidence.
(2) § 357(c): Applies only when Liabilities > Basis of Property
o § 357(c)(1): If the sum of amount of liabilities exceeds the total of the adjusted basis of the
property transferred pursuant to such exchange, then such excess shall be considered as a
gain from the sale or exchange of a capital asset or of property which is not a capital asset, as
the case may be.
 Character of the gain is the same as the property contributed, and long-term or shortterm should be determined by the holding period of the transferor. (§ 1.357-2(a))
o Applies to section 351 or section 361
o § 357(c) EXCEPTIONS to the Exception:
 (1) § 357(c)(3):
 (A) If taxpayer transfer, in an exchange to which § 351 applies, a liability the
payment of which either – (i) would give rise to a deduction, or . . . flush
language: then, for purposes of § 357(c)(1), the amount of such liability shall
be excluded in determining the amount of liabilities assumed.
 Example: Dosa man contributes his Dosa Cart ($20 basis) and Unpaid Salary
($30 liabiity) to a corporation. Normally § 357(c)(1) would create a $10 gain
because liability > basis. However, § 357(c)(3) kicks in because the payment of
the $30 liability would give rise to a deduction if actually was paid because
corporation can deduct salary payments so we ignore this liability assumption.
Therefore it puts us back in the operation of § 357(a). No gain & basis in the
stock = $20, because under § 358(d)(2), excludes liabilities under § 357(c)(3).
 Policy: Don’t want operating expenses to trigger gains in small businesses
because we want to promote small business.
 RR 95-74: lists liabilities that are covered under § 357(c)(3). Don’t need to
know the details, but just know that is exists for when we practice!
 Black & Decker Case: Sells one of its companies for $500 that will be taxable to
a trust that was set up by a former employee. § 351 transaction, where $501 M
Cash + $500M in Liabilities so under § 357(a). However, in calculating the
basis in the Sub, B&D used § 357(c)(3) even though L<Basis, and thus with §
358(d)(2) the liability didn’t reduce the basis leaving a basis of $500M, which
was very sneaky! Sale of the Sub to the trust resulted in a $500M RL (AR: $1M
– AB: $501M). The District Court ruled in favor of B&D, but the Circuit Court
reversed.
 IRS Notice 2001-17: IRS called the B&D transaction an abusive transaction.
This became a “listed transaction”  the taxpayer now has to file a special
from with the IRS that they did this  this raises a red flag, and if don’t file the
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
form then there could be a $200,000 fine and a 40% penalty on the
understatement of taxes.
In response to the Notice and B&D case § 358(h) was enacted to counter it: ONLY
APPLIES WHEN BASIS > FMV AND WHEN HAVE § 357(c)(3) LIABILITIES!!!
 § 358(h)(1): If basis of the property exceeds FMV of the property, then such
basis shall be reduced (but not below the FMV) by the amount of any liability –
(A) which is assumed by another person as part of the exchange, AND, (B) with
respect to which subsection (d)(1) does not apply to the assumption.
o Part (B) means that the basis of the property will be reduced by §
357(c)(3) liabilities (aka deductible liabilities), which normally is not
deducted from basis under § 358(d)(2).
Flynn
§ 357(c): don’t treat debt relief/assumption of liability as boot
§ 358(a)(1): says that that this section applies to § 351.
§ 358(d): assumption of liability and its effect on basis. Debt relief treated as money. So Flynn’s basis
would be ($10 [old basis] – 0 [boot] + 0 [gain recognized] – 10 [liability assumed] = $0 basis in the stock
Shake
§ 362(a)(1)—$10 [carryover basis] + $0 [gain recognized] = $10 basis in the equipment.
Sidenote: If § 357(b), if it applies, then the entire liability assumption is treated as boot—meaning if there
is actual boot and liability, then the liability IS treated as boot.
7. Same as Question (6), except that the equipment Flynn transferred to Shake Corp. is worth $45 and is subject
to a $20 mortgage.
Contribution of Property Encumbered by Debt Where Debt Assumed Exceeds Contributors Basis in the
Property
Flynn
§ 357(c)—excess rule. To the extent the liability exceeds Flynn’s basis, the excess will be treated as gain.
This will be taxed as capital gain. § 357(c) says it shall be considered gain from the sale of a capital asset.
So $10 §357(c) gain. Taxed at 20%. This results in a $2 tax.
Basis: § 358(a)(1): $10 [old basis] – $0 [boot received] + $10 [gain] - $20 [liabilities assumed] = $0 Basis
This results in a $0 basis.
Shake
§ 362(a)(1): $10 [transferred basis] + $10 [gain recognized by Flynn] = $20 basis in the equipment.
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Unit VII.A—Acquisitive Reorganizations (“A” and “C” Reorgs)
I.
§ 368 Roadmap
 § 368 is a Nonrecognition statute.
o List of Reorganizations under § 368(a)(1): A, B, C, D, E, F, and G
o Then there are § 368(a)(2) Reorganizations.
 § 368 roadmap
o § 368 requirements
o Judicial requirements
- Continuity of interest (COI)
 Target shareholders continue to own the combined entity
- Continuity of business Interest (COBE)
 § 1.368-1(d): (1) Target’s business continued, OR (2) Is Acquiror using
significant portion of the Target’s assets.
 Want the old business to continue in the combined entity
- Business Purpose Doctrine
 Practitioners say this is the most important
 Must have some legitimate reason, other than tax avoidance.
o Shareholder consequences
- Target SH and Acquiror SH
o Corporate Consequences?
- Target and Acquiror
 Consequences in an “A” reorg
o Target Shareholders
- § 354—Gain/Loss
 Says shareholders will not recognize any gain or loss.
- § 356—Boot
 Same concept as from § 351.
o Acquiror
- § 1032—Gain/Loss
 No gain or loss because corporation can deal in its own stock
- § 362(b)—Basis
- § 381(a)—Tax Attributes
o Target
- § 361(a)/(b)
 Target has no gain on exchange of assets
- § 361(c)
 Generally no gain/loss on the liquidation
THE HUB
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II.
III.
Nonrecognition of Gain or Loss to Corporations; Treatment of Distributions—§ 361(a)
 Provides for non-recognition where:
o Exchanges property solely for stock or securities in another corporation a party to the
reorganization
o Pursuant to a plan
- § 1.368-2(g)
 Party to an organization is defined in § 368(b)
 § 361(b)— allows property received to not stop noonrecognition so long as all of it is distributed to
the shareholders.
Assumption of liabilitity—§ 357
 (a) don’t treat liability as money.

 Rev. Proc. 77-37
o 90% of FMV of target’s net assets, and
o 70% of FMV of Target’s gross assets
 Rev. Rul. 88-48
o Pre reorg sale of half assets for cash is okay if the cash and stock are distributed to
shareholders after
o Must be unrelated
o Cash must be transferred in exchange with Purchasing corp.
Tiny Corp. is a closely held corporation incorporated under the laws of the State of Delaware with 100
shares of voting common stock outstanding, owned 50 shares by Amy (basis $200), 30 by Ben (basis $400), and
20 by Charles (basis $150). Tiny Corp. has the following assets:
Basis
Value
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Non-operating Assets
Operating Assets
Totals
$200
$700
$900
$300
$900
$1200
Tiny Corp. has outstanding liabilities of $200 (in the form of 20-year registered bonds), and
accumulated earnings of $400. The aggregate value of Tiny Corp.’s outstanding stock is $1,000 ($10 per share).
Buddy Corp. is a publicly held corporation incorporated under the laws of the State of Delaware, the
stock of which is listed on the New York Stock Exchange.
Determine the tax consequences to Tiny Corp., Amy, Ben, Charles and Buddy Corp. of the following
transactions. Assume throughout that all debt instruments of Buddy Corp. are not publicly traded and bear
interest payable annually at 1% above the federal rate [see § 1274(d)] applicable to the maturity in question.
Problems
Question 1
Statutory Merger (“A” Reorg)
§ 368(a)(1)(A): the term reorganization means – (A) a statutory merger or consolidation.


What is a merger?
o § 1.368-2(b)(1)(ii)—defines statutory merger or consolidation
- Statutory merger pursuant to statute.
- 2 Steps, resulting in Target and acquirer combining
 Step 1: Target will exchange all assets in exchange for acquirer stock
 Step 2: Target will liquidate
Judicial Requirements
o Continuity of Interest:
- Southwest Natural Gas (1951): All requirements of merger were met, but what was
being received in payment, there was only 1% of A Stock in the bucket of
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consideration, and this was not enough to constitute continuity of interest.
- Rev. Rul. 66-224
Shareholder
% of Target Stock Received (Sit.1)
Received (Sit. 2)
A
25
$50k cash
$25k cash, $25k A
stock
B
25
$50k cash
$25k cash, $25k A
stock
C
25
$50k worth of A
$25k cash, $25k A
stock
stock
D
25
$50k worth of A
$25k cash, $25k A
stock
stock
 Situation 1: In the Bucket - $100K Cash & $100k Stock so 50% of Stock.
 Situation 2: In the Bucket - $100K Cash & 100K Stock so 50% of Stock.
 Takeaway: “COI” is determined by the aggregate bucket, not who got what.
So both of these situations have “COI.”
- Nelson Case (SCOTUS) (1935): There was 38% stock in the Bucket, and SCOTUS
said COI is met.
- ***§ 1.368-1(e)(2)(v), Ex. 1 resolves all of this!!!
 40% is acquirer stock so 40% IS THE THRESHOLD!!!*** NEED 40%
STOCK IN THE BUCKET.
o Continuity of Business Enterprise (COBE)
- § 1.368-1(d): (1) Is Target’s business continued OR (2) Is the Acquiror using a
significant portion of the targets assets?
o Business Purpose Doctrine
Statutory merger (“A" reorganization). In a statutory merger under the laws of the State of Delaware,
Tiny Corp. merges into Buddy Corp. As a result of the merger, the following events occur by operation of law:
the transfer of all Tiny Corp. assets to Buddy Corp.; the assumption by Buddy Corp. of all of Tiny Corp.’s
liabilities; the dissolution of Tiny Corp. As consideration, Buddy Corp. issues the following to Amy, Ben and
Charles, the former Tiny Corp. shareholders, proportionate to their interests in Tiny Corp.:
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(a) $1,000 of Buddy Corp.’s 8% registered bonds, payable after 20 years, and convertible into Buddy Corp.
voting common stock at the election of the bondholder after 5 years.
Use of 20 Year Bonds, Convertible into Common Stock After 5 years in Merger
Is this a good A reorg
In the Bucket: Only $1,000 20-year bonds.
 LeTulle v. Scofield: Similar consideration, but the bonds were 11-year bonds. This did not
meet the COI.
 Helvering v. Southwest Consolidated Corp.: Option to convert into voting common stock
under warrants did not meet the COI because at the date of the exchange they had no stock.
Therefore, bonds will be a problem for COI, and this is a taxable transaction now—it is NOT a
good A Reorg. Liquidation will be taxed under § 331/§336 (for Amy, Ben, and Charles), and sale
of Assets & Liabilities will be taxed under §1001 (for Tiny and Buddy).
(b) $1,000 worth of Buddy Corp.’s 8% cumulative non-voting preferred stock.
Use of Non-voting Preferred Stock in Merger
In the Bucket: Only $1,000 of 8% NVP stock.
 John Nelson v. Helvering: Non-voting preferred stock (NVP) counts as COI. Had 38.5% of
NVP, and this was ok for COI in this case.
o No distinction between preferred and non-voting stock.
Therefore, there is COI with 100% of NVP stock in the bucket (the entire bucket represents COI)
and this is a good A Reorg
(c) Same as (1)(b) except that the preferred stock is entitled to one vote per share, but it represents only 1%
of Buddy Corp.’s outstanding stock.
Stock Used in to Acquire Target Represents 1% of Acquiror Stock Outstanding—No problem
This % does not matter. The % we are worried about is the % in the bucket. Remember that the
ultimate goal is to determine whether it is something more than a mere change in form.
In the Bucket: 100% voting preferred stock
 Minnesota Tea Co. Case: Focused on Continuity. Target shareholders must have (1)
definite and material interest (refers to the type of investment) AND (2) substantial
value/must be a substantial part of what is transferred (this is the Bucket).
This meets COI, and assuming it is a Good “A” Reorg. What are the tax consequences?
Tiny Corp: (Target Corporation)
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


Step 1: EXCHANGE (all assets and debt)
o § 361(a): No gain or loss shall be recognized to a corporation if such corporation is
a party to a reorganization and exchanges property, in pursuance of the plan of
reorganization, solely for stock or securities in another corporation a party to the
reorganization.
 Party to a Reorganization (§ 368(b)):
 (1) a corporation resulting from a reorg, and (2) both corporations,
in the case of a reorg resulting from the acquisition by one
corporation of stock or properties of another. Flush language: in
most cases, the controlling corporations are also a party to the reorg.
 Pursuance to a plan of reorg (§ 1.368-2(g))
 Solely for stock or securities in another corporation a party to the
reorganization.
o § 357(a): the assumption of the liability shall not prevent the exchange, and shall
not be treated as money or other property. We saw this section for § 351
transactions, and it also applies when § 361 applies.
o We have met all of these requirements of § 361(a) and § 357(a) so NO GAIN OR
LOSS ON THIS EXCHANGE.
 $300 RG but NOT recognized
Step 2: LIQUIDATION and distribution to shareholders
o § 361(c): General Rule: No gain or loss shall be recognized to a corporation a party
to a reorganization on the distribution to its shareholders of property in pursuance
of the plan of reorganization.
 Note: 361(c)(2) has an exception where the property is not qualified
property. However, this is not applicable here.
o We have met the requirement under § 361(c) so NO GAIN OR LOSS ON THIS
LIQUIDATION.
Hypo: What if Tony’s basis in assets were $150 and liability is still $200  Same result
as above because § 357(c)—if liabilities exceed basis then the excess will be treated as
gain on sale. Does not apply because § 357(c) only applies to § 351, § 355, and
§ 368(a)(1)(D) only!!!
Amy, Ben, and Charles (SHs of Target Corp.)
 § 354(a): General Rule: No gain or loss shall be recognized if stock or securities in a
corporation party to the reorganization are, in pursuance of the plan of reorganization,
exchanged solely for stock or securities in such corporation or in another corporation a
party to the reorganization.
o (1) Stock or Securities in a corp. party to reorg
o (2) Exchanged solely for stock or securities in another corp. a party to the reorg,
AND
o (3) Pursuant to a Plan of Reorg
 § 358(a): Basis in Buddy’s stock will be the basis formula under § 358.
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
We have met the 3 requirements of § 354(a), and NO GAIN OR LOSS TO THE
SHAREHOLDERS.
Buddy Corp.:
 § 1032: No gain or loss (dealing in own stock).
 § 362(b): Transfers to Corporations: if property was acquired by a corporation in connection
with a reorganization to which this part applies, then the basis shall be the same as it would be
in the hands of the transferor, increased in the amount of gain recognized to the transferor on
such transfer.
o Basis = Basis in hands of Transferor + Gain Recognized to the Transferor in Such
Transfer
 § 381(a): Tax attributes of Tiny Corp. are transferred to Buddy Corp.
(d) $100 of Buddy Corp.’s 8% 2-year notes, $500 of Buddy Corp.’s 8% 20-year registered bonds, and 40
shares worth $10 per share of Buddy Corp.’s voting common stock (a total of $400).
Use of 2-year Notes, 20-year Bonds, and Common Voting Stock—COI (40%) and Tax Consequences of A
Reorg.
In the Bucket: $100 of notes (don’t count toward COI), $500 of 20 yr bonds (don’t count toward
COI), and $400 of stock (counts towards COI because of Minnesota Tea).
o $400 stock / $1,000 total value transferred = 40%  Therefore, COI–***§ 1.368-1(e)(2)(v),
Ex. 1
o So Good A Reorg
Tiny Corp (Target Corp.)
 § 361(a): The word “security”?
o Case law (some of these cases are stated in RR 2004-78):
 If a note has a term of more than 10 years, then it is called a security.
 If note has a term of less than 5 years, then it is not a security.
 5-10 years: grey area
o RR 2004-78: The Target Corporation security holders exchange their Target Corporation
securities for Acquiring Corporation debt instruments with terms identical to those of the
Target Corporation securities (including the maturity date), except that the interest rate is
changed (for example, to reflect differences in creditworthiness between Target
Corporation and Acquiring Corporation). These securities represent the continuity of
interest because they are identical. Therefore, the debt instruments of the Acquiring Corp.
exchanged for the securities of the Target Corp are securities within the meaning of § 354.
 Therefore, the 20-year bonds are securities, and the 2-year notes are not securities for § 361(a).
 ***§ 361(b): Exchanges not Solely in Kind – This relaxes the “solely for stock or securities” Rule:
§ 361(b)(1)(A): if the corporation receiving such other property or money distributes it in pursuance
of a plan of reorganization, no gain to the corporation shall be recognized from the exchange.***
o Here, THERE IS NO GAIN ON THE EXCHANGE BECAUSE THE 2-YEAR NOTES
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
WERE DISTRIBUTED UP TO THE SHAREHOLDERS ALONG WITH THE OTHER
STOCK & SECURITIES DURING THE LIQUIDATION.
LIQUIDATION:
o § 361(c)(2)(A): In general – If- (i) in a distribution referred to in paragraph (1), the
corporation distributes property other than qualified property, AND (ii) the FMV of such
property exceeds its adjusted basis (in the hands of the distributing corporation), flush
language: the gain shall be recognized to the distributing corporation as if such property were
sold to the distributee at its FMV.
 § 361(c)(2)(B): “Qualified Property”  (i) any stock in (or right to acquire stock in)
the distributing corporation or obligation of the distributing corporation, or (ii) any
stock in (or right to acquire stock in) another corporation which is a party to the reorg
or obligation of another corp. which is such a party if such stock (or right) or obligation
is received by the distributing corporation in the exchange.
 “obligation”  broad definition of debt and includes all bonds.
o THEREFORE, THE SECURITIES, NOTES, AND STOCK ARE ALL QUALIFIED
PROPERTY SO NO GAIN OR LOSS ON THE LIQUIDATION.
Amy
 She has 50 shares of Tiny Corp., which is a 50% stake. Her basis in the Tiny Stock = $200.
o 50% of $100 2-year notes = $50 2-year notes. 50% of $500 20-year bond = $250 20-year
bonds. 50% of $400 voting stock = $200 voting stock.
o Under § 354(a): She is giving up 50 shares of Tiny Corp. Stock and getting:
 (1) Buddy stock (No gain or loss under § 354(a)(1): Stock for Stock);
 (2) 20 yr. Securities (Have gain or loss because do not fall under § 354(a)(1):
Stock for Securities does not work under § 354(a)(2)(A)(ii))—securities received
and no securities surrendered, results in the inapplicability of § 354(a)(1).;
 (3) 2-year note (treated as BOOT/other property).
o Very Important Summary:
 Stock for Securities  This can’t get § 354(a)(1) treatment. Ask Blank what
happens here when there is Stock and Securities given up just for Securities!!!
 Go to § 354(a)(3)  this sends you to § 356 if you get property that does not
get § 354(a)(1) treatment.
o § 356(a): if § 354(a) would apply but for the fact that property
received not allowed, then gain shall be recognized but not in excess
of the sum of the money and FMV of property received. Gain will be
recognized to the recipient, but in an amount not in excess of the
sum of such money and the FMV of such other property.
 “Other property”: § 356(d)(2)(A): In general under §
356(d)(1) “other property” includes securities, but under §
356(d)(2)(A) if the securities under § 354 or § 355 would be
received without the recognition of gain, then don’t include
these securities—if they would get nonrecognition under §
354(a).
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
 Stock for Stock  Gets § 354(a)(1) treatment.
 Securities for Securities  Gets § 354(a)(1) treatment.
o **Need to determine gain or loss now: AR: $500 [the sum of everything Amy received],
AB: $200 [her basis in Tiny Stock], RG: $300  have to recognize all $300 gain because
under § 356(a) the other property is the $250 20 yr. securities and the $50 2-year note so
recognize gain capped at $250+$50 = $300.
 Recognize all realized gain where Boot gain does not exceed Realized Gain.
Amy’s Basis
o 2-year note: § 358(a)(2) – Other property: The basis of any other property (except money)
received by the taxpayer shall be its FMV. Therefore, the basis = $50.
 Basis of boot is FMV under § 358(a)(2)
o 20-year securities: § 358(a)(2): FMV of property = $250.
o Buddy stock: § 358(a)(1): $200 [original basis in Tiny Stock] – [$300 FMV of boot
received] + $300 [gain recognized] = $200 Basis
Ben
 He has a 30% interest in Tiny Corp, and basis = $400. Giving up 30 Tiny Shares.
o $30 2-year notes; $150 20-year securities; $120 Buddy stock
 § 354(a)(1) covers the stock for stock and therefore it is tax free/deferred.
 Both the notes and securities under § 354(a)(3) send you to § 356(a)(1): AR $300
[includes all property received], AB $400; RL ($100), the loss is not recognized
under § 356(c).
 § 356(c): flush language: no loss from the exchange or distribution shall be
recognized.
 Because there is a loss, no gain will be recognized on receipt of the boot.
 Ben’s Basis:
o 2 yr. note: § 358(a)(2): FMV basis = $30
o 20-year securities: § 358(a)(2): FMV basis = $150
o Buddy stock = § 358(a)(1): $400 [original basis in Tiny stock] - $180 [FMV of Boot] =
$220 Basis
Charles
 He has a 20% interest, with a basis = $150.
o $80 stock; $20 2 yr. note; $100 20 year securities
 § 354(a)(1) covers the stock for stock, so it gets nonrecognition.
 Both the notes and securities under § 354(a)(3) send you to § 356(a)(1): AR $200,
AB $150; RG $50, the gain is recognized under § 356(a)(1) up to the capped
amount of $120 (the other property) so the full $50 gain is recognized. CAN
REFER TO THIS AS BOOT GAIN AS WELL.
 Charles’ Basis:
o 2 yr. note: § 358(a)(2): $20
o 20 year security: § 358(a)(2): $100
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o Buddy stock = $150 [original basis in Tiny stock] - $120 [FMV of boot] + $50 [gain
recognized] = $80.
Buddy
 § 1032: no gain or loss (dealing in own stock)
 § 362(b): Tiny’s basis in the assets + Tiny’s gain = $900 + 0 = $900.
o Note: § 362(b) is focusing on the Trasferor’s gain—here the shareholders are
recognizing gain, not the Transferor (Tiny).
How is the boot gain taxed?
 Clark v. Commissioner: Supposed to pretend that Charles, Ben, and Amy only received Buddy
stock (with the value of everything received). Therefore, Charles received $200 of Buddy stock in
this pretend transaction, and then pretend Buddy pays Charles $125 (boot gain) for Buddy Stock.
Then, test it under § 302 redemptions  If meaningful reduction, then sale or exchange
treatment.
 For this class, assume always there is a sale or exchange treatment so capital gain treatment.
Therefore Boot Gain taxed @ capital gain rates.
o We can make this assumption because for public companies, SHs will normally have a
meaningful reduction in a redemption due to the Revenue Ruling we studied during
redemptions.
i.
What if Buddy Corp.’s voting common stock traded at $10 per share on the NY Stock Exchange
when the merger agreement was signed, but trades at $6 per share when the merger closes 4
months later?
Post Contract Price Fluctuation—§ 1.368-1(e)(2)
The values of the stock are different. Here the stock is only worth $240 out of a total $840
in value. This would make the portion of the bucket less than 40% and create an issue for
COI. There would be no more continuity at the time of the closing. Can this mean that the
entire merger is taxable as a result? YES!!
New Rule: § 1.368-1(e)(2)—the idea is to stop people from worrying about post-signing
price fluctuation. If the merger provides for fixed consideration, then can use the value of
the stock the day before the signing of the merger agreement.  Need a signed deal though
for this!!!
Therefore, we would use the $10 per share value, which would allow the % to remain at
40% and satisfy the continuity of interest requirement, this rather than $ 6 per share.
Question 2
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Statutory merger ("A" reorganization) - Miscellaneous continuity issues. In a statutory merger under
the laws of the State of Delaware, Tiny Corp. merges into Buddy Corp. solely in exchange for Buddy Corp.
voting stock.
(a) Ben exercises dissenter's rights under Delaware law and is paid in cash for his shares.
Dissenter’s Rights in A Reorg Situation
Dissenter’s rights: Ben doesn’t want stock he wants cash because he doesn’t want to be part of
Buddy Corp.
§ 1.368-1(e)(1): Continuity of Interest: Broad language: “in connection with the potential
reorganization . . .” this language is very broad, and consideration other than stock will be used in
analyzing COI.
Therefore, have to look at the cash in this problem because it is in connection with the potential
reorg.
In the Bucket: $70 shares of Buddy Stock (1 share for every 1 share of Tiny) and 30% is Cash
because Ben is a 30% shareholder of Tiny. Therefore, 70% is stock so COI [40% requirement] is
met.
Can Ben get his cash without being a part of the Reorg?  Ben could sell his shares to Amy and
Charles or Tiny can redeem the shares from Ben (§ 1.368-1(e)(8), Ex. 9: pre-acquisition
redemption by Target – this is OK!).  Both of these plans may all look like 1 transaction
though!!!  Separate on timing and use separate written documents to make it not all one
transaction!
(b) Amy, Ben, and Charles agree to the merger transaction only on the condition that Buddy Corp. give its
binding promise to assist them in selling their Buddy Corp. shares at a future date if they request its
help. Immediately after the merger, as they had planned all along, Amy, Ben and Charles sell all of their
Buddy Corp. stock to unrelated parties with Buddy Corp.’s help.
Sale of Shareholder Stock Before or After Reorg to Unrelated Parties
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1.368-1(e)(1)(i) & -1(e)(8), Exs.: Shareholders are free to sell their stock to unrelated parties after the
reorganization or before the reorganization: the Regulation uses the language that a “mere
disposition” is fine! As long as sold to an unrelated party!!
Is there a problem that Buddy Corp. is helping them sell the Buddy Corp. stock?
 § 1.368-1(e)(8), Ex. 1: There can be a preexisting contract to sell to a 3rd party, which is OK!
 § 1.368-1(e)(8), Ex. 3: Acquiror can assist like Buddy is.
Therefore, there is no problem with Buddy Corp. helping them sell the Buddy Corp. stock.
(c) Shortly after the merger, Spino Corp., a wholly-owned operating subsidiary of Buddy Corp., buys all the
Buddy Corp. stock issued to Amy and Charles in the merger, using cash that Spino Corp. had
accumulated over the years.
Sale of Stock Post Reorg to Related Party—Treat as Cash and Determine Bucket
Related Party so beware!
§ 1.368-1(e)(8) ex. 4 (iii): Treat as receiving cash now instead of stock! This ddoes mean outright that
it is not a reorg, but must look to the BUCKET. Therefore, In the Bucket: Ben received 30% stock
and Amy & Charles are 70% interest holders and they received cash (because related) so no COI
because only 30% stock in the bucket.
Fails COI Requirement and now the entire transaction is TAXABLE.
(d) Several months before the merger with Tiny Corp., Buddy Corp.’s directors approved a "stock buyback"
program, whereby Buddy Corp. announced its intention, on a discretionary basis, and depending on
market conditions, to purchase Buddy Corp. shares in the open market. Buddy Corp. had made a few
such purchases before the merger. Would it make any difference if the stock buyback program had been
announced after Buddy Corp. began negotiations with Tiny Corp.?
Stock Buy Back Agreement
“Stock buyback” program create a problem?
 After the negotiations, Buddy Corp. could buy back Amy, Charles, and Ben’s tock, but the
stock buyback program is on the open market so anyone can sell their shares back.
o What’s the issue? Selling stock to a related party. However, this is open market sale.
o RR 99-58: as long as A,B, and C don’t have a “specific agreement” with the
corporation, then the stock buyback program is still COI even if A,B, and C sell back
their shares in the buyback program. The Bucket is still all stock. An equity interest
must be in the bucket, and it must be at least 40%.
Takeaway on COI:
 COI is just determined 1 second after.
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


No debt counts for COI.
SHs can sell to anybody even Buddy, but beware of related parties.
Etc. (Blank wrote a paper).
(e) Tiny Corp. was in the business of manufacturing televisions under a patented process and selling them at
retail in the United States under the Tiny Corp. brand name. What if, immediately after the merger,
Buddy Corp. sells Tiny Corp.’s manufacturing plants and retail stores and continues to manufacture
televisions in its own plants under Tiny Corp.’s patented process, selling them under the Tiny Corp.
brand name in Buddy Corp.’s own retail outlets?
After Reorg Sells Target’s Old Business Assets But Continues Business (and sells under Old Business
Name)
§ 1.368-1(d)—COBE
 Needs to continue historic business or use the assets of the old business
Here, Buddy is continuing the historic business by producing Tiny Corp. brand name televisions
through patented process even though Buddy sold some of the assets.
§ 1.368-1(d)(5), Ex. 4 & 5: Examples where there is no COBE: Ex. 4 – T manufactures children’s
toys and P distributes steel and allied products. On Jan 1, 1981, T sells all of its assets to a 3rd party
for $100,000 cash and $900,000 in notes. On Mar 1, 1981, T merges into P. COBE is lacking. The use
of the sales proceeds in P’s business is not sufficient. Ex. 5 – T manufactures farm machinery and P
operates a lumber mill. T merges into P. P disposes of T’s assets immediately after the merger as part
of the plan of reorganization. P does not continue T’s farm machinery manufacturing business.
COBE is lacking.
 Ex. 4 selling all assets for cash and notes and then merging will not satisfy COBE.
 Ex. 5 merger and then sell all assets from target corp also will not satisfy COBE
 Look at the Target and ask if the Target’s business made it over into the Acquiror’s
business
Question 3
§ 368(a)(1)(C): The acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in
exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring
corporation), of substantially all of the properties of another corporation, but in determining whether the
exchange is solely for stock the assumption by the acquiring corporation of liability of the other shall be
disregarded
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
Requirements
o (1) Acquiror must acquire SUBSTANTIALLY ALL the properties of Target solely for
Acquiror voting stock, AND
- “substantially all”
 90% of FMV of Target’s net assets, AND
 70% of FMV of Target’s gross assets.
 Rev. Proc. 77-37
- Assumption of Liabilities
 Disregarded for solely for voting stock requirement
 §1.368-2(d)(1).
o (2) Target must liquidate and distribute all of Acquiror stock, securities and other property.
- § 368(a)(2)(G)—Distribution requirement for C Reorg:
 A transaction shall fail to meet the requirements of paragraph (1)(C) unless
the acquired corporation distributes the stock, securities, and other properties
it receives, as well as its other properties, in pursuance of the plan of
reorganization (i.e., the target must liquidate). For purposes of the preceding
sentence, if the acquired corporation is liquidated pursuant to the plan of
reorganization, any distribution to its creditors in connection with such
liquidation shall be treated as pursuant to the plan of reorganization.
 The lingo is the “liquidation requirement.”
 Only for “C” reorgs. Will fail unless the entire corporation distributes all of
the assets.
 Distributions to creditors by T will also count as distribution to shareholders
o Note: No statutory merger required
“C” Reorganization
"C" reorganization. In a transaction not structured as a statutory merger, Tiny Corp. transfers all its
assets to Buddy Corp. for the following alternative types of consideration, after which Tiny Corp. promptly
liquidates: No Merger so no “A” reorg
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(a) $1,200 of Buddy Corp.’s 8% registered bonds, payable after 20 years, and convertible into Buddy Corp.
voting common stock at the election of the bondholder after 5 years.
Use of Bonds in C Reorg—Not Voting Stock—Not Good “C” Reorg
$1,200 of 8% registered bonds
COI for § 368(a)(1)(C) is not the judicial doctrine of the 40% bucket, but the COI is listed in the
statute, which is the “solely for voting stock,” which is a loosened test compared to § 368(a)(1)(B).
This is not a Good “C” Reorg because registered bonds are not voting stock, therefore NOT A
GOOD “C” REORG.
(b) $1,200 worth of Buddy Corp.’s 8% cumulative nonvoting preferred stock.
Use of Nonvoting Preferred Stock—Not Voting Stock—Not Good “C” Reorg
This is not voting stock and therefore violates § 368(a)(1)(C) “voting stock” requirement.
Therefore, NOT A GOOD C Reorg.
Still would want to try to satisfy statutory merger (a)(1)(A).
The tax consequences of this would be a §1001 sale: AR: 1200
You might tell the clients to “merge” for state law purposes because it would be a good “A” re-org
(c) $1,200 worth of Buddy Corp.’s 8% cumulative preferred stock that is entitled to one vote per share but
represents only 1% of Buddy Corp.’s outstanding stock.
Use of Voting Preferred Stock—Representing 1% of Acquiror Stock—Good “C” Reorg
$1200 Preferred Stock that represents 1% of Buddy Corp  it is voting stock, but is 1% enough?
 The statute says “all or a part” and 1% seems like a “part.” Therefore, Good “C” Reorg.
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Tax consequences of good C Reorg
Tiny (Target)
§ 361(a) no gain or loss to Tiny
§ 361(c) distribution to shareholders no gain or loss on receipt.
ABC (Target Shareholders)
§ 354 stock for stock so all nonrecognition
§ 358(a) transferred basis in the stock (A: $200; B: $400, C: $150)
Buddy (Acquiror)
§ 1032 no gain or loss on issuance of its own stock
§ 362(b)—Buddy takes Tiny’s basis + any gain recognized by the Target Corp.
(d) $1,000 worth of Buddy Corp.’s 8% cumulative preferred stock that is entitled to one vote per share.
Buddy Corp. assumes Tiny Corp.’s liabilities of $200.
Voting Preferred Stock AND Liabilities
Voting stock + assumption of liabilities
The liabilities are disregarded for the “solely for voting stock” requirement under § 368(a)(1)(C),
and therefore a Good “C” Reorg.
Tax Consequences
Under § 357(a), the liability is not treated as boot—tells us to ignore liabilities. For the analysis of
the tax consequences to target SHs.
*This is saying where § 361 is turned on we ignore the assumption of liability. Here § 361 is
turned on because § 368(a)(1)(C) has been met.
Question 4
"C" reorganization -- "solely" relaxation rule.
Tiny Corp. transfers all of its assets to Buddy Corp. for the following alternative consideration, and Tiny
Corp. immediately liquidates after the asset transfer.
Relaxed “solely for voting stock”: § 368(a)(2)(B)(iii): if the acquiring corporation acquires for voting stock
described in paragraph (1)(C), property of the other corporation having a fair market value which is at least 80
percent of the FMV of value of all property of the other corporation. Flush language: liability is treated as
money paid for the property (aka include it with the nonvoting stock consideration—everything other than
voting stock is treated as nonvoting stock).
 This loosens the “solely” for voting stock standard and if there are other assets with the voting stock
then the threshold above must be met to be a Good “C” Reorg.
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
Formula: FMV Assets * 80% (DONE ON GROSS ASSETS).
o In other words, nonvoting stock cannot exceed 20% of target assets
(a) $200 worth of Buddy Corp.’s 8% cumulative non-voting preferred stock, and $950 worth of Buddy
Corp.’s voting common stock. Buddy Corp. also assumes $50 of Tiny Corp.’s liabilities.
Voting Stock, Non-voting Stock, and Liabilities Used in C Reorg
$200 NVP; $950 voting stock; $50 assumption of liability
§ 368(a)(2)(B)—additional consideration in certain “C” reorgs. This is the relaxed “solely for
voting stock” rule.
§ 368(a)(2)(B)(iii)—Buddy has to acquire solely for voting stock a FMV of at least 80% of Tiny’s
gross assets. Therefore, 20% of the “bucket” can consist of something other than voting stock.
§ 368(a)(2)(B) Flush: Solely for purposes of determining the relaxed voting requirement, the
assumption of liability will be considered other property (i.e. non-voting stock). If a corp pays
something other than voting AND also assumes liability, then it will treat everything that is nonvoting stock will be treated as non-voting stock. Even $1 can cause the liability to be considered as
non-voting stock. Put simply, if something other than debt relief is received, some “other
property” then the liability will be considered in determining whether the “solely for voting stock”
We will count as non-voting the NVP and the debt relief. see FLUSH language of § 368(a)(2)(B). If
there is something other than non-voting stock received, in this case non-voting stock, the
liabilities shall be treated as money (non-voting stock). BUT only for the purpose of the test in §
368(a)(2)(B).
Test: Tiny’s Assets = $1,200 (FMV of Tiny’s Property) * .8 = $960 so this is the threshold, which
80% of the FMV of Tiny’s Assets and is the minimum of voting stock that is required to be used to
satisfy the “solely for voting stock” requirement. Here, $950 voting stock < $960 threshold so this
does not qualify as a “C” Reorg. RELAXED SOLELY FOR VOTING STOCK TEST.
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Remember: this 80% test only applies where there is something received in addition to voting
stock.
Note: Assume we didn’t know the FMV of Tiny’s property, but knew Buddy paid $1,200 for the
assets. Then we can figure / assume that the FMV of property is $1,200 ($950 voting stock + 200
nonvoting preferred + $50 assumed liability) (Philadelphia Park Case rationale). This is reverse
engineering figuring out the FMV of Tiny’s property. Then multiplying that 1200 x 80% would
leave $960, then would have to treat assumed liabilities as money and it fails.
(b) $200 worth of Buddy Corp.’s 8% cumulative non-voting preferred stock, and $1,000 worth of Buddy
Corp.’s voting common stock. To satisfy its bondholders’ claims, Tiny Corp. transfers $200 of Buddy
Corp. common stock to its bondholders.
Voting and Non-voting Stock Used AND Voting Common Given to Debt Holders/Creditors
$1000 voting stock; $200 non-voting preferred
BUT 200 common paid to debt holders.
Tiny uses the $200 NVP to pay of Tiny’s debt (the creditors). 1.) Meet the 80% threshold here
because $1,000 voting > $960 threshold [Note: the stock to creditors does not impact the
threshold]. 2.) “Substantially All” – YES, Buddy acquired 100% of the assets.
Tax Consequences
Tiny
§ 361(a): no gain or loss on exchange
§ 361(c): no tax on distribution of Buddy stock to shareholders
 This is “qualified property” because Tiny is distributing stock of Buddy which is a party to
the reorganization.
§ 361(c)(3): For purposes of this subsection, any transfer of qualified property by the corporation to its
creditors in connection with the reorganization shall be treated as a distribution to its shareholders
pursuant to a plan of reorganization. Shall be treated as distribution to SHs (pretend that creditors are
SHs) so no gain or loss.
 No gain or loss on transfer to debt holders (creditors treated as shareholders) in connection
with a reorganization
Amy Ben and Charles
§ 354(a): No gain or loss on receipt of stock since Buddy is a party to the re-org
§ 358(a)(1): Exchanged basis—
o Start with SH’s basis in property MINUS
o FMV of boot received PLUS
o Gain recognized by SH MINUS
o (d) Liabilities assumed by Corp =
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o SH’s basis in stock
Debt Holders/Creditors
Give up debt (20-year registered bonds are “securities” and get common stock
§ 354(a)(2)(A)(ii): securities for stock is covered and receives no gain or loss under § 354(a)
 Note: does not cover stock for securitiesif so, kicks you to § 356.
Therefore, the bondholders will not recognize gain or loss, and they will take the same basis in the
stock that they had in the bonds.
i.
What if, instead of issuing the preferred stock, Buddy Corp. pays Tiny Corp. $200 in cash that
Tiny Corp. uses to pay its bondholders?
Use of Cash to Pay off Debt Holders, Paid By Acquiror Through Target to Creditor
$1000 voting stock; $200 NVP
$200 cash to debt holders
Good “C” Reorg: It satisfies the 80% threshold for “solely for voting stock.”
Tiny:
§361(b)(1)(A): (b)Exchanges not solely in kind


(1)GainIf subsection (a) would apply to an exchange but for the fact that
the property received in exchange consists not only of stock or securities
permitted by subsection (a) to be received without the recognition of gain,
but also of other property or money, then—
(A)Property distribute If the corporation receiving such other property or
money distributes it in pursuance of the plan of reorganization, no gain to
the corporation shall be recognized from the exchange, but


1.) Exchange: § 361(b)(3): Treatment of Transfers to Creditors: Because Money (cash)
was transferred from Tiny to Creditors then no gain or loss because just considered as
a distribution in pursuance of the plan of reorganization so no gain or loss.
2.) Liquidation: § 361(c): “qualified property” does not include cash, but still not a
problem because can’t have gain on cash because basis always equals amount realized
so can’t ever have gain. § 361(c) calls for Gain to be realized on distribution of
appreciated property if nonqualified property is distributed to the SHs.
A, B, and C:
 § 354(a): no gain or loss.
 § 358: exchanged basis
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Buddy Corp:
 § 362(b): takes Tiny’s basis.
Question 5
“C" reorganization -- "Substantially All".
THE 80% THRESHOLD TEST DOES NOT COME INTO PLAY WHEN THERE IS ONLY VOTING
STOCK BEING TRANSFERRED. ONLY USE THE 80% THRESHOLD TEST WHEN A MIX OF
CONSIDERATION.
“Substantially All”
 90% of FMV of Target’s net assets, AND
 70% of FMV of Target’s gross assets
 Rev. Proc. 77-37.
(a) Tiny Corp. transfers all of its operating assets to Buddy Corp. solely in exchange for $900 of Buddy
Corp. voting stock. Tiny Corp. holds back (does not transfer to Buddy Corp.) its $300 of non-operating
assets, a portion of which it uses to pay its liabilities. Tiny Corp. then liquidates and distributes all of its
property (including the Buddy Corp. shares that Tiny Corp. received in the exchange) to its
shareholders.
Sub All Test in C Reorg (90% Net Assets and 70% Gross Assets)
Tiny is retaining $300 Non-Operating Assets.
Substantially All Test: Two-Part Test: RR 77-37:
 90% of FMV of NET ASSETS
o % = Before $1,000 Net Assets (1200 – 200 [debt])  After $100 Net Assets (300
retained – 200 [debt])
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


Therefore the Reduction in Net Assets = 90% because went from 100%
assets to only owning 10% of the assets so that is a reduction of 90% of
the FMV of the Assets.
 900 transferred / 1000 total net assets
70% of FMV of Target’s GROSS ASSETS
o .70 * $1200 [FMV of Assets Received] = $840  $900 > $840 so Passed this test.
The two-part test was PASSED.
Therefore, this is a Good “C” Reorg.
** Blank mentioned a RR 88-48 that says as long as you hold back assets to pay off creditors, it is
okay.
(b) Same as part (a) except that Buddy Corp. assumes Tiny Corp.’s liabilities of $200 and issues only $700
of Buddy Corp. voting stock.
Sub All where Debt Assumed in C Reorg, Example of Failed Sub All
1.) There Seems to be a Mix Consideration: is the 80% Threshold Met: $1,000 voting stock & 100
assumption of liability; however under § 368(a)(1)(C) the assumption of liability is
disregarded. Therefore, there is only voting stock as consideration, so PASSED this test.
2.) “Substantially All”
 90% Net Assets:
o Net: Before $1,000 Net Assets  After $300 Net Assets (because no liability to
offset the $300) – this is 70% of the Net Assets, which fails this test!!!
 70% Gross Assets: Don’t have to run this test because already failed the 90% Net
Assets test.
Therefore, Not a Good “C” Reorg.
Another Issue: RR 57-518 & 88-48: There is no debt so no reason why Tiny would retain the assets,
which would cause failure of the “C” Reorg as well. This is a safe harbor test. If there is debt, then
they corporation can keep enough of the assets to pay off the debt.
(c) Tiny Corp. sells 1/3 of its operating assets for cash. Tiny Corp. then transfers all of its assets to Buddy
Corp. in exchange for $1,000 of Buddy Corp. voting stock (Buddy Corp. assumes Tiny Corp.’s
liabilities). Tiny Corp. then liquidates and distributes all of its property (consisting of the Buddy Corp.
shares that Tiny Corp. received in the exchange) to its shareholders.
Sale of Assets Prior to C Reorg
Tiny selling 1/3rd of its operating assets prior to the Reorg:
 1/3rd * $900 = $300 of operating assets for cash to a 3rd party.
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
“Substantially All:” RR 88-48: As long as to an unrelated AND proceeds from the sale don’t go to
SHs of Tiny or stay with Tiny, then it is Ok! Therefore, the sale proceeds will go to the acquiring
corp.
This is ok—Good C reorg.
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Unit VII.B—Acquisitive Reorganizations (“B” Reorganizations)
I.
II.
General
 Solely voting stock. Immediately after the acquiror must have § 368(c) control.
 Here the target survives, but it is a separate entity.
 This is only voting stock, it much stricter than the previous “A” and “C” reorgs.
o Technically $1 could spoil this
 Ex. What about where 20% acquired for cash and 80% acquired for stock
o Rev. Rul. 85-139 could suggest not. BUT technically, the statute could support that
conclusion that this transaction is okay.
 Can’t combo with § 338 election
 § 1.368-2(c) creeping B within 12 months treated as 1 transaction.
o Immediately after?
o § 1.368-2(c)—B reorg can occur in a series of transactions in relatively short period of times
(12 months). It doesn’t all have to happen at once.
 § 1.368-2(j)(6)—10 years is long enough to make the stock acquired for cash “old and cold” and,
therefore, it is okay.
o ex. 4 and 5 —these say 10 year lapse being enough time to separate the cash transaction from
the stock transaction. In this situation you can treat the transactions as separate.
 Judicial COI does not apply here.
§ 368(a)(1)(B)

III.
The acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in
exchange solely for all or a part of the voting stock of a corporation which is in control of the
acquiring corporation), of stock of another corporation if, immediately after the acquisition, the
acquiring corporation has control of such other corporation (whether or not such acquiring
corporation had control immediately before the acquisition
Rev. Rul. 98-10
 Provides that paying off debt holders in reorgs is okay.
 Most notable for extending tax=free treatment to debt-for-debt exchanges.
o Notably, some of the debt holders were also shareholders. Nevertheless the ruling concludes
that the “solely for voting stock” requirement is met bbecasue the target shareholders
received only voting stock “in their capacity as shareholders”
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IV.
V.
VI.
VII.
- Distinguishing from receiving the other as debt holders.
Rev. Rul. 72-354
 Treasury permitted Type B reorg treatment in a case in which the acquiring corporation sold stock
preciously acquired for cash in an unconditional sale with no agreement or arrangement to reacquire
the stock and subsequently entered into a type B stock-for-stock exchange.
 Can purge the stock purchased with cash by selling that stock to a 3rd party.
 Must be a real bona fide sale to a 3rd party.
 This functions to cleanse the stock.
Rev. Rul. 68-825
 T corp established an escrow account and put its own funds into it to pay dissenting shareholders
cash for their stock. Subsequently the Acquiring corp acquired 100% of T stock. The Service held
that this would not bust the “B” reorg. The ruling makes it clear that a “B” reorg would not be
available if the acquiring company paid dissenting company or reimbursed the acquired corporation
for its payment to the dissenting shareholders
Rev. Rul. 75-360
 the redemption must involve the Target’s money.
 Solely for voting stock requirement not met where cash from acquiring corporation was used to pay
off target company bank loan.
Rev. Rul. 85-139
 Rev. Rul. 85-139 illustrates the situation where an acquiring corporation has its subsidiary acquire a
portion of the outstanding stock for cash (10%) and then subsequently the acquiring corp exchanges
its own voting stock for the remaining stock outstanding in the Target corporation (90%). The
Service notes that had Target acquired all of the outstanding stock for cash and stock, it would fail
the “solely for stock” requirement of § 368(a)(1)(B). “P’s structuring of the transaction to have its
wholly owned subsidiary acquire some of the X stock for cash does not produce a different result.”
Problems
Same facts as Unit VII-A. Tiny Corp. is a closely held corporation incorporated under the laws of the
State of Delaware with 100 shares of voting common stock outstanding, owned 50 shares by Amy (basis $200),
30 by Ben (basis $400), and 20 by Charles (basis $150). Tiny Corp. has the following assets:
Non-operating Assets
Operating Assets
Totals
Basis
$200
$700
$900
Value
$300
$900
$1200
Tiny Corp. has outstanding liabilities of $200 (in the form of 20-year registered bonds owned by Lucy),
and accumulated earnings of $400. The aggregate value of Tiny Corp.’s outstanding stock is $1,000 ($10 per
share).
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Buddy Corp. is a publicly held corporation incorporated under the laws of the State of Delaware, the
stock of which is listed on the New York Stock Exchange.
Determine the tax consequences to Tiny Corp., Amy, Ben, Charles and Buddy Corp. of the following
transactions.
1. Buddy Corp. acquires all of the Tiny Corp. common stock from Amy, Ben, and Charles solely in exchange
for voting preferred stock of Buddy Corp.
All Target Stock Solely in Exchange for Acquiror Stock—“B” Reorg
§ 368(a)(1)(B): The acquisition by one corporation, in exchange solely for all or a part of its voting stock
(or in exchange solely for all or a part of the voting stock of a corporation which in control of the
acquiring corporation), of stock of another corporation if, immediately after the acquisition, the
acquiring corporation has control of such other corporation(whether or not such acquiring corporation
had control immediately before the acquisition)
 2 Requirements:
o 1) Purchasing corporation must have control (total voting and per class) over the target
corporation immediately after the stock acquisition—this is § 368(c) control, 80%.
o 2) Target Shareholders must exchange Target stock solely for all or part of the
acquiring corporation’s voting stock (or the acquiring corps parent).
 Note: this is VERY strict requirement. § 368(a)(2)(B) “relaxed solely for voting
stock” doesn’t apply to “B” Reorgs. Technically, $1 would spoil this.
1) Buddy acquires all of Tiny stock in exchange for Buddy stock so the “solely for voting stock”
requirement is satisfied.
2) Immediately after 100% control, when only needed 80%, so § 368(c) control exists.
Therefore, this is a good “B” Reorg
Tax Consequences
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Tiny (Target)
Just owned by a new owner. No gain or loss.
Amy Ben and Charles (Target Shareholders)
§ 354(a) nonrecognition
§ 358(a) exchange basis. Old basis in Tiny Stock becomes new basis in Buddy stock.
Buddy (Acquiror)
Now owns Tiny, so Tiny stays alive.
§ 1032 allows for dealing in own stock.
§ 362(b) transfer basis, basis that Tiny Shareholders (Amy, Ben, and Charles had in the stock). THIS
IS DIFFERENT than “A” and “C.”
**What about where the stock is public? Rev. Proc. 81-70 allows sampling to determine basis. This
point not tested.
a. Suppose, in addition, that Buddy Corp. exchanges its own 15-year registered bonds for the Tiny
Corp. bonds held by Lucy.
“B” Reorg Where 15-year Acquiring Corp Bonds Exchanged for 3rd Party Bonds Held in Target Corp
Rev. Rul. 98-10: Provides that paying off debt holders in reorgs is okay. Most notable for
extending tax-free treatment to debt-for-debt exchanges. Key Factor is here that the debentures
were mostly held by a 3rd party because the fact that a substantial proportion of the Y debentures is
held by bondholders who own no stock in Y has the effect of ensuring that the value of the
debentures issued by X in exchange for the debentures of Y realistically reflects the value of the Y
debentures alone and does not constitute indirect nonqualifying consideration for the Y stock.
Notably, some of the debt holders were also shareholders. Ruling concludes that the “solely for
voting stock” requirement is met because the target shareholders received only voting stock “in
their capacity as shareholders
Good “B” reorg.
The payment of debt for debt is treated as a separate, taxable transaction from the
reorganization. For purposes of characterizing the “B” reorg, it treats the stock for stock and
debt for debt exchanges as separate.
Tax Consequences
Lucy (Debt holder)
§ 354(a): As a party to the reorg, therefore under Rev. Rul 98-10 she gets § 354(a) treatment.
This is even though it is treated as separate from the reorg.
b. Same as (1)(a) except that Buddy Corp. purchases the $200 of outstanding Tiny Corp. bonds from
Lucy, the holder, for cash.
Acquiring Corp Purchase Outstanding Bonds in the Target Corporation from a 3rd Party
149
Once again, Rev. Rul. 98-10 helps resolve this issue. The payment of debt to a 3rd party is
considered a separate taxable transaction from the reorganization so it will no bust the B
reorg.
2. Buddy Corp. acquires all of the Tiny Corp. common stock from Amy, Ben and Charles for $200 in cash and
$800 worth of Buddy Corp. voting stock, the consideration being allocated ratably among Amy, Ben and
Charles in proportion to their holdings of Tiny Corp.
Acquire All Target Stock in Exchange for Acquiring Corp Stock AND Cash
800 stock; 200 cash
This is not a § 368(a)(1)(B) Reorg because cash is also being exchanged along with voting stock. The
“solely for voting stock” requirement is a very strict standard under § 368(a)(1)(B).
Not a good “B” reorg. The boot busts the reorg. Even though the control piece is acquire for stock, it
is not satisfied/the cash busts it.
a. Suppose instead that Amy’s and Ben’s Tiny Corp. stock was acquired solely for voting stock of
Buddy Corp., while Charles’s Tiny Corp. stock was acquired for cash.
Acquisition of Some Target Shareholder’s Stock for all Cash and Some for All Acquiror Stock
It doesn’t matter that 80% control was obtained solely for voting stock because still have Boot
and Boot busts a “B” reorg.. This is still a problem and the “B” Reorg fails.
3. On January 2, July 1, and December 1, respectively, Buddy Corp. acquires Ben’s Tiny Corp. stock for cash,
Charles’s Tiny Corp. stock solely for Buddy Corp. voting stock, and Amy’s Tiny Corp. stock solely for
Buddy Corp. voting stock. Does any of these acquisitions qualify as a "B" reorganization?
Acquisition of Target Stock over Time/Separate Transactions—Some for Acquiror Stock, Some for Cash
The argument would be that only steps 2 and 3 were part of the reorg.
Timing/Immediately After—Looking for a “Creeping ‘B’”
§ 1.368-2(c): B reorg can occur in a series of transactions in relatively short period of times (12
months). It doesn’t all have to happen at once.
This makes it look bad because treating as one, the cash would be a part of the reorg.
 Reg example:
o 1939 buy stock for cash
o 1955 then get the rest of the stock for stock
 Reg saying if there are 16 years between then the transaction will not be poisoned.
150
§ 1.368-2(j)(6), ex. 4 and 5: 10 year lapse is enough time to separate the cash transaction from the
stock transaction. In this situation you can treat the transactions as separate.
This is the creeping “B” situation.
 10 years is long enough to make stock purchased for cash “old and cold”
The key here is that a lot of time has to pass. Therefore, the facts provided here would not be
sufficient—NOT A GOOD B Reorg!!
a. If Buddy Corp.'s initial cash purchase poisons "B" treatment for all three acquisitions, what might be
done to salvage "B" reorganization treatment for the two later acquisitions? See Rev. Rul. 72-354;
Rev. Rul. 68-562.
How to Salvage a “B” Reorg Poisoned by Stock Acquired for Cash
One way to avoid the dangers is for the acquiring corp (Buddy) to unconditionally sell all of
the earlier cash acquired shares to a 3rd party prior to any offer to acquire the target
shareholder’s stock in a subsequent B reorg.
Rev. Rul. 72-354: Treasury permitted Type B reorg treatment in a case in which the acquiring
corporation sold stock preciously acquired for cash in an unconditional sale with no agreement or
arrangement to reacquire the stock and subsequently entered into a type B stock-for-stock
exchange.
One problem is that if all of the stock was sold the 80% control requirement required by §
368(a)(1)(B) and defined in § 368(c) would not be met because Ben owned 30% of the stock.
However, Rev. Rul. 72-354 makes it clear that Buddy could subsequently exchange Buddy
stock for the 3rd parties stock without busting the “B” reorg, so long as there is no agreement
that the subsequent acquisition will occur at the time the Tiny stock is sold to the 3rd party.
 Sell Ben’s stock for cash to a 3rd party.
 Next would acquire control of voting stock.
 Can look to Rev. Rul. 72-354—must be a real bona fide sale to a 3rd party. This
functions to cleanse the stock.
 But would then need to acquire at least 10% for voting stock from 3rd party for
voting stock.
b. Suppose that Ben announces that he will not participate in the exchange because he does not want
Buddy Corp. stock. Buddy Corp., however, wants a "clean" acquisition with no minority
shareholders of Tiny Corp. hanging on. Tiny Corp., therefore, redeems Ben's Tiny Corp. stock for
cash (using exclusively Tiny Corp.'s own funds). Thereafter, Buddy Corp. acquires all of Amy’s and
Charles’s Tiny Corp. common stock (amounting at this point to 100%) solely in exchange for Buddy
Corp. voting stock worth $700 (an appropriate price, since the value of Tiny Corp. has been
diminished by the cash redemption). See Rev. Rul. 68-285.
151
Acquiring Dissenter’s Stock—Target Redeems Dissenting Target Shareholder Stock for Cash
Rev. Rul. 68-285: the Target corp established an escrow account and put its own funds into it to
pay dissenting shareholders cash for their stock. Subsequently the Acquiring corp acquired 100%
of T stock. The Service held that this would not bust the “B” reorg. The ruling makes it clear
that a “B” reorg would not be available if the acquiring company paid dissenting company or
reimbursed the acquired corporation for its payment to the dissenting shareholders.
 Redemption won’t spoil a “B” Reorg
Rev. Rul. 75-360: Borden (the acquiring corporation) was paying for the redemption of E&M
shareholders, by E&M getting a bank loan to pay of its SHs, then Borden giving E&M money to
pay of this bank loan. This was not considered a tax-free reorganization under § 368(a)(1)(B)
because it was not “solely for voting stock.”
 Takeaway: Redemption must use Target’s own money
Here, Tiny [the Target] is paying its own cash to Ben to redeem his stock. The facts indicate
that the Buddy stock transferred has been reduced based on the reduction in assets in Tiny.
As a result, Buddy is not reimbursing Tiny for its cash payment to Ben and the “B” reorg
should not be busted. GOOD “B” Reorg.
c. What if Buddy Corp. transfers $300 to Tiny Corp. to reimburse Tiny Corp. for its outlay in
redeeming Buddy Corp.’s stock? See Rev. Rul. 75-360.
Rev. Rul. 75-360: illustrates the point that the two transactions would not be treated
separately. Consequently, “B” reorg status would be disallowed and the entire transaction
would be considered a taxable sale or exchange.
Here the money is coming from Buddy [the Acquiror], which will bust the B.
d. What if, instead, Buddy Corp. causes its wholly-owned subsidiary, Shiny Corp., to buy Ben’s Tiny
Corp. stock, while Buddy Corp. issues its Buddy Corp. voting stock to Amy and Charles?
Acquiring Corp Acquires Target Stock for Acquiror Stock BUT Has Sub Acquire Some Target Stock for
Cash
Rev. Rul. 85-139: illustrates the situation where an acquiring corporation has its subsidiary
acquire a portion of the outstanding stock for cash (10%) and then subsequently the acquiring
corp exchanges its own voting stock for the remaining stock outstanding in the Target corporation
(90%). The Service notes that had Target acquired all of the outstanding stock for cash and stock,
it would fail the “solely for stock” requirement of § 368(a)(1)(B). “P’s structuring of the
transaction to have its wholly owned subsidiary acquire some of the X stock for cash does not
produce a different result.”
152
Therefore, these facts align with that ruling and suggest that the Buddy’s use of a sub to
acquire some of Tiny’s stock for cash will bust the “B” reorg because it violates the “solely for
stock” requirement.
Also, if Shiny stock used instead of cash. Now we have Shiny getting the 30 shares for stock
and Buddy using its voting stock to get Amy and Charles’s stock.
§ 368(a)(1)(B)—Statute says Parent OR Shiny stock. So no can only use one OR the other, not
BOTH. ** this was where some kid read the facts wrong and Blank worked through it
anyhow.
Hypo:
What if instead Amy and Charles’s stock is redeemed for cash and then Buddy Corp gets
Ben’s stock for voting Buddy stock?
This is an extreme case of the pre reorg redemption. It still would be allowed.
COBE
Is this an issue?
NO, Tiny corp is just distributing cash, the business itself still exists and will continue doing
whatever business it was involved in.
COBE is not likely to be an issue in “B” reorgs.
Hypo:
What if Buddy acquires all of the stock for voting stock and then buys some outstanding
treasury shares for cash from Tiny. The cash never will get into shareholder’s hands.
In this case the shareholders are only getting voting stock.
RR 72-522: (didn’t get this in packet) but it says that this okay.
153
Unit VII.C—Acquisitive Reorganizations: Triangular Reorganizations
Dolphin Co. is a corporation, the shares of which are owned 100% by Reed, an individual. Dolphin Co.
has assets with a gross value of $1,200 (adjusted basis of $900), liabilities of $200 and E&P of $300. Reed's
basis in his Dolphin Co. stock is $650. Sawyer, Inc. is a publicly held corporation whose stock is listed on a
national exchange. Clay Co. is a wholly-owned corporate subsidiary of Sawyer, Inc. Sawyer Inc.’s basis in its
Clay Co. stock is $100. All of the following alternative transactions occur on January 2 of the current year in
pursuance of a plan of reorganization. In each case, what are the tax consequences to each of the parties?
1. C Reorganizations. In each of the following parts, assume that, following the exchange with Sawyer, Inc.
(or Clay Co., as the case may be), Dolphin Co. liquidates and distributes all of its properties to its
shareholder, Reed.
a. C Reorganization with "Drop-down". In a transaction not effected as a merger under local law,
Dolphin Co. transfers all its assets to Sawyer, Inc. solely for Sawyer, Inc. voting stock and Sawyer
Inc.'s assumption of Dolphin Co.'s $200 of liabilities. Sawyer, Inc. then promptly transfers the
Dolphin Co. assets to Clay Co. (subject to liabilities) for additional Clay Co. stock.
C Reorg with Drop Down—Assets for Stock and then Drop Assets to Acquiror Sub
§ 361(a)(1)(C)
What problems here? (if not for the controlling corporation language)
The assets are not retained by Sawyer. They go to Clay. The potential problem is that the
acquiror has to acquire substantially all of the assets. Old cases Groman/Bashford (not in
packet and don’t need to know) said this was a problem. BUT then § 368(a)(2)(C) allows it.
Whether “drop-down” allowed
§ 368(a)(2)(C): “A transaction otherwise qualifying under paragraph (1)(A), (1)(B), (1)(C), or
(1)(G) shall not be disqualified by reason of the fact that part or all of the assets or stock which
were acquired in the transaction are transferred to a corporation controlled by the
corporation acquiring such assets or stock.
 So “C” reorg not ruined by dropping assets down to a § 368(c) controlled corp.
o Here Sawyer is a 100% owner of Clay Co. the drop down will not create a
continuity of interest issue, so long as the transaction would otherwise qualify for
154

“C” reorg status—C because this is not a statutory merger AND it is a
transaction involving assets.
Acquiror Basis in Sub Stock as a result of the drop down.
o § 358(a): [§ 362(b) basis in assets (this is Target’s basis in assets, which then
becomes Acquiror’s basis in the assets] + [Acquiror’s basis in Sub stock]
 This will also be affected by any boot involved.
Tax Consequences
Dolphin (Target)
§ 361(a): No gain or loss. The assumption of liabilities is not a problem under § 357(a)—
liabilities are ignored.
§ 361(c) no gain or loss on the liquidation
Reed (100% Owner of Target)
§ 354(a): no gain or loss
§ 358(a): carryover basis—same basis it had in the Dolphin Stock. $650 in Sawyer Stock.
Sawyer (Acquiror)
§ 1032: no gain or loss
§ 362(b): same basis in assets as Dolphin co. (Target) of $900.
Drop down to Clay, this is treated as a § 351 transaction:
§ 351(a): provides no gain or loss to Sawyer on this transaction
§ 358(a): Basis in Clay Co. Stock: $900 [§ 362(b) basis in assets—this is Dolphin’s basis in
assets, which then becomes Sawyer’s basis in the assets] – $200 [liabilities* assumed by Clay] +
$100 [Sawyer’s basis in Clay Co stock] = $800.
 *§ 358(d): liabilities treated as money and therefore reduces basis.
Sawyer doesn’t actually have to receive stock in this transaction. This is a “meaningless
gesture.” This is because Sawyer is the 100% owner of Clay.
Clay Co. (Acquiror’s 100% Owned Sub)
§ 362(b): Takes Dolphin Co. basis in assets = $900 basis.
§ 381: Tax Attributes for from Dolphin to Sawyer per § 381 and then from Sawyer to Clay per
§ 381: as illustrated in § 1.381(a)-1(b)(2). So Dolphin tax atttibutes end up in Clay.
b. Triangular C Reorganization. In a transaction not effected as a merger under local law, Dolphin
Co. transfers all its assets to Clay Co. and Clay Co. assumes all of Dolphin Co.'s liabilities. Clay Co.
pays for the Dolphin Co. assets by transferring to Dolphin Co. $1,000 worth of Sawyer, Inc. voting
stock (which stock had previously been contributed by Sawyer, Inc. to Clay Co. to be used for this
purpose).
Triangular “C” Reorg—Sub Uses Parent Stock to Acquire Target
155
Good “C” reorg?
§ 368(a)(1)(C)—parenthetical allows stock of a controlling corporation to be used in the
acquisition. So it can be Sawyer stock OR Clay stock BUT NOT BOTH. Yes. Good C reorg.
Tax Consequences
Dolphin Co (Target)
§ 361(a): no receipt no gain or loss
§ 361(c): no gain or loss on liquidation
Reed (100% Owner of Target)
§ 354(a): no gain or loss
§ 358(a): exchange basis, takes basis in Sawyer stock it had in Dolphin stock = $650 basis.
Sawyer (Parent of Acquiring Corp, Its Stock is Being Used in Acquisition)
Sawyer won’t have gain because it isn’t doing anything BUT there IS BASIS adjustment.
§ 1.358-6(c), (d)—addresses basis adjustments in triangular reorg. Only about basis.
“Over-the-Top” Method: Pretend: Sawyer acquired the assets from Dolphin Co directly and
then transferred (dropped down in § 351) them to Clay Co. NO gain or loss results from this
pretend transaction.
 In other words Parent increases its previous basis in its S shares by the basis in the T
assets acquired in the transaction.
§ 358(a): Basis in Clay Co. Stock: $900 [§ 362(b) basis in assets: this is Dolphin’s basis in
assets, which then becomes Sawyer’s basis in the assets] – $200 [liabilities* assumed by Clay] +
$100 [Sawyer’s basis in Clay Co stock] = $800.
Clay
§ 1032: no gain or loss (even though using Sawyer stock not clay stock—§ 1.1032-2(d)).
§ 362(b) takes carryover basis in assets = $900 basis (Dolphin’s basis)
§ 381(a) takes Dolphin’s tax attributes.
2. Forward Subsidiary Merger. Each of the following transactions between Dolphin Co. and Clay Co. is
effected as a statutory merger under applicable local law.
a. Clay Co. acquires all the assets of Dolphin Co. (and assumes all its liabilities) solely in exchange for
$1,000 of Sawyer, Inc. non-voting preferred stock (which previously had been contributed by
Sawyer, Inc. to Clay Co. for this purpose). What result to the parties?
Sub Uses Parent Stock To Acquire Target—Type “A” Forward Triangular Merger: Sub Remains
This is a statutory merger.
156
This is a statutory, forward merger—Meaning that Dolphin (Target) is merging into Clay
(Sub). This has Sawyer NVP going to Dolphin and assets and liabilities going to Clay.
§ 368(a)(2)(D): Use of stock of controlling corporation in paragraph (1)(A) and (1)(G) cases. The
acquisition by one corporation, in exchange for stock of a corporation (referred to in this
subparagraph as “controlling corporation”) which is in control of the acquiring corporation, of
substantially all of the properties of another corporation shall not disqualify a transaction under
paragraph (1)(A) or (1)(G) if
o (i) no stock of the acquiring corporation is used in the transaction, and
o (ii) in the case of a transaction under paragraph (1)(A) , such transaction would have
qualified under paragraph (1)(A) had the merger been into the controlling corporation.
4 Steps Occur:
Step 1: Acquiror stock is transferred to a Sub. Sub must be a sub that is controlled [§ 368(c)
80% control] by the Acquiror.
Step 2: § 368(a)(2)(D)(ii): Need a statutory merger that would satisfy for § 368(a)(1)(A)
 Keep in mind this DOES NOT have “sub all” requirement.
 Continuity of interest once again becomes relevant. Our bucket is in play again. **
NEED 40%. Doesn’t have to be voting stock here. Can be NVP. Any type of stock
works here.
Step 3: Target must transfer “substantially all” of its assets to the subsidiary
 Imposed under § 368(a)(2)(D). “Sub all” is the same requirement as in a “C” reorg.
Step 4: Sub transfers Acquiror stock to Target. § 368(a)(2)(D)(i): Sub can’t use any of its own
stock in the transaction.
Why Structure a Forward Merger, instead of just “A” Reorg?
All of the liabilities end up with the sub, they don’t get into the acquiror.
Good (a)(2)(D) reorg? YES!
§ 368(a)(1)(A): Yes, inside the bucket we have all NVP preferred stock, therefore 40% COI
satisfied and good statutory “A” Reorg.
Sub all: Yes, all of the assets were transferred from Target to Sub (Dolphin to Clay).
Control: Yes, Sawyer owns 100% of Clay, satisfying § 368(c) 80% control.
157
Reed
§ 354(a): no gain or loss.
§ 358(a): Takes exchange basis in Sawyer stock of $650 (its basis in Dolphin stock)
Dolphin
§ 361(a): no gain or loss on exchange
§ 361(c): no gain or loss on liquidation
So nothing happens here for tax consequences
Clay
§ 1032: says can use own stock, which is not the case here.
§ 1.1032-2(c): says Clay [Sub] can use Sawyer’s [Parent] stock in this transaction.
§ 362(b): Clay takes exchange [Dolphin’s basis] in the assets = $900 basis
Sawyer
Once again nothing is really happening to Sawyer here. All about BASIS.
§ 1.358-6(d): addresses basis adjustments in triangular reorg.
“Over-the-Top” Method: Pretend: Sawyer acquired the assets from Dolphin Co directly [§
362(b) and § 381] and then transferred [dropped down in § 351] them to Clay Co. NO gain or
loss results from this pretend transaction.
 In other words Parent increases its previous basis in its S shares by the basis in the T
assets acquired in the transaction.
§ 358(a): Basis in Clay Co. Stock: $900 [§ 362(b) basis in assets: this is Dolphin’s basis in
assets, which then becomes Sawyer’s basis in the assets] – $200 [liabilities* assumed by Clay] +
$100 [Sawyer’s basis in Clay Co stock] = $800.
Hypo:
What if Clay had bought the stock on the market?
This will not ruin the reorg. Because we still meet the technical rules of § 368(a)(2)(D).
However, § 1.1032-2(d), ex. 2: This stock will be treated as boot to Clay, on which the sub will
recognize gain. Bought for $500 and exchanged for $1,000. Would have to recognize $ 500 of
realized gain.
§ 1.1032-2(c): If Clay got Sawyer stock not pursuant to the plan of reorg, then it would also
give rise to gain on the reorg when the stock was exchanged.
b. Forward Subsidiary Merger with Boot. Suppose instead that Clay Co. issues $400 of 20-year
debentures (and exchanges only $600 of Sawyer, Inc. stock) in the transaction.
Sub Uses Parent Stock to Acquire Target—Type “A” Forward Triangular Merger: Sub Remains AND
BOOT [20-year debentures] is Used
Good § 368(a)(2)(D) Reorg?
158
COI: In considering whether COI exists we look to the bucket. In this situation 60% of the
bucket is stock, exceeding our 40% threshold.
 20-year debentures are not stock/equity per Le Tulle and, therefore are boot.
 This was the only thing that changed from (a) so type “A” reorg exists.
Sub all: Yes, all of the assets were transferred from Target to Sub (Dolphin to Clay).
Control: Yes, Sawyer owns 100% of Clay, satisfying § 368(c) 80% control.
Tax Consequences
Reed (100% Owner of Target)
Receives $600 stock and $400 debt relief
§ 354(a)(1): no gain or loss on the receipt of the stock.
§ 354(a)(2)(ii): if securities are received and no securities are surrendered then we have a
limitation on the § 354(a) nonrecognition provision.
 Therefore, nonrecognition for stock for stock but not for securities/debt § 356
§ 356: tells us if § 354 would apply if not for other property received, then we will have
recognize gain [realized gain will be recognized] but not in excess of boot received!
AR = 1000; AB = 650; Realized gain = 350
Boot received = $400 [20-year debentures]
Therefore, $350 is taxable as “boot gain”, the $400 Boot value is limited by the realized gain.
Basis in Sawyer stock
§ 358(a)(1): basis would 650 [basis in old (Dolphin) stock] – 400 (boot received/debt) + 350
[recognized gain] = $600 basis in stock.
Dolphin (Target)
§ 361(a): no gain or loss because solely for stock or securities
§ 361(c): no gain or loss on the liquidation
Clay Co. (Sub/Acquiror)
§ 1032: provides for no gain or loss. § 1.1032-2 regs allow the use of Sawyer [Parent stock].
What about the debentures?
Clay is using boot. It won’t ruin the reorg., but Clay will have to recognize gain on the boot to
the extent that there is built-in gain.
Sawyer (Parent)
Basis will have to go through the “over-the-top” method
§ 1.358-6(d): addresses basis adjustments in triangular reorg.
“Over-the-Top” Method: Pretend: Sawyer acquired the assets from Dolphin Co directly [§
362(b) and § 381] and then transferred [dropped down in § 351] them to Clay Co. NO gain or
loss results from this pretend transaction.
 In other words Parent increases its previous basis in its S shares by the basis in the T
assets acquired in the transaction.
159
§ 358(a): Basis in Clay Co. Stock: $900 [§ 362(b) basis in assets: this is Dolphin’s basis in
assets, which then becomes Sawyer’s basis in the assets] – $400 [Boot Received*] – $200
[liabilities assumed by Clay] + $100 [Sawyer’s basis in Clay Co stock] = $400 Basis
*1.358-6(c), ex 1(E): FMV of property supplied by the sub will be used to reduce the basis.
c. Forward Subsidiary Merger with Use of Parent Voting Stock and Subsidiary Non-voting
Stock. Suppose instead that Clay Co. exchanges $40 worth of its non-voting preferred stock and
$960 worth of Sawyer, Inc.'s voting stock in the transaction.
Forward Subsidiary Merger with Use of Parent Voting Stock and Subsidiary Non-voting Stock
§ 368(a)(2)(D)(ii): no stock of the Acquiring corporation can be used in a § 368(a)(2)(D) reorg.
Here Clay is using some of its own stock which causes the Forward Subsidiary merger to fail.
Therefore, this transaction would not receive tax free reorg treatment, unless it could satisfy
one of the other reorgs.
A reorg satisfied?
Normal A Reorg: If Dolphin merged into sawyer, we would have 96% stock in the bucket and
this could qualify.
A reorg into Clay: If dolphin merged into Clay would not qualify because only 4% stock would
be in the bucket. So it would fail A reorg COI.
B reorg?
No because not stock for stock, there are assets involved in this deal.
C reorg into Clay Co?
Yes, it would be a good triangular C reorg.
The clay NVP stock would trigger the language in § 368(a)(2)(B): additional consideration in
certain “C” reorgs. This is the relaxed “solely for voting stock” rule. Acquiring corporation
acquires, solely for voting stock, property of the other corporation having a FMV which is at
least 80% of the FMV of all of the property of the other corporation.
FMV of Dolphin assets = 1200 x .8 = $960. Clay exactly that amount, $960 and therefore
makes it a good triangular C Reorg.
Have to take the $200 debt into account, which is why it has to be 80% of $1200, rather than
just $1000. Clay must pay at least 80% which is $960 of the assets for voting stock. This
happens here. $960 is exactly the amount that clay is giving, even though it is Sawyer voting
stock, clay is allowed to use it.
NOTE: Had the stock been voting stock from Clay, then it would have been only voting. BUT
could only have Sawyer stock OR Clay stock, then the C reorg would fail.
§ 1.368-2(d): illustrates that only the stock of Sub OR parent can be used, if BOTH are used,
the “C” Reorg will FAIL!!
160
So here non voting stock OR clay voting stock could bust the C reorg.
3. Reverse Subsidiary Merger. Assume that Reed owns 80% of Dolphin Co. and Kyle, an individual, owns
20%. Sawyer, Inc. transfers $850 of its voting stock and $150 in cash to Clay Co. (newly formed) solely for
stock of Clay Co. Immediately thereafter, Clay Co. (whose only assets are the Sawyer, Inc. stock and $150
in cash) merges into Dolphin Co. under applicable state law. Under the plan of merger, and by operation of
state law: (i) the Clay Co. stock owned by Sawyer, Inc. is exchanged for $1,000 of Dolphin Co. stock; (ii)
all of Clay Co.'s assets (and liabilities, if any -- here there are none) are transferred to Dolphin Co.; (iii) Clay
Co. dissolves; and (iv) the Dolphin Co. stock held by its shareholders, Reed and Kyle, is exchanged, pro
rata, for the $850 of Sawyer, Inc. stock and $150 in cash received by Dolphin Co. on the merger of Clay Co.
into Dolphin Co. As a result, Sawyer, Inc. owns 100% of Dolphin Co. after the transaction. What result to
the parties?
Reverse Subsidiary Merger
§ 368(a)(2)(E): Statutory merger using voting stock of corporation controlling merged corporation. A
transaction otherwise qualifying under paragraph (1)(A) shall not be disqualified by reason of the fact
that stock of a corporation (referred to in this subparagraph as the “controlling corporation”) which
before the merger was in control of the merged corporation is used in the transaction, if—
o (i) after the transaction, the corporation surviving the merger holds substantially all of its
properties and of the properties of the merged corporation (other than stock of the
controlling corporation distributed in the transaction); and
o (ii) in the transaction, former shareholders of the surviving corporation exchanged, for an
amount of voting stock of the controlling corporation, an amount of stock in the surviving
corporation which constitutes control of such corporation.
161
Rev. Rul. 67-448: Acquiror transferred A stock to sub. Then sub merged into Target. The survivor was
the target. After the merger, the target paid off the dissenting shareholders with cash. IRS said this was a
good “B” reorg.
 This was pre-§368(a)(2)(E)
§ 368(a)(2)(E): Transfer otherwise qualifying under § 368(a)(1)(A), but can use stock of the acquiring
corporation.
Two big requirements:
1) “Sub All”—target has to hold sub all of its property AND substantially all of the merged
corporation—§ 368(a)(2)(E)(i)
 So sub all applies to BOTH target and sub
 NOTE: This is a unique “sub all” requirement.
2) Control of Target for voting stock of Parent—this is more strict than (a)(2)(D). § 368(a)(2)(E)(ii)
Reed and Kyle need to transfer control of Dolphin (the corporation they previously controlled) to
Sawyer
Advantage of this to a B reorg.
You can use boot in the transaction, whereas in a “B” reorg you cannot use boot.
The Transaction:
All of this happens at the same moment in time.
Step 1: Sawyer [Parent] transfers $850 voting and $150 cash [BOOT] to Clay [Sub].
Step 2: Clay [Sub] merges into Dolphin [Target]
Step 3: Clay [Sub] transfers the stock and cash to Dolphin [Target]
Step 4: Dolphin [Target] distributes the stock and cash to Reed and Kyle [Target Shareholders] pro
rata
Step 5: Kyle and Reed [Target Shareholders] then transfer their Dolphin [Target] stock to Dolphin
[Target]—like a redemption.
Step 6: Dolphin [Target] transfers the Dolphin stock to Clay [Sub] AND
Step 7: Clay [Sub] liquidates and distributes the Dolphin [Target] stock to Sawyer [Parent]
This leaves Kyle, Reed, and historic Sawyer shareholders owning Sawyer. And Sawyer owns
Dolphin.
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After the transaction is done, Reed and Kyle own Sawyer, which owns Dolphin.
Good (a)(2)(E)?
1. Sub All: “Sub All”—target has to hold sub all of its property AND sub all of the merged
corporation—§ 368(a)(2)(E)(i). This is not a problem because Dolphin has all of its assets and all of
Clay’s Assets.
2. § 368(a)(2)(E)(ii): Control of Target for voting stock of Parent—this is more strict than §
368(a)(2)(D). Reed and Kyle are giving up 85% (850/1000) of their stock for Sawyer stock (although
100% stock is being given up, part is given up for cash). This meets the 80% control requirement of §
368(a)(2)(E)(ii)—§ 368(c) control. So we are good on the control requirement because 85% > 80%.
Therefore, this is a good § 368(a)(2)(E) Reverse Triangular Merger.
NOTE: What would happen if Dolphin sold off half of its assets 5 minutes before the transaction?
Additionally, what if Clay Co. sold off half of its assets 5 minutes before. This could raise an issue
with the “sub all” requirement. A judge could step the transactions together.
Tax Consequences
Reed and Kyle (Target Shareholders)
§ 354(a): non recognition on the exchange of stock for stock, a party to the reorganization. These are
all parties to reorganization.
§ 356: Boot, to the extent they have realized gain. We are not given these numbers, but it is the same
as above. So the cash will be boot and gain will be recognized.
Dolphin (Target)
§ 361(a): no gain on stock for stock—once, again related to a party to the reorganization.
§ 361(b)(1)(A): property distributed to shareholders no gain or loss as long as Dolphin passes it to its
shareholders.
§ 361(c): distribution, no gain or loss on distributions to shareholders in pursuance to plan of
reorganization
Clay (Sub) —This is different than anything we have seen
**This is basically treated as an exchange pursuant to a reorg and then a liquidation pursuant to a
reorg. Here, Sawyer is Clay’s shareholder. Clay is engaging in an exchange with a party to the
reorganization. Therefore, no gain or loss and Clay liquidates/does not exist afterwards.
§ 361(a) No gain or loss on transfer to Dolphin
§ 361(b) no gain or loss on any boot received, so long as distributed to shareholders.
§ 361(c) no gain or loss on liquidation on distribution to its shareholders.
Sawyer
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**Just think of Sawyer as a shareholder of Clay. This is along the same thought process as Clay,
being a 100% owner of Clay and get the advantage of § 354.
§ 354(a)—no gain or loss to Sawyer.
Basis:
Use “over the top” method § 1.358-6(c)(2)(A)(i): End result is the same—use the same method used in
forward triangular mergers.
Imagine a step happening that doesn’t happen in real life, pretend:
 Sawyer receives Dolphin Assets and Liabilities and then contributes them to Clay, this even
though Clay ultimately liquidates.
 § 362(b) basis  351 exchange  358
Sawyer’s Basis in Assets: 900 [exchange basis in Dolphin assets: § 362(b)] – 200 [liabilities assumed] +
150 [cash contributed by Sawyer to Clay Co to be used in transfer to Dolphin, treated as initial basis
in Clay stock comes from § 351 contribution] = $850
Basically, Sawyer gets basis in Clay Co. for the cash given for use in the transfer. The stock issued to
Clay co. has -0- basis. Closest Code support is § 1032, but it really doesn’t say this.
§ 368(a)(2)(E)(i): basically says that the assets used solely for the reorg (here the cash and stock from
Sawyer), will be ignored in determining whether the “sub all” requirement has been met.
a. Reverse Subsidiary Merger; Cash-out of Dissenter. Assume the Dolphin Co. shares are owned
75% by Reed and 25% by Kyle. Kyle dissents to the merger and Dolphin Co. pays him $250 in cash
for his Dolphin Co. shares, using Dolphin Co.'s own money. Reed exchanges his Dolphin Co. stock
for $750 of Sawyer, Inc. voting stock.
Reverse Subsidiary Merger; Cash-out of Dissenter (Target Redeems Shareholders for Cash)
This is allowed so long as the “control for voting stock” requirement still is met—§
368(a)(2)(E)(ii).
Still have a reverse triangular merger, but the consideration mix is different.
Step 1: redemption of Kyle stock
Step 2: All $750 is voting stock being used, being distributed to Reed for his Dolphin Stock.
Control issue:
80% control must be acquired.
After the redemption, Reed is the 100% owner. But what if the transaction is stepped
together? Only 75% control received in exchange for $750 stock.
§ 1.358-2(j)(6), ex. 2
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Says that we can ignore the redemption of the dissenter’s stock. For purposes of the control
requirement we will treat the Kyle’s stock as gone for the control requirement!! Therefore,
this transaction passes the control test!
Substantially all issue:
Would the cash used in the redemption be considered assets leaving the target corporation?
§ 1.358-2(j)(3)—we have to apply the “sub all” test from C Reorgs, which comes from Rev.
Proc. 77-37.
 70% of GROSS Assets acquired: 1200 gross  .7 x 1200 = 840
o 1200 – 250 [cash paid for Kyle stock in redemption] = 950, which exceeds 840.
Passes.
 90% of NET Assets acquired: 1000 net (1200-200 [liabilities])  1000 – 250 (cash paid
to redeem Kyle stock) = $750. 750/1000 = 75%
o Fails because 75% is less than the 90% required.
Therefore, this would FAIL § 368(a)(2)(E) Reverse Triangular/Subsidiary Merger
b. Creeping Reverse Subsidiary Merger. Assume Reed and Kyle receive only Sawyer, Inc. voting
stock (and no cash). Could this transaction be effected as a § 368(a)(2)(E) merger if Sawyer, Inc.
already owned 25% of Dolphin Co.?
Creeping Reverse Subsidiary Merger (Already own 25%)
This is a situation where Sawyer already has 25% control of Dolphin
Good § 368(a)(2)(E)?
Control:
§ 368(a)(2)(E)(ii)—“IN THE TRANSACTION”, have to exchange control.
 Here, only 75% control is exchanged. Therefore, the control test FAILS.
**Can’t have a creeping § 368(a)(2)(E).
Good § 368(a)(2)(B)—“B” Reorg?
The determining issue would be how long ago Sawyer obtained the stock. If 20 years ago,
likely “old and cold” and therefore would be considered to be a good “B” reorg.
4. Triangular B Reorganization. Revert to the basic model in which Reed owns 100% of Dolphin Co.'s stock
with a basis of $650.
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a. Clay Co. acquires all of Reed's Dolphin Co. stock solely in exchange for the transfer by Sawyer, Inc.
of $1,000 Sawyer, Inc. voting stock to Reed.
Reverse Triangular “B” Reorg—Stock for Stock BUT Sub Using Parent Stock to Acquire Target
Sawyer giving voting stock to Reed
Reed giving Dolphin Stock to Clay
At the end, Dolphin will survive and be a sub of Clay, which remains a sub of Sawyer.
§ 368(a)(1)(B)—need to have acquisition by Sub of the stock of the Target. It doesn’t tell us
that Clay has to be the one to transfer the stock. Therefore, Sawyer CAN transfer the stock to
Reed and Reed can give its Dolphin stock to Clay.
§ 1.368-2(c): CAN’T USE BOTH CLAY AND SAWYER STOCK—Must use one or the other.
Tax Consequences
Reed (Target Shareholder)
§ 354(a): no gain or loss
§ 358: take a $650 exchange basis
Clay (Acquiror—Sub)
§ 362(b): Clay will take Reed’s basis in the stock, $650.
Note: the difference here is because it is stock for stock rather than stock for assets.
Dolphin (Target)
Just being sold. No consequences to Dolphin.
Sawyer (Parent)
§ 1032: no gain or loss on the use of its stock in the exchange
Basis: ** Different than previous over the top methods
§ 1.358-6(c)(3)
This is a little different than previous “over the top”
166
**We treat Sawyer as getting the Dolphin stock and then treat Sawyer as contributing it down
to Clay.
So Sawyer gets a $650 basis in the Dolphin stock.
$100 [initial basis] + $ 650 [transferred basis § 362(b) of Dolphin and then gives to Clay under
§358 in a § 351] = $750 basis in the Clay stock.
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Unit VIII—Divisive Reorganizations & Spin-Offs
Introductory Problem: Acquisitive "D" reorganizations
§ 368(a)(1)(D)—Acquisitive “D” Reorgs
I.


II.


Requirements:
o Transfer of All or Part of Target’s Assets
o If, Immediately after, Target or its SH
o “Is In Control” of Acquiror
 NOTE: § 368(a)(2)(H): provides a special control rule for “D” Reorgs. Must look to
the § 304(c) definition of control.
 § 304(c): As least 50% control by vote OR value
o If, Stock or Securities of Acquiror, Are distributed Under
 § 354 OR
 § 354(b) gives us an exception, which is an exception to § 354(a), and says
that it won’t apply to a D reorg.
 § 354(b)(1)—“All or Part of Its Assets”—“sub all” of the targets assets must
be transferred to the acquiror.
o 90% net
o 70% gross
 § 355
 Spin-Off
 Split-Off
 Split-Up
**The way to remember you are in a D reorg, the target or the shareholder will control the
acquiror!!
Process
Step 1: Acquiror gives stock for “sub all” of assets of Target
Step 2: Liquidation of Target gets rid of A stock and takes T stock.
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


III.



Step 3: Target is gone, Target shareholders must have control of the Acquiror—§ 368(a)(2)(H)—BUT
this is § 304(c) contro1 (50% requirement of vote or value).
Target must receive stock in the exchange, it must constitute 50% of the value of the acquiror. Can also
contain boot.
§ 368(a)(2)(A) contains a tie breaker rule. If a reorg satisfies both C and D, then D controls
Differences— C v. D
No solely voting stock requirement in D, which is a requirement in C.
Both have liquidation requirement
D control is § 304(c) control (50%), no such requirement in C.
Problems
General Facts. Camelot, Inc. is a corporation, the shares of which are owned equally by Jack and Annie, both
individuals. Camelot Inc.’s assets are worth $1,200 (basis $300); it has liabilities of $200; its shares are worth a
total of $1,000. Osborne Co. is a corporation, the shares of which trade on the New York Stock Exchange.
Which of the following transactions constitutes a reorganization under § 368(a)(1), and of which type?
1. Camelot, Inc. transfers all of its assets to Osborne Co.; Osborne Co. assumes Camelot, Inc.'s liabilities;
Osborne Co. issues $1,000 of its voting stock (worth 5% of Osborne Co.) to Camelot, Inc.; Camelot, Inc.
dissolves and distributes the Osborne Co. stock equally to Jack and Annie.
“D” Reorg Attempt that Fails 50% Control, Still Possible to Satisfy § 368(a)(1)(C)
Camelot transfer all assets and liabilities to Osborne
Osborne transfers Osborne voting stock $1000 (5%).
Then Camelot liquidates.
Good D Reorg?
Control Requirement is not met. Here, there is only 5%, § 304(c) requires at least 50%. §
368(a)(2)(H) directs us to this control test.
Is this a good C reorg?
Acquisition by 1 corp solely for voting stock of the other, we can disregard debt relief/assumption
of liability under § 368(a)(1)(C).
So yes, good C reorg.
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2. Same as (1), except that the Osborne Co. voting stock transferred to Camelot, Inc. is worth 50% of
Osborne Co.'s total outstanding stock.
“D” Reorg with 50% Control Requirement Satisfied
Good D reorg?
“Sub All”: Transfer by Camelot of sub all of assets and liabilities to Osborne
§ 304(c): Control requirement is met, 50%. Jack and Annie will control 50% of Osborne after the
exchange.
Liquidates and transfers assets to shareholders
This is a good D reorg.
Tax Consequences
Jack and Annie
§ 354(a): no gain or loss
§ 358(a): exchange basis [whatever basis was in Camelot stock will be basis in Osborne stock]
Camelot
§ 361(a): applies on the exchange. No gain or loss.
§ 361(c): applies on the liquidation. No gain or loss.
Osborne
Is all that survives and is sitting there with the assets.
No gain or loss
Basis: this is the only consequence
§ 362(b): Osborne will take Camelot basis in the assets. It will have a basis of $300 in the assets.
Good C reorg?
Still a good C reorg! Nothing changed here other than the value of the stock.
NOTE: § 368(a)(2)(A)—this is a tiebreaker rule. If both C and D, it shall be a D reorg.
a. What if Camelot, Inc.'s basis in its assets were only $100?
Fact that Liabilities Exceed Basis in “D” Reorg does not Bust “D” Reorg
Here the liabilities exceed the basis. Liabilities $200 and Basis is $100
Does not ruin the D reorg. What affect then?
§ 357(c)(1)(B): in the case of an exchange to which § 361 applies by reason of a plan of
reorganization within the meaning of § 368(a)(1)(D) with respect to which stock or securities
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of the corporation to which the assets are transferred are distributed in a transaction which
qualifies under § 355 . . . if liabilities exceed basis, excess shall be gain.
 Could trigger gain, but it is irrelevant because we are not in § 355. § 357(c) requires
the transaction to be a § 355 transaction if § 368(a)(1)(D) reorg for liabilities in
excess of basis to trigger gain. The shareholders [Jack and Annie had no gain or
loss because of § 354
Camelot
§ 361(a): applies on the exchange. No gain or loss.
§ 361(c): applies on the liquidation. No gain or loss.
3. Same as (2), except the Osborne Co. stock transferred to Camelot, Inc. is non-voting stock.
Use of Non-voting Stock in a “D” Reorg is Allowed; However, Would No Longer Meet “C” Reorg
Good D reorg?
Yes, the non-voting stock does not preclude the satisfaction so long as the other requirements are
still met. Here the only difference between (2) is that it is non-voting. Therefore, it is satisfied and
the same result would occur.
§ 368(a)(1)(D)—vote OR value is all good.
 Here we have 50% of value, even though not voting. So we are good.
Good C reorg?
This would cause a C reorg to FAIL because non-voting stock cannot be used in a C reorg—§
368(a)(1)(C)—“in exchange solely for all or part of its VOTING stock”
Variation:
Transfer of Only 50% of Target Assets Causes “D” and “C” Reorg to Fail
What if only 50% of assets and liabilities were transferred from Camelot to Osborne?
Good D?
§ 368(a)(1)(D): “Sub All” would not be met because substantially of all of the assets were not
transferred.
Good C?
§ 368(a)(1)(C): “Sub All” would not be met 70% of gross assets not satisfied. This“substantially
all” is from Rev. Proc. 77-37:
 90% of FMV of Target’s net assets, AND
 70% of FMV of Target’s gross assets.
Section 355 Problem
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§ 355 variations
 Spin-Offs


o Create a new corporation with jelly business and leave the old peanut butter business. The
shareholders will both own the two businesses.
o If it meets § 355:
 No gain or loss to distributing company
 No gain or loss to shareholders on receipt of stock in controlled (jelly) company.
o If it fails:
 § 311 distributing level
 § 301 at shareholder level
o A spin-off can be a D reorg or a 355 transaction; if there’s a new entity being created then
it’s a D reorg as well.
Cases
o Helvering v. Gregory
 **§ 112 is current § 368
 Facts
 TP owns a company (United) that has a sub (Monitor) that is worth a lot of
money.
 TP creates a controlled company (Averill), which gives TP all of its stock. TP
directs United to transfer Monitor stock to Averill.
o Averill formed 9/18/28
o 9/24/28 Averill liquidates and distributes Monitor stock to TP, which
is taxed at capital gains.
 TP then sells the Monitor stock to Buyer for cash. She has FMV basis in
liquidated stock and receives no gain on sale.
 Court says that the transaction was not consistent with Congress’s intent.
Therefore, disallows the transaction
 Birth of “Economic Substance Doctrine”
 Was a mere device for tax avoidance.
 § 355 was a response to this case.
§ 355—Distribution of Stock and Securities of a Controlled Corporation
o Requirements (ALL must be satisfied)
 1) Distribution of Control, § 355(a)(1)(A)
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





Immediately before distribution.
Talking about § 368(c) [80% by vote and of each class] control
Distributing Corporation must distribute to its shareholders stock in a
corporation [controlled corporation] that it controls immediately before the
distribution.
2) **No Device, § 355(a)(1)(B)
 This is the concept shown in Gregory. Can’t create a device which will allow
TP to convert one type of income into another type of income. Mainly
dividend to capital gain (which really doesn’t matter anymore with tax
rates). BUT recovery of basis can still make it relevant.
 § 1.355-2(d)
o Device Factors:
 Pro Rata Distribution
 This could be an indication of dividends being
distributed
 Subsequent Sale/Exchange
 Nature and Use of Assets
 Tons of cash in sub?
o Non-Device Factors
 Publicly traded
 Would be too complex to be practical
 Corporate Business Purpose
 Even if pro rata distribution
 Distribution to corp shareholders
 Corporate shareholders like dividends so we aren’t
worried about it.
o Transaction Not Device
 Absence of E&P
 If no E&P there would not have been dividend anyhow
 § 302(a) transaction
 If could have gotten redemption treatment, this would
have just been a sale/exchange.
 This is kind of like a shareholder business purpose requirement
3) **Active Trade/ Business, § 355(a)(1)(C)
 § 355(b)(1)(A)–Distributing and Controlled must be engaged in active trade
or business immediately after distribution OR
o § 355(b)(2):Business must have been conducted for 5 years.
 § 355(b)(1)(B)—“holding company rule”—immediately before distribution,
Distributing had no assets and immediately after each of the controlled
corporations is engaged immediately after the distribution in the active
conduct of a trade or business
4) No Retention, § 355(a)(1)(D)
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



Distributing must distribute ALL of controlled stock OR an amount
constituting § 368(c), and it is established to the satisfaction of Secretary . . .
5) Business Purpose
 § 1.355-2(b)(3)
 This because it is the goal of § 355 was to prevent tax avoidance.
 Examples:
o Decrease costs overall
o Make it easier to manage the corporations
 Rev. Proc. 96-30
o This gives examples of what constitute a good business purpose.
 Increasing access to capital
 Resolving fit and focus issues
 Etc.
 Why are we splitting these corporations.
 Rev. Rul. 2004-23
o Facts: Board was told you can increase the stock value to
shareholders if instead of operating under one corporate umbrella,
you have two separate corporations.
o Holding: this satisfied business purpose, even though shareholders
were the ones being benefited. Because at corporate level, the stock is
worth more which is a good business purpose.
6) COI
 This is different from the Reorg COI
 § 1.355-2(c)(1)
o Both Distributing and Controlled must be at least 50% owned after
the transaction by shareholders of Distributing
7) COBE
 The businesses that were conducted before the transaction must continue to
be continued after.
o The duration is not made clear.
General Facts. Alden Co. has 2,000 shares of common stock outstanding (worth $1 per share), of which Henry
and Benny have each owned 50%, 1,000 shares each, for the last five years. Henry’s basis for his stock is $800
and Benny’s basis is $1,200.
Alden Co. is engaged in two lines of business (and has been so engaged for the last 5 years unless the facts
specify otherwise): the manufacture and sale of peanut butter (“Peanut”), and the manufacture and sale of jelly
(“Jelly”). The assets of each division are worth $1,000 and have a basis of $500; separate records have been
kept for each business; all assets are readily allocable to the respective businesses; no liabilities exist; Alden Co.
has E&P of $1,000.
1. On January 2, 2009 the following alternative transactions occur. What are the tax consequences to the
parties?
Henry basis = 800
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Benny basis = 1200
Each have 1,000 shares
Jelly: 500/1000
Peanut butter: 500/1000
Alden E&P: 1,000
a. In order to facilitate expanded (and more favorable) bank financing of Peanut's business and to
effect cost savings (reduce duplication of employees), Alden Co. transfers all of the Peanut assets
to new Peanut Co. for all of its stock and all of the Jelly assets to new Jelly, Inc. for all of its
stock. Immediately thereafter, Alden Co. liquidates and distributes the Peanut Co. stock to Henry
and the Jelly, Inc. stock to Benny.
Split-UP—§ 368(a)(1)(D) and § 355 Met Where New Subs Created for Transaction
o Create two new businesses and then liquidate, giving one shareholder jelly and the other
peanut butter. Both shareholders give all of their stock and receive only one type of
controlled stock in return
o If it Meets § 355:
 No gain or loss at distributing level
 No gain or loss at shareholder level
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o If fails
 § 336 at distributing level
 § 331 at shareholder level
o This really is the only way to get corporate property of a company without having gain or
loss on the transaction.
Henry basis = 800
Benny basis = 1200
Each have 1,000 shares
Jelly: 500/1000
Peanut butter: 500/1000
Alden E&P: 1,000
At the end of the day, each party owns one of the corporations.
Looks like a split up—exchange the stock of the distributing corporation and receive stock
in the controlled corporation.
If § 355 didn’t exist:
Alden (Distributing Corp)
§ 351 applies when Alden incorporates Peanut and Jelly
§ 351(c)(1): Alden is going to disappear, but § 351 still applies. § 351(c)(1) [would be (c)(2)
if weren’t pretending § 355 didn’t exist] says that when determining control, it doesn’t
really matter so long as the corporation is distributing stock to its shareholder.
§ 336: On the liquidation, Alden will have to recognize gain and loss
NOTE: § 361(c) does not apply because we are not in a reorganization.
Good § 368(a)(1)(D)?
No, because sub all assets requirement is not satisfied. There is NO transfer of assets.
Benny and Henry
At shareholder level under § 331 sale or exchange treatment on liquidation
If § 355 applies (just look to the outline of these factors above and apply relevant ones):
Control:
Yes. § 368(c) [50% of vote OR value] control is met because Alden has 100% control of
both Peanut Butter and Jelly
Device:
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Yes. Benny could sell the stock in Jelly that it received in a § 355 situation and get capital
gains treatment. These factors are laid out in § 1.355-2(d) But this is not present in facts.
Pro Rata? Yes.
Subsequent Sale/exchange? This just mentioned.
Nature of Assets? If there is a lot of cash in the sub?
Active/Trade or Business:
Yes. Doesn’t matter here because of § 355(b)(1)(B)
Satisfied because although Alden disappears, Peanut butter and Jelly are still involved in
the business.
Retention:
Yes. Everything is being distributed.
Business Purpose:
Yes, they wanted to be able to borrow more and cost savings. Just need one compelling
business reason.
COI:
Yes, both Peanut Butter and Jelly are owned 100% by the historical owners. 100% > 50%
threshold.
COBE:
Yes, assuming staying in the same businesses.
Good § 355 tranaction?
Yes, § 355 transaction is GOOD.
Tax Consequences
Henry and Benny
§ 355(a)(1) FLUSH language: provides for no gain or loss for the shareholders where § 355
is met.
Basis: § 358: in the case of an exchange to which § 355 applies . . . Apply § 358 as usual for
basis to Distributees.
Basis is just an exchange basis, basis in property exchanged
Benny = $1200
Henry = $800
Alden
Think about PB and J being Acquirors of Alden.
§ 368(a)(1)(D) will apply. Transfer by a corporation of all or part of its assets to another
corporation if immediately after, the transferor [Alden] or one of its shareholders is in
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control of the assets which are transferred, but only if distributed in pursuance to § 354 or
§ 355.
**Where new subs are formed and then distributed you have a § 368(a)(1)(D) and then a §
355
§ 361(c): Alden does not have to recognize gain on the distribution of the stock to Benny
and Henry because we have a good “D” reorg and the distributions are being made to its
shareholders in pursuance of a plan of reorganization. Alden is the Target.
So no gain or loss for Alden—§ 361(c)
Peanut Butter and Jelly (Acquirors)
§ 1032—corporation can deal in its own stock. PB & J dealt in their own stock and
therefore have no gain or loss on this transaction.
PB&J Basis
Take Alden’s basis in those assets, each $500. per § 362(b)
Alden’s E&P
§ 1.312-10(a); § 312(h)
Allocated in proportion to the assets distributed, here 500 and 500 so each gets $500 of the
$1,000 E&P
i. What difference would it make if, instead of operating the two businesses directly as
divisions, Alden Co. had operated the businesses since their inception by subsidiary
corporations wholly owned by Alden Co. (Peanut by Peanut Co. and Jelly by Jelly, Inc.)?
§ 355 without valid “D” Reorg—Subs Already Exist (Difference is that Alden has no
gain under § 355(c), rather than § 361(c))
Nothing has changed in regard to the analysis. The only change is that they were
historic subsidiaries
Can you still have a good § 368(a)(1)(D) reorganization?
NO! there is no D reorg here because there is no transfer of assets.
BUT § 355 says you can still have a good § 355 without the D reorg
Henry and Benny
§ 355(a): no gain or loss to Benny and Henry
Alden**This is where the difference occurs
§ 355(c): No gain or loss. Even where not in pursuance to a reorganization.
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
Exception: § 355(c)(2): distribution of appreciated property other than
qualified property.
§ 355(c)(2)(B): Qualified property—stock or securities in the controlled corporation
Note: § 361(c) provides for any stock or obligation. As a result, the definition is
broader in § 361(c).
PB&J
In this case nothing is happening to PB&J, they are simply owned by different
shareholders.
NOTE: § 355 covers the no gain or loss treatment for both corporation and
shareholders!!
b. Henry and Benny no longer see eye to eye. Their co-ownership and co-management produce
friction and conflict, and they wish to go their separate ways. To that end, Alden Co. transfers
the Peanut assets to Peanut Co. for all its stock. Immediately thereafter, Alden Co. distributes the
Peanut Co. stock to Henry in exchange for all of his Alden Co. stock.
Split-Off: § 355 and D Reorg

Split-Offs
o One shareholder will own the new jelly company and the other shareholder will own the
peanut butter company.
o If it meets § 355
 No gain or loss at distributing level
 No gain or loss at shareholder level
o If it fails:
 Treat as redemption
 § 311 for distributing
 § 302/§ 301 for shareholders
This transaction will also qualify as a “D” reorg SO LONG as § 355 is met.
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Note: In this instance we can’t have a § 354 “D” Reorg because § 354 requires “sub all”
assets to be transferred.
Issues:
Whether valid Business Purpose:
RR 2004-23
This was the RR where shareholders benefited from the transaction through increased
stock value. RR said that this did not preclude finding a valid BP
Rev Proc 96-30
Fit and Focus—if the split-off cures management, systematic, or others issues—this is a
very broad test.
Likely satisfied.
Device:
If this were treated solely as a redemption it would satisfy § 302(b)(3) allowing § 302(a) sale
or exchange treatment We said that the list of things that are NOT a device were
transactions that would receive § 302(a) treatment, which it would have received if cash
instead of stock used. Therefore, this is Not a device—1.355-2(d)(5)(iv).
Active T/B:
Yes. both are engaged in business in active trade or business immediately after the
transaction. No indication that § 355(b)(1)(A) would be violated/that they were controlled
and acquired were no longer engaged in T/B.
Distribution of control: all control of peanut co occurred.
No Retention: Yes
COI: >50% owned by historic shareholders.
COBE: Yes, business will continue.
So it seems that the same outcome would occur as in (a)(i).
i. What if, in (b), a couple of months before the distribution, Violet had purchased 80% of
Benny's Alden Co. stock (leaving Benny with only 10% of Alden Co.).
Effect of 3rd Party Buying Historic Shareholder Interest Before Split Off
Issue: Continuity of Interest
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§ 1.355-2(c)(1)—At least 50% of both corporations must be owned by historic
shareholders
§ 1.355-2(c), ex. 4 gives us an example to this effect— The continuity of interest
requirement is not met because the owners of Alden prior to the distribution (Henry
and Benny) do not, in the aggregate, have a continuity of interest in each of PB&J
after the distribution, i.e., although Henry and Benny collectively have retained 60
percent of their equity interest in the former combined enterprise, the 20 percent
interest of Benny in Alden is less than the minimum equity interest in the
distributing corporation, that would be required in order to meet the continuity of
interest requirement.
COI not satisfied, therefore fails § 355.
Treat as redemption
 § 311 for distributing
 § 302/§ 301 for shareholders
There is no bright line length of time for this shareholder to hold the stock. It is just
a potential issue.
2. § 355(b) active business requirement. Assume the basic transaction passes muster under § 355 (i.e.,
business purpose, no device, etc). What would be the effect of the following factual variation?: The
Peanut and Jelly businesses had been conducted separately by Crunchy Corp. and Grape Corp. for the 4
years ending 12/31/2005. On 1/1/2006, Alden Co. acquired the Jelly business through a state-law merger
of Grape Corp. into Alden Co., in which Alden Co. issued only Alden Co. stock. As part of the plan of
reorganization, Alden Co. transferred the Jelly assets to newly-organized Jelly, Inc. in exchange for all
of its stock. Six months after that, Alden Co. acquired all of the Crunchy Corp. stock in exchange solely
for Alden Co. voting stock, and changed the name of Crunchy Corp. to Peanut Co.. Alden Co. has
continued to operate both businesses through its Peanut Co. and Jelly, Inc. subsidiaries. In 2009 Alden
Co. distributes the Peanut Co. stock (Peanut Co. holds the Peanut business) to Henry in exchange for all
of his Alden Co. shares.
Active Business Requirement—§ 355(b)—General
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**This is the requirement that requires the most discussion and argument.
Peanut and Jelly have been conducted separately by other businesses for 4 years.
Peanut run by Crunchy. Alden buys all Crunchy stock solely for Alden voting stock.
Shareholders turn in Crunchy stock for Alden stock.
Jelly run by Grape. Grape merged into Alden and pays Alden stock to Grape shareholders.
Alden then contributes the assets to Jelly
2009 Alden passes off all of Peanut stock to Henry
Active T/B
§ 355(b)(1)(A): distributing and controlled must be engaged in active trade or business
immediately after distribution.
§ 355(b)(2)(B): has been actively conducted throughout the 5-year period ending on the date of
distribution, doesn’t tell who must run the business in that 5-year period.
§ 1.355-3(b)(2)—gives some additional information on T/B, perform active functions in the day to
day business.
§ 355(b)(2)(C): cannot have been acquired in a transaction in which gain or loss was recognized in
whole or in part; no taxable transactions
Alden in active T/B:
§ 355(b)(1): gives us the guide. § 355(a) applies only if either—
(A) the distributing corporation, and the controlled corporation (or, if stock of more than one
controlled corporation is distributed, each of such corporations), is engaged immediately after the
distribution in the active conduct of a trade or business, OR
(B) immediately before the distribution, the distributing corporation had no assets other than
stock or securities in the controlled corporations and each of the controlled corporations is
engaged immediately after the distribution in the active conduct of a trade or business.
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
Who are the Controlled corporations here?
 Controlled corp: entity of whose stock is distributed. Here, controlled corporation is
limited to Peanut.
§ 355(b)(1)(B): does Alden have stock only stock of peanut? No also owns stock in Jelly, BUT Jelly
is not a controlled corporation.
§ 355(b)(2)(C): You will not be able to rely on the business if acquired within 5 years in a
transaction in which gain or loss was recognized in whole or in part—meaning has to be
nontaxable.
Jelly
Is it good active trade or business?
§ 355(b)(2)(C): Acquired in nontaxable transaction. This was an A reorg. So it was acquired in a
nontaxable transaction. A reorg with no boot. If there had been a dollar of boot, it would have
been a problem and caused the active T/B to fail.
This is a business that can be relied on as active T/B by Alden.
This § 368(a)(2)(C) drop down from § 368(a)(1)(A) reorg and continues to be tax free.
Good 5-year business
** Remember, not a controlled corporation in this analysis.
Peanut
Good 5-year business?
Yes, “B” reorg so it received tax free treatment
§ 355(b)(2)(D)(ii): control of a corporation was so acquired by any such corporation in transaction
a transaction where no tax was recognized.
**So when dealing with “B” reorg, you will use § 355(b)(2)(D)(ii).
Peanut is a Controlled corp in this analysis
Good 5-year business
We have two valid businesses.
Does § 355(b)(1)(B) apply? The holding company? Does not apply because in addition to stock in
Peanut, it also holds stock in Jelly, which is not a controlled corporation. So it holds stock other
than just stock in the controlled company.
§ 355(b)(1)(A):the distributing corp and the controlled corp must be engaged immediately after
the distribution in the active conduct of a trade or business
 Peanut co will be involved in Peanut co. But will Alden be involved? NO.
§ 355(b)(3)(A): special rules: for determining whether meet (2)(A), all affiliated corps will treated
as one corporation. Alden and Jelly will be treated as one corporation. Therefore, if we look at
this statute, Peanut Co will conduct active T/B directly, Alden Co will not, but part of its affiliated
group (Jelly) will be conducting active T/B. We treat Alden and Jelly as one corporation.
Therefore, under § 355(b)(1)(A)—both are actively engaged in T/B, Jelly doing so through it’s
affiliated group [Jelly].
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a. What if Alden Co. bought 30% of Crunchy Corp. for cash in 2003, 6 years before the
distribution, and acquired the remaining 70% in 2008, 1 year before the distribution, solely for
Alden Co. voting stock?
Active T/B—§ 355(b)—Acquired in 5-year period Tax Free?—§ 355(b)(2)(D)
The question is all about acquiring control of Crunchy. § 355(b)(2)(D)(ii) busted from this
transaction?
Need to know if valid “B” Reorg to determine this.
The cash likely busts the “B” Reorg, it would have to happen 20 years (old and cold).
30% for cash 6 years ago
70% voting 1 year ago.
Examples in regs were 10 and 16 year. This would be risky that we don’t have a good B
reorg. If we don’t have a good B reorg, then the whole transaction is taxable and it will kill
the § 355(b)(2)(d)(ii).
b. What if Alden Co. acquired 95% of Crunchy Corp. for voting stock in 2005 (i.e., within 5 years
before the distribution) and bought the remaining 5% for cash in 2008 in an unrelated
transaction?
Bought 5% for cash in unrelated transaction. 95% for voting stock. 5% for cash.
Control has to be acquired in a nontaxable transaction. B reorg only requires 80% control.
As long as viewed as unrelated acquisition for cash would not bust the B reorg and it would
remain a good B reorg. § 355(b)(2)(D)(ii).
- And, since it was a good B reorg, the active T/B requirement at (b)(2)(D) is
satisfied.
- Aldean acquires crunch – was it acquired within the 5 years in a non-recognition
transaction? – Yes—Aldean acquired 95% in exchange solely for voting stock –
this is a good B reorg, so pass the requirement under (d)(ii)
o What is Henry Getting?
- He is getting 95% and then 5%
 §355(a)(3)(B) – We treat the 5% as boot because of this rule
 5% of 1000 is 50 – this is the amount of boot
 AR = 50 (boot) plus 950 (voting stock)
 AB in his stock = $800
1. So realized gain is 200
a. So, he has to recognize all 50 dollars of boot
b. Then go to 358 to determine his basis after
c. At the ned of the day he has two types of peanut
stake, his 95% and his 5%
d. Basis in the 5% stake= per 358(a)(2), he has a basis
of 50 (FMV)
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e. W ith respect to the 95% stake (the other 950 of
stock his basis is 800-50+50= 800
- What happens to Aldean?
c. What if, rather than acquiring the Crunchy Corp. stock, Alden Co. had acquired the Crunchy
Corp. business by state law merger of Crunchy Corp. into Alden Co. in 2003, 6 years before the
distribution, for 30% cash and 70% Alden Co. non-voting common stock?
30% cash and 70% stock.
BUT this happened six years ago so it was outside of the 5-year time period. So still good
Active T/B. Trick Question.
d. What if Crunchy Corp. had 2 classes of voting stock outstanding, Class A, representing 80% of
the voting power but only 75% of the value of Crunchy Corp., all of which Alden Co. acquired
solely for Alden Co. voting stock. A shareholder unrelated to Alden Co. held, and continues to
hold, the Class B stock, representing 20% of the voting power and 25% of the value of Crunchy
Corp. (now Peanut Co.).
Control Requirement of § 355(a)—§ 368(c)
Two classes of stock outstanding. Alden acquired all of class A stock 75% value, 80% vote.
Another shareholder owns Class B stock, 25% value, 20% value.
Alden paid voting stock and got class A Crunchy stock.
Alden doesn’t have 80% of one of the classes of stock. Must have control of ALL stock. He
doesn’t have § 368(c) control. It is a Good B reorg.
The basic control requirement is failed. Alden doesn’t even control Peanut Co.
§ 355(a) requires § 368(c) control and therefore because no control happens, the § 355 fails.
Look to § 355(a)(1)(D)(ii)
3. § 355(d). Henry and Benny no longer see eye to eye. Their co-ownership and co-management produce
friction and conflict, and they wish to go their separate ways. To that end, Alden Co. transfers the Peanut
assets to Peanut Co. for all its stock. Immediately thereafter, Alden Co. distributes the Peanut Co. stock
to Henry in exchange for all of his Alden Co. stock.
§ 355(d)—Disguised Sales.
 Under § 355(d), distributions of certain disqualified stock will trigger recognition of gain to
the distributing corporation, contrary to the general corporate level nonrecognition rule in §
355(c)(1).
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


Briefly summarized, stock in the distributing corporation itself, or stock in a corporation
controlled by the distributing corporation (its subsidiaries), is considered disqualified stock
under § 355(d) if it was acquired by purchase within the five-year period ending on the date of
the distribution—§ 355(d)(3), (d)(5). Disqualified stock focuses on stock acquired in a taxable
transaction.
As such the distribution will trigger gain to the distributing corporation as if the stock were
sold to the distributee shareholders at fair market value—§ 355(d)(1), (c)(2).
**NOTE: The § 355(d) rules do not alter the nonrecognition available to the shareholder
ditributees.
Hypo:
Peanut Corp is appreciated in value 500 AB and 1000 FMV
3rd party really wants to buy the peanut corporation which is owned by Alden.
Alden is owned by Benny and Henry 60%/40%
So Blank comes along and buys all of Benny’s stock. Blank then says he wants Alden to distribute
the stock of Peanut to him and he will just trade in all of his stock for Peanut stock, through
Alden.
Assume it is a good § 355 distribution—a split off.
What consequence (§ 355 applies)
Alden
No gain or loss—§ 355(c)
This lets Blank own Peanut without Alden having to recognize gain or loss at the corporate level.
This instead of Alden selling Peanut directly to Peanut.
As a result of this § 355(d) was enacted
Basic § 355(d) idea:
A distribution by Alden will not satisfy § 355 if immediately after the distribution any shareholder
owns either 50% of stock by vote and the stock was acquired within 5-years of the distribution.
No Section 355 at Distributing level IF:
 Immediately after any shareholder owns at least 50%(by either boting or value) of
 Either distributing or controlled and
 Stock was acquired in a taxable transaction within 5 years prior to the distribution
§ 355(d) does not say that the entire § 355 is ruined. It just says that the stock will not be qualified
property, so if you trigger § 355(d), when Alden distributes the stock, then Alden will recognized
gain. BUT the shareholders will still have § 355(a) nonrecognition.
 SO only prevents § 355(a) treatment for distributing corporation, NOT shareholders.
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a. What if Henry had acquired his Alden Co. stock by cash purchase one year before the
distribution?
Split Off—§ 355(d) Situation (Purchase of Stock One Year Before Distribution)
This is just a SPLIT OFF. Henry being redeemed for Peanut Stock. Assume § 355
requirements were met. Split off will work as long as § 355 requirements are met.
Henry bought Alden stock for cash 1 year ago.
§ 355(d)(2)(A): disqualified distribution: if any person holds disqualified stock in the
distributing corporation which constitutes a 50% or greater interest in such corporation.
 Tells us we have a problem if 50% of stock acquired in a taxable transaction prior
to transaction.
 Disqualified Stock defined in § 355(d)(3)(B): basically if acquired in a taxable
transaction in the 5-years prior to the distribution.
Benny
Any problems with Benny?
No
Henry
Henry will own 100% of peanut. Henry only owns controlled, but distributing or
controlled is in § 355(d). This was acquired tax free. BUT § 355(d)(3)(B)(ii) tells us that
disqualified stock means any stock in a controlled corporation received in a distribution to
the extent attributable to stock described in (a) [this is the disqualified stock, purchased in
preceding 5 years]. Henry is getting the stock because it is attributable to the Alden stock.
Therefore, this is bad stock for § 355(d) because he purchased the Alden stock. So even
though he received the Peanut stock in a non-purchase situation, the stock to which it
relates [Alden] WAS purchased.
Still gets § 355(a) treatment—REMEMBER: even though happening at shareholder level,
the impact is at the distributing corp lever.
Alden
§ 355(d):Will recognize gain or loss
4. Partial Liquidations, Morris Trust & § 355(e). Box Co. desires to acquire Alden Co.'s Jelly business
but not the Peanut business. The following alternative transactions occur following intense discussions
between the boards of Box Co. and Alden Co. regarding valuation and structure of the transaction.
Partial Liquidation, Morris Trust & § 355
“Morris Trust” transaction—§ 355(e)(1)— If the stock of a controlled corporation is distributed in a
transaction that qualifies as a tax-free corporate division, and either the distributing corporation or the
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controlled corporation is acquired in a transaction to which the rule applies, the stock of the controlled
corporation is not treated as “qualified property.” In this event, recognition of gain is imposed on the
distributing corporation as if it had sold the stock of the controlled corporation for fair market value
immediately before the distribution. No adjustment to the basis of the stock of either corporation is
allowed by reason of the recognition of gain. If the corporation recognizing the gain is an S
corporation, the shareholder may be entitled to a stepped-up basis for those shares.
Morris Trust Case: State Bank is the Target and had an insurance business and a banking business.
National Bank wanted to buy the banking business. Target took its unwanted assets and contributed
to a new subsidiary, then distributed new subsidiary stock to its shareholders. Parties waited a couple
of days and then Target merged into National Bank. Holding:Court said this tax-free divisive
reorganization preceding the merger Blueprint: Company wants to spin off unwanted assets in a type
“D” reorg just prior to a tax-free acquisitive reorg. The result that occurs if successful is that target
corporations can transfer less than substantially all of their assets and still be eligible for tax-free
non-recognition in the acquisition of the desired assets that followed. NOTE: § 355(e) stops this
result.
 Buyer’s want to buy a business without causing the sellers to recognize corporate gain
 State Bank took insurance business and put it in a sub. Then it distributed that stock
to its shareholders in a § 355 transaction.
 Then merged into National bank.
 Court said this was okay.
§ 355(e)
 No § 355 at Distributing level IF:
o 50% or greater interest (by vote or value) in distributing or controlled
o Is acquired “ pursuant to a plan ( or series of realted transactions)
 § 355(e)(2)(B): 2- year presumption that merger happens 2 years after or before the merger
o § 1.355-7 (won’t be tested on these regs)
Focus here is on distributing rather than shareholder [as in § 335(d)]
§ 355(e)—Recognition of Gain on Certain Distributions of Stock or Securities in Connection with
Acquisitions
Prevents § 355 non recognition treatment at distributing level (doesn’t affect shareholder)
 if:
o 50% or greater interest by vote or value in distribution or controlled
o Is acquired pursuant to a plan or series of related transactions.
 There is a 2-year presumption there was a plan
 Prevents people spinning off what they didn’t want tax-free and then doing mergers.
§ 1.355-7 Regs provide nine specific safe harbors.
a. Alden Co. sells all the Jelly assets to Box Co. for $1,000, distributes the sale proceeds pro-rata to
Henry and Benny, and continues to conduct the Peanut business.
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Alden sells Jelly to Box Co for cash
Cash then distributed to shareholders
This is just a § 1001 sale.
Shareholders will get a § 301 cash distribution.
b. Alden Co. transfers the unwanted Peanut assets to Peanut Co. in exchange for all of Peanut Co.’s
stock and distributes the Peanut Co. stock equally to Henry and Benny. Shortly thereafter, Alden
Co. sells all the Jelly assets to Box Co. for $1,000 in cash and Alden Co. liquidates. Does the
transaction constitute a "D" reorganization by reason of § 355?
Difference is that sub is created and then Peanut Co stock is distributed to shareholders.
Step 2 is that Alden sells all of the Jelly assets to Box Co for cash. Alden then liquidates.
Do we have good § 355 distribution?
Looks good.
§ 355(e): Not a problem because no stock is involved in the acquisition. Box Co is not
acquiring stock of Alden Co [distributing corp] or a controlled corporation
i. Suppose Box Co. acquires the Jelly assets solely for Box Co. voting stock (worth $1,000)
rather than cash and Alden Co. liquidates.
Box Co stock instead of cash
No § 355(e) because there is not stock acquisition of either Alden [distributing] or
Peanut [controlled]
c. Alden Co. transfers the Peanut assets to Peanut Co. in exchange for all of Peanut Co.’s stock and
distributes the Peanut Co. stock equally to Henry and Benny. Shortly thereafter, Box Co.
acquires all of the Alden Co. stock from Henry and Benny for $1,000.
§ 355(e) Triggered Where 50% or Greater of Distributing Corp Stock Acquired by 3rd Party
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Box Co. buys Alden stock from Henry and Benny shareholders
This triggers § 355(e) because Box Co. gets a 50% or greater interest in the distributing
corporation. Alden will have gain at the corporate level under § 355(e).
We also have a device problem because they sold their stock in distributing for cash so the
spin-off is ruined as well.
The entire thing is a bad § 355.
Step 1: distribution of Peanut to shareholders.
Step 2: Shareholders distribute Alden Stock to Box Co and receive $1000.
Here 100% of Alden [distributing] acquired by Box Co. 100% > 50%
Alden
§ 355(e): Prevents normal § 355 treatment and requires Alden to recognize gain on the
distribution of the peanut business, on the spin off
Benny and Henry
§ 355(a): No gain or loss.
Note: This looks like a device and could be a bad § 355. There is at least a potential
concern that the sale of stock for cash could be a device and cause the entire transaction to
be taxable to everybody.
So if shareholders have actions that cause this to be a device the whole thing is busted and
taxable.
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