Purple means I highlighted something he touched in class specifically.
Unit IA- Why Tax Corporate Income?
Classical System of Taxation
 Two levels of tax
o Tax 1: Corporation taxed once on profits/income to the corporation
 35%- 11(b)
o Tax 2: Corporation transfers earnings to SHs and SHs receive income
 Under § 1(h)- 15% (qualified dividend rate)
 Subchapter C: Corporate distributions and adjustments
o § 301—§ 385
 Corporate income tax only applies to C corporations
 Most international countries do not use the double tax system/classical
system.
 Why Use Classic System?
o Simplicity
o Regulatory tool
o Benefits
 Limited liability (corporation is a person § 7701(a)(30))
 Infrastructure
 Courts
o Limit power (managerial power)
 Political power- corps can contribute to campaigns
 Market power- monopoly, oligopoly
 Economic power- employees
 Limit negative externalities
o Progressivity
o Avoiding Capital Lock In
 Corporations don't distribute revenue, and the only way is to pay tax as a
human, and corp is a nice place to keep money
 If no corporate tax, then get paid down generation by generation and keep
money in corp (since you would only get taxed on distribution)
o Revenue
Efficiency
 An efficient system maximizes utility.
 Neutral Behavior people don't change their behavior
o Classic neutral tax- head tax (just being alive), window tax.
 Corporate tax is not efficient- it changes behaviors
o Encourages debt financing
- No deduction for dividends paid, BUT deduction for interest
paid to a SH (the SH had a bond with the Corp). Thus, this
system encourages debt.
o
o
Disincentives companies to exist in the US. US corps will just leave.
Retention of earnings rather than distribute to shareholders. Corps would leave all
of the $$ in the corporation and never distribute the $$ to SHs. See Section 531, 532,
and 533. Section 533 is a limiting section on the IRS.
 Accumulated Earnings Tax- 532- imposed on corp availed of for the purpose
of avoiding the income tax with respect to its SHs…by permitting E&P to
accumulate instead of being divided or distributed (beyond reasonable
needs of business.
o Form bias
 Formation of partnership, LLC, S corporations (company would rather be a
partnership than being a corporation).
o Tax Shelters
o Intended tax avoidance: people will not invest in the economy because they will
spend $$ trying to avoid paying corp taxes.
o Unintended tax avoidance: Congress never intended for companies to try and avoid
paying taxes.
o Disguised Dividends (salaries)
 Incentivizes corporations to pay out those who.
 Rents, salaries, etc.
o No clear incidence
 Don't know who bears the tax
 Nominally- the one who writes the check
 Real or Economic- the one who bears the economic burden
 Since the corporation is a fictional entity, it cannot bear the ultimate burden
 Basically if the incidence of the tax falls on the corp, then really the SHs bear
the tax.
 Taxes paid b corp arguably reduce profits otherwise available for
distribution to the SH owners
 Or, consumers may bear the cost, by increasing the price of goods or
services to cover tax costs, they can preserve profits for the SHs and
shift corporate tax burden to consumers .
Traditional View: Corps will only distribute if they have to, if they do not, they will never distribute
to SHs.
- The Bush Admin wanted to abolish the double tax on SHs, so they compromised and
now dividends are taxed at a lower amount, 20%, which is less than normal income.
Bush people thought that Corps would never distribute to SHs if they knew that they
would pay a huge tax.
New view: They know that there will be a two taxes, but they are ok with this because they accept
the fact that there will be double taxation.
Harberger Model:
Who bears Tax: No just SHs and Corps! Instead, ALL holders of capital.
No deduction for dividends paid, BUT deduction for interest paid to a SH. Thus, this system
encourages debt.
Unit IB- Choice of Form and Entity classification
Advantages- Subchapter C:
1. Limited liability- protects people from being sued
a. Key for deciding the form of the business
b. High risk businesses- beneficial to be corp
2. Centralized Management (simple)
a. SH investors cannot participate directly, but elect BOD
3. Established law
a. Clear what the duties of managers/SHs are
4. Continuity of Life/Existent entity- exists after life of the owner ends, can expand by taking
advantage of markets
a. Altho sometimes might want to dissolve quickly
5. Corporate deductions
a. DRD
6. Capital markets
a. Corporate stock easier to market
7. Benefits for employees
a. Qualified deferred comp plans, profit sharing, stock options
Cost of formation is a consideration (but not necessarily better for Corps)
Unit 1 B
Other Structures
 Sub S Requirements §1361
o 100 or fewer SHs
o SHs must be individuals
o No nonresident alien SHs
o Only one class of stock
o Some corps are ineligible (insurance companies, banks)
 Sub S:
o No entity level tax- only owners pay tax at one level
o Drawbacks- rules about shareholders. Thus, it is hard to gain investors.
 LLC/ Partnerships
o Entity that shields the investors/owners from liability- Biggest advantage
o No tax at the entity level
o LLC are unincorporated bus org all of whose members have limited liability but
whose members still are entitled to participate in the management of the business
o Drawbacks- Can’t publicly trade LLCs (no NYSE)
 If you do this, then you will be taxed as a corporation- 7704(b)
 A partnership whose shares traded on the market is a publicly
traded partnership.
 7704(a)- treated as a corporation (Called a Publicly Traded Partnership)
 exception- 7704(d) Trade interest in an entity w/o treating it as a
PTP, more than 90% passive income .
 7704(c): Limits passive income
- Sole Proprietor is the last option to structure a business.
Corporate Tax Rates- 11(b)
 15% that doesn't exceed $50,000
 25% from $50,000-$75,000
 34% as exceeds $75,000 but not $10,000,000
 35% above $10,0000
 Flush language- Page 93. Lesser of 5% of such excess of $100k.
o Increase tax at the end of the year
o Only for corporations, Congress takes away graduated rates once income above a
level, once they earn 18,333,333- every dollar at the 35% rate
o For this class assume 35%
For Corps there is no preference for long-term capital gains.
For individuals, though, see 1(h)(1) for capital gains:
1) Long term = Taxable Income up to $75,400 = 0%
2) T.I. 75,300 – 466,950 = 15%
3) T.I. 466,950 + = 20%
e.g. You make $1mil all if that
Net Investment Tax Section 1411: 3.8% tax on net investment tax. Designed for wealthy people. For
people who have AGI $200k+. You pay 3.8% + the 20% you already paying.
Class Notes: What is a dividend? It is profit. It does not mean the $$ that was given to the
corporation by a SH – that would be capital. We do NOT tax a return of capital.
Qualified Dividend Rate
 Individuals pay a 15% rate on Qualified dividends- 1(h)(11)
 Requirements:
o (1) Qualified Dividends are dividends received from domestic corporations and
qualified foreign corporations
 Qualified foreign corporation: if the corporation is incorporated in a
possession of the US or, eligible for benefits with a tax treaty with the US
(basically a corporation in a “good” jurisdiction). QFC are Corps usually form
countries where we have treaties with.
 IRS 2006-101 lay out all of the countries that are QFCs.
 Qualified corp- dividends paid on established US securities market
 Shares on Brazilian stock exchange, options listed on Chicago board
exchange
o Note: even if its not a QFC, if its stock is traded in US and
dividends are paid, then can get 15%
 BUT: IRS Notice- 2003-71- options do not count as stock for
purposes of the 15% tax rate
o (2) AND have been held in company for MORE than 60 days during the 121 day
period (60 days before 60 days after) beginning 60 days before the ex-dividend days
(ex-dividend dates = The day a dividends is declared but cannot receive the
dividend) You can buy the stock but will not be able to receive the dividend).
o Need to hold the stock for 61 days during the 121 day period is what this comes
down to.
o Rule= if you don’t hold it for the 61 days, then the dividend paid to you will be
treated as ordinary income because it is NOT a qualified dividend!!
 (Coordinates with § 246(c))
 If it does not meet the qualified dividend rate, then ordinary income
 IRS Notice- 2003-71- options do not count as stock for purposes of the 15% tax rate
o Problem IB, 2- A company that is incorporated in Brazil, their shares are traded on
the Brazilian stock exchange
Unit 1B, Problem 1
Corporation
Partnership
Post 12/31/13
Entity Earnings
Entity Tax
Post tax Distribution
H&W tax
Total Tax
Net to H&W
Effective Tax rate
$5M
$1,750,000 (35%)
$3,250,000
$650,000
$2,400,000
$2,600,000
48%
$5M
$0
$5m
$1,980,000
$1,980,000
$3,020,00
39%
$1M
$350K
$650K
$257,400
$ 607,400
$392,600
60.7%
A) Blue Chip Co- US entity, accrual method, husband and wife own all of it
 Effective tax rate: Total tax/Entity earnings
o 447,500/1M= 44.7% tax
o “joint tax analysis”
B) What if this was a partnership?
C) 1B packet: lifecycle of new individual rates:
 Everything will change- 39.6% will be top marginal bracket
 The only change post 2013, the rate to the individual will adjust- 39.6% will be the top
individual rate
 This effects form choice a lot
Unit 1B, Problem 2
 A) Everything the same, but incorporated in UK; UK has 35% corporate tax
 If the UK taxes the entity at 35% rate- doesn't change the answer,
 We have a treaty- the UK- “qualified foreign corporation” (for 1(h)(11))- to be this it must
be a good jurisdiction, and UK is listed there- so entitled to the special 15% rate under
1(h)(11)
Influence of the capital gains/ordinary income distinction on corporate transactions oand on the
development of Sub C
Check the Box Regulations: Treas Reg § 301.7701-2(b) Classification/Classifying an Entity
One way to get out of a corporate tax is to chose to be a partnership/LLC
See Unit 1B for Chart/Diagram for the Check the Box Regulations.
§ 301-7701-2(b): How an Entity is taxed:
Part 1 of inquiry: Determining the entity
1. Ask, Do we have a separate entity?
a. Do the participants carry on a trade or business and divide a profit? (§301-77011(a)(2))
i. If yes, then no need to have anything formally incorporated
ii. Must answer no if the participants only share the expenses
1. The mere co-ownership of property does not necessarily create a
separate entity either
2. A joint venture/K’tual arrangement creates a separate entity for tax
purposes only if the participatns “carry on a T/B or financial op or
venture and divide the profits
2. Do we have a business entity or trust?
a. § 301-7701-4(a) Trust: we just stop and no more work
i. 301-7701-4(a) We have a trust if we have a trustee if we have a trustee who
takes title to the property for its beneficiaries
1. If its being used for a business, then not a trust
2. Trust: does not involve associates in a joint enterprise for the
conduct of business for profit.
b. Business Entity: if we have a business entity, defined by -2(a) and we have to figure
out how to tax this go to sheet
i. A business entity is a separate tax entity not properly classified as a trust or
otherwise subject to special treatment
Part 2: How an entity is taxed (Business entity)
1. § 301-7701-2(b) Certain entities are automatically treated as a corporation and NO
ELECTION IS ALLOWED:
a. If it is a corporation under state law then it's a corporation for federal tax law as
well- 301.7701-2(b)(1), (3)
i. E&E: Publicly traded partnership (traded on established market or interest
tradeable on secondary market), deemed corporations (not partnerships)
under 7704
b. Certain listed foreign entities: 7701-2(b)(8)
c. 2(b)(4)- Insurance companies or banks
i. Then you can stop and you are taxed as a corporation
ii. If not, continue
Treas. Reg. § 301.7701-3: provides the entity election and default classification rules for entitles not
electing
ENTITY CLASSIFCATION RULES FOR DOMESTIC CORPS
2. If it is an entity that is not a PER SE corporation, but it is an ENTITY AND DOMESTIC:
a. 2 or more owners
i. You can either do default partnership or you can elect corporation (Form
8832) (301.7701-2(a))
b. 1 owner:
i. Default: disregarded entity (nothing, the corporation doesn't exist)- if
corporation makes entity then ordinary income
ii. Or you can file an election to make it a corporation
ENTITY CLASSIFICATION RULES FOR FOREIGN CORPS
3. If it is a FOREIGN ENTITY:
a. And it is a per se corporation:
i. Check list to see whether corporation is a per se corporation (special names)
1. If it is a per se under 301.7701-2(b) then inquiry over, and no
election can be made
b. If it is NOT a per se corporation and the entity has
i. 2 or more members, AND
1. If everyone has limited liability
a. Default: corporation
b. Can elect to make partnership
2. If one or more member has limited liability
a. Default: partnership
b. Elect: corporation
ii. 1 Member w/ liability (unlimited liability)
1. Disregarded entity (default)
2. Can elect to make a corporation
iii. 1 Member w/ limited liability
1. Default- corp
2. Elect- to be disregarded entity
Considerations in making an election re: think about the benefits/disadvantages of
 Example if can be either a corporation or a disregarded entity (i.e., if this is a foreign corp,
not a per se, and has 1 member w/ limited liability)
 Note: this is also owned by a US corp, and wants to make loan to sub.
Check the Box Example:
 Blue Chip Co, a US corp forms Newco, a Dustch Besloten Vennoostschap (BV), in order to
conduct business in Netherlands
o Under Dutch law, the losses of investors rare limited to the amount of their cap
subscriptions (only the amount that they gave to entity)
 So BCO wants to fund Newco BC w/ debt:
o BC will lend Newco BV $5M
o Newco will pay back BCco over 3 years + interest
 Initial- Is this a separate business entity?
o Yes, it is a separate entity being used for business.
o Not a trust- being used for business
 1) Not a per se b/c its not on the list
 2) 301.7701-2(b)
o We have 1 owner (Newco, the US Corp) and losses are limited, therefore we have
limited liability, so therefore it is taxed as a corporation
o Or it could elect to be a disregarded entity
 Last- is there any kind of election BV can make and should it make it?
o The BV can elect to make it a disregarded entity, and everything will be treated as
one being
 Should it do this?
o Interest payments are deductible for corporations
o Then if blue chip co is receiving income then it is taxed
o If the BV is a corporation then it is a separate entity, it will have interest deductions
and blue chip will have income
o That is what will happen if we do nothing
o BUT if we disregard the entity then there is no tax consequence from loaning
money to the subsidiary
o Therefore we should elect to disregard the entity
o Especially when we have large amount of capital
o Thus, if Blue Chip lebt money to the Newco they would not have interest income and
thus would not have to pay taxes on it.
Unit IIA & Unit IIB- Money & Non-Cash Distributions
Corps could give SHs 1) dividend 2) interest payment 3) Redemption (corporation distributes
cash or other property to its shareholders in return for its own stock, thus reducing the number of
outstanding shares).
A Liquidating distribution (as opposed to what we’re covering in non-liquidating distributions), the
corporation distributes its remaining assets after payment of liabilities to its creditors at or about
the time of its termination as a going concern.
Consequences of Characterization of Debt vs. Equity
 Interest payment (debt) the corporation can take a deduction for payment of
interest.
o Also a loan is not income since there is an obligation to repay
o Payment on stock is not deductible
 If the payment is for equity triggers 301(a) for Distribution of Property `
 Inflow
o Interest receipts from dividend receipts
o No deduction in interest receipts vs. DRD
 Debt vs. Equity: has an effect on incorporation/reorg
o Debt=boot; stock=tax free
§ 385(b): Debt vs. Equity Factors:
 Whether there is a written unconditional promise to pay on demand or on a specified date a
sum certain in money in return for an adequate consideration in money or money’s worth,
and to pay a fixed rate of interest.
o If yes debt
o If not written not good for debt factor (more equity)
 Whether there is subordination to or preference over any indebtedness of the corporation
o The more subordinated the more it sounds like equity
 The ratio of Debt to Equity of the corporation
o High leverage (already a lot of debt issued, means not likely to get paid back)
 Convertibility into the stock of the corporation
o If you can convert more like equity
 The relationship between holding of stock/stock and interest
o If people who hold the instrument are treated like stockholders, then sounds more
like equity
 Source of repayments (Inmar):
o If money distributed comes from corp profits equity
o If money borrowed & used to pay SHs debt
Inmar Products: Corporation makes marine engines, majority Sh makes “loan”
 Fixed interest rate, notes weren’t written down, no fixed maturity rate but payable on
demand, source of repayment not from profits= debt
o Note: if you have no rights in bankruptcy, this heavily favors equity.
Unit IIA- Problem 1(a)
 Achilles co, corporation, issuance of Preferred B, achilles is prohibited from issuing additional debt
(b/c of covenants), stock would pay dividends based on inverse of LIBOR (if interest rate rises, stock
pays smaller dividend). Investors can require Achilles to repurchase stock if dividends aren’t paid or
fall below a certain level (sweetner); Subordinated debt, but senior to common stock; Called
preferred B common stock
o Is this debt or equity?
 Initial- labeled as stock- is that relevant?
o If they call it stock, they cant recharacterize it, but IRS can recharacterize it under 385(c)
 1) Demand repurchase debt




2) Relationship to LIBOR fixed payments every quarter- sounds like debt
3) Subordinated more like equity- but here its in between 2 things- could be between two things
4) High D/E ratio rule preventing them from issuing more debt, looks more equity.
Maybe lack of ability to participate in management would make it more likel debt
o Interest payments themselves will generate the red flag
301 Distributions: distributions of property by a corporation to a SH with respect to its stock
 Distributions of property with respect to stock
 Property includes money, securities and any other property except stock in the corporation
making the distribution (317(a))
Dividend Defined § 316:
1)
2)
3)
4)
You calculate it ONLY at the end of the year.
Accumulated
Current E & P = This taxable year.
Fist, look to see if we have any current E and P; Second, look to see if there is any
Accumulated; Third, if the distribution came first from Current E & P.
Unit IIA: MONEY DISTRIBUTIONS
Class Notes: Example Amy and Mark own 50% of stock of Corp. Amy basis = $50; Mark basis = $50;
Corp distributes $100 to each Amy and Mark. – Disregard.
1) What is the Corporation’s Current Earnings & Profits available for SH?
Looking to see what the economic income is to the corps.
When a Corporation makes a distribution (on equity):
 1) Look to 301(a): Except as otherwise provided in this chapter, a distribution of
property (as defined in 317(a)) made by a corporation to a SH with respect to its
stock shall be treated in the manner provided in subsection (c)
o “Except as otherwise provided” –
o “With respect to its stock”- distribution is made to them in their capacity as
shareholders look out for distribution to CEO, might not be paying in their
capacity as SH. Not because you are g
o It may look like a §301 distribution, but it is really a payment of salary or
repayment of debt – watch for this. Has to be “with respect to the stock.”
o Cash Distributed + FMV of Property Received – Liabilities Assumed by SH –
Liabilities to Which Prop is subject
 1.A) 317(a): Property: Money, securities and any other property; except that such
term does not include stock in the corporation making the distribution (or the rights
to acquire such stock). I.e., stock dividends.
o Options do not count
o Distribution of stock (stock split) does not count
 2) 301(b) Amount distributed (matters for non-cash distributions)

o Cash distributed + FMV of other property distributed—liabilities assumed by
shareholder—liabilities attached to the property itself
3) 301(c) Taxing the amount distributed (THREE STEP PROCESS)
o (1) First, Find the portion of the distribution that is a dividend taxed as
income (note: qualified dividend income trigger 15% under 1(h)(11)).
o The portion of the distribution that is a dividend is included in the SHs Gross
Income. ** Remember, though, under §1(h)(11) it is a qualified dividend and
will receive favorable rates.
 316: Dividend: any distribution of property made by a corporation to
its shareholders (1) out of its accumulated E&P after 2/28/1913, or,
(2) out of its current E&P without diminution by reason of any
distributions made during the taxable year, without regard to the
amount of the E&P at the time the distribution was made
 Flush language: “Except as otherwise provided…every
distribution is made out of earnings and profits to the extent
thereof, and from the most recently accumulated E&P”
 A) Allocate E&P to each SH who receives a distribution: IF distribution
to multiple shareholders, must allocate E&P
 Amount of Distribution * (Current E&P/Total Distributions
over the year)=
 B) If there is Accumulated E&P, the order of the distributions matters
because we will “burn through E&P”—1.316-2(b)
 I.e. First, we allocate current E&P ratably. Then, if there is
accumulated, we see if one SH received a distribution earlier
and the accumulated E&P will be applied to them accordingly.
o (2) Second, § 301 (c)(2) Reduce basis in the stock by the amount that is not
a dividend
 Note: if it is not a dividend (from the corporation’s profit) then it is
just a return of what the shareholder initially invested (thus, the basis
should be reduced for the cost recovery).
 See below, but if there is MORE E&P than amount distributed (e.g.,
670 E&P/600 distributed) then you skip this step! This simply means
that there was more than enough E&P to cover, thus no need to
reduce the basis.
o (3) Third, § 301(c)(3): Any excess of the basis is treated as a gain from the
sale or exchange of property (301(c)(3)(A)). Can’t Reduce basis below zero.
This gain/loss WILL receive capital gains/loss treatment because it is a
capital asset.
o (4) Fourth, Reduce Corporation’s Earnings and Profits “to the extent
thereof” by
 The amount of money+ Principal amount of obligations of the
corporation (on the property distributed) + adjusted basis of the
other property so distributed.
 Can’t go below zero.
First, look to Current E&P first.
For Accumulated Earnings and Profits
Example Problem from UNIT II for Rey: Current E&P $82 and $50 accumulated E&P.
Kessel distributed $75 to Rey on Feb 2 and $75 to Wayland Corp on 5 May.
For Rey: First, 82/150 x $75 = $41. So, current E&P gets split ratably, so $41 is Rey’s
dividend. Then burn through the accumulated E&P. Thus, the $50 covers the whole $41 and
therefore, all of the $75 is a dividend. Thus, $75 x .20 = $15 tax liability.
First, always apply the current E&P ratably. SO take $41 off of $75 for Rey. That leaves a
balance of $34. Now “burn through” the E&P. There is plenty of accumulated E&P to cover
the $34. SO the whole thing is a dividend for Rey. The balance of Accumulated E&P will be
$16 (50-34).
Second, amount not a divided = $0! So no need to adjust basis.
For Wayland: Same facts Wayland also gets the $41 for Current E&P (because current is
ALWAYS spilt ratably). Next, because Rey used up $16 of the $50 Accumulated, that means
there is left $14 of Accumulated. We must burn through that.
So, $75 of the distribution gets hit with the $41 current E&P. That means there’s a balance
of $34 left for Wayland to deal with. Apply the rest of the $16 accumulated. That puts
Wayland’s dividend at $57 ($41 current E&P + $16 Accumulated E&P) of the $75
distribution. But, because it is a corporation, reduce that $57 by the DRD.
So, 57 – 45.60 (DRD reduction of 80%) = 11.40 amount of dividend x 35% (because they
are a corporation, there is no favorable 20% rate like for individuals) = total tax liability
of 3.99. `
Next, adjust for basis. Amount not a dividend = 75 – 57 = $18 NOT a dividend. 301(c)(2)
says to reduce basis by this amount. Thus, $200 – 18 = $182 new basis for Wayland.
Nimble Dividends Test: 74-164, Sit.2; Treas Regs 1.316-1(a)(1)
Look at Regs 1.312 – 6 and -7
 If it is given, then use the amount Given, or,
 (1) Calculate Current E&P: § 312 (cash distributions)
o 1) Start with Taxable Income
 Business income+ Dividends + Net Capital Gains (NET, not just capital
gains) – Deductible Business Expenses
o 2) Add back excluded items that increase corporation’s ability to pay dividends
 1.312-6(b) bonds (interest earned on bonds), insurance proceeds
Municipal bond income is not taxable (generates interest but it is tax exempt
interest)
o 3) Add back deductible items that do not represent decrease in wealth
 Dividends received deduction
o 4) Subtract non-deductible items that reduce actual economic income
 i.e., Interest on a loan taken by a company to get tax exempt bonds
(265(a)(2) (not deductible expense but they paid money)
 Capital Losses NET capital losses, not deductible but still a real loss
 Taxable income liability not deductible but still paid the taxes (take 35%
of the amount calculated in #1). It’s the tax liability, NOT the taxable
income.
o 5) See below: Remember, after you calculate the tax consequences to the SH, we
have to calculate Final E&P 312(a)
(2) IF DEFICIT in CURRENT E&P but POSITIVE Accumulated E&P…
o Prorate the amount of the deficit from beginning of year to date of distribution to
determine available E&P at time of distribution (1.316-2(b))
 1) Count number of days from 1/1 to date of distribution (use 30
(months)/360 (years) convention)
 2) Find percentage of the year= Number of days/360
 3) Amount of Deficit * percent of year
 4) Accumulated E&P- Prorated Loss Amount= E&P available for the
distribution.
o Goal: figure out how much of the loss happened during the period leading up to the
time when SHs got distribution
 Relevant to how much profit available to distribute
o If the loss can be attributed to a one time event then might not have to prorate the
losses (if you cannot, then prorate)


2) Tax Consequences to SHs: 301
 1) Calculate amount of distribution that was a dividend (c)(1)
o Amount of Distribution * (Current E&P/Total Amount of Distributions) =
Amount that is a dividend
 Dividend defined in 316*
 First comes out of Current E&P 316(a)(1); and then accumulated E&P in
order of distributions
 2) If Corporate SH, reduce by DRD (243); If individual, calculate tax liability
 3) Reduce basis by amount that is not a dividend (c)(2)
 4) Any excess is capital gain (c)(3)
3) Adjustments to Final E&P of the Corporation: 312
 312(a) Calculate Final E&P at the END OF THE YEAR (after calculating tax consequences to
SHs) and add to ACCUMULATED E&P (if any left over)
o Current E&P – (Amount of Cash distributed + Principal amount of obligations +
Adjusted Basis of other Property)
o Reduce current E&P to the extent thereof (never below zero)
NON CASH DISTRIBUTIONS (Unit IIB)
General Utilities (old rule) no g/l on distribution of appreciated or depreciated property of
corp to SHs. Codified in 311(a). 1986, 311(b) kicked in. If Corps distribute appreciated
property, then the distributing corps must recognize gain. Repealed mostly by 311(b) except
preserves no loss recognition for corporation on distribution of depreciated property.
First, Calculate Interim E&P if the Corporation makes a distribution of Property or Liabilities
 (1) If there is a Distribution of APPRECIATED PROPERTY: §312(b) [must calculate Interim
E&P and use this to calculate SH tax consequences this is the profit at the time of the
distribution]
o 1) Start with the Current E&P and Increase E&P by FMV-Adjusted Basis (the gain of
the total distribution). This just means increase current E&P by the gain.
o 2) Decrease E&P by current tax liability ((FMV-Adjusted Basis)*35%)
o 3) Calculate tax consequences to SHs
o 3) Calculate Final E&P at the END OF THE YEAR and add to ACCUMULATED E&P
 (2) If there is a Distribution of both APPRECIATED AND DEPRECIATED PROPERTY
o 1) Interim E&P is not adjusted due to distribution of depreciated property, however,
still distributing some appreciated
o 2) Current E&P + (FMV-AB of appreciated property ONLY, i.e. gain on
appreciated prop)
o 3) Decrease E&P by current tax liability (on appreciated property ONLY) ((FMV of
apprec prop – AB of apprec prop)*35%)
o 4) Use Interim E&P calculated to calculate tax consequences to BOTH shareholders,
regardless of whether receiving appreciated or depreciated property
o 5) Calculate final E&P at end of year, decreasing interim E&P by FMV of
appreciated property and Adjusted Basis of depreciated property
 (3) If Distribution with LIABILITY ATTACHED: §312(c)
o 311(b)(2): “gain is recognized as if such property were sold to distributee at FMV”
o Remember Crane (nonrecourse debt “NRD”)): Amount realized includes amount of
debt relief
 But, Since we treat as SH purchasing from corp, we know if NRD attached,
then price paid to corp = FMV- NRD. However, then we know that b/c of
Tufts, the amount realized also includes NRD
o Tufts: NRD is included in the amount realized despite the difference between FMV
and the amount of the loan
 Thus must calculate interim E&P as with appreciated property.
 1) Increase E&P by the gain (Amount realized= Amt paid to corp+debt
relief)- AB
 2) Reduce E&P by tax liability
o Final E&P is a slightly modified calculation
o If liability exceeds FMV (FMV is not treated as less than the amount of the liability),
then corporate gain= liabilities-AB= 336(b)
 (i.e., if property has FMV of 150 w/ mortgage of 200 & basis of 80)
 Then gain = 200-80 = $120 (not 200-150)
 (4) If Corp distributes AN OBLIGATION OF THE CORPORATION: §311(a)/(b)
o §311(b) does not apply and No gain or loss is recognized by the corp
 Therefore, no adjustments to Interim E&P
Tax consequences to the Shareholders
 (1) 301(c)(1):The amount that is a dividend (dividend if corporation has Current E&P—
316) is included in SH’s gross incomeo If qualified dividend (1(h)(11)) 15% rate
If CORPORATE SH reduce the amount that is included in gross income by DRD
(243)
o The amount of the distribution 301(b)= Amount of CASH received + FMV of
other property received – liabilities assumed by SH. **Thus, a $400 bond with a
$100 liability given to a SH would = a $300 distribution to the SH.
o (301)(d): Shareholder will take as its basis the FMV of the property.
o 1.301-1(b): a shareholder has income when it is “unqualifiedly made subject to the
demands of the SH.”
 If there is a Liability attached:
 Pretend as if the SH purchased property from Corp (311(b)(2))
o SH would purchase for FMV-liability.
 Reduce distribution by amount of liability (but not below 0). SH still
entitled to FMV basis
 If liability> FMV, excess could be considered contribution to corp’s
capital (thru relief of liability?) & could argue that SH should receive
an increase in basis of the excess (1.301-1(j) see unit IIC,
constructive dividends)
o If more than one SH receiving distribution, allocate E&P
 Amount of Distribution * (Current E&P/Total Amount of Distributions)
= Amount that is a dividend
o If Distribution of Appreciated Property
 Amount of Distribution * (Interim E&P/Total Amount of Distributions)
= Amount that is a dividend
(2) 301(c)(2): Portion of the distribution that is NOT a dividend is applied against and
reduces the SH’s basis in his stock
o Basically, not enough E&P to cover distribution requires reduction in basis because
this is a tax free recovery of the original contribution
o Cost Recovery here must reduce basis
(3) 301(c)(3): Any remaining part of the distribution will be gain from sale/exchange of
property
o If held for more than 1 year long term capital gains rate
(4) 301(d): If Property is distributed SH takes basis in property of FMV (regardless of
whether liabilities are attached to property)
o DO NOT FORGET THIS STEP!!
o



Tax Consequences to the Distributing Corporation:
§311: Taxability of Corporation on Distributions
 311(a) General rule- no gain/loss recognized on distribution with respected to its stock of
(1) Stock or (2) Property (largely repealed by 311(b)
 311(b): Distributions of Appreciated Property
o Gain recognized on distribution of appreciated property
o E&P must be adjusted accordingly
312: Adjust Final E&P of the Distributing Corporation For NON CASH DISTRIBUTIONS
Start with INTERIM E&P: ** See Prof Blank Note on this** Saved on a separate word doc.
 If APPRECIATED PROPERTY: §312 (b)/312(a)(3)
o Reduce E&P the FMV of the property distributed during the year (312(b)(2)
substituting FMV for adjusted basis of other property)
 If DEPRECIATED PROPERTY
If the property was depreciated, reduce E&P by adjusted basis (312(a)(3) No
substitution)
** If appreciated & depreciated property, reduce E&P by FMV of the property distributed &
the adjusted basis of the depreciated property**
 If LIABILITY ASSUMED: § 312(c)
o Reduce E&P by FMV of the property less the amount of liabilities assumed by the
Shareholders
o Final E&P= Interim E&P- (AR-liabilities assumed)
 If Corp distributes AN OBLIGATION OF THE CORPORATION: §311(a)/(b)
o §311(b) does not apply and No gain or loss is recognized by the corp
 Note: SH still receives Property (w/ FMV of the obligation)
o Reduce Final E&P by the amount of the principle of the obligations
 If Distribution of CERTAIN STOCK AND SECURITIES: § 312(d)(1)
o No effect on E&P if Corp issues its own stock or stock in another corp or options to
purchase stock or options in another corp
o
Unit IIC- Constructive Dividends
This is a short Unit section ** There are three types**
Three Types of Constructive Dividends
1. Outflows that result in no corporate income (don't result in tax)
 Ex: Candy Corp Leases a sugar refinery to Carlson for 1 year, and Carlson makes 1-time
rental payments to the 2 shareholders, George and Lenny. Idea is to get around
corporate level tax, and G&L are only taxed on ordinary income.
o In actuality, G&L are agents for Corp. Should be income at Corporate level, and
then a distribution to G&L (2 levels of tax)
o See Problem #2 on Unit IIC
2. Outflows that are deductible to the corporation
 Example: Corp distributes machine to employee in satisfaction of unpaid salary. Corp
held the machine as an asset, with basis of $2K and FMV of $10K. As Salary (not with
respect to stock), it is deductible to corp (salaries deductible).
o They have an $8,000 gain b/c of a realization event but ALSO a $10K deduction
for ordinary and necessary business expense
o If it is a dividend, not deductible, no deduction $8K gain (311(b))
 Example: Nicholas Cage owned own company and it paid for things he did and tried to
deduct them as business deductions.
 See problem #3 on Unit IIC.
3. Outflows that result in no Shareholder income
 Rev. Ruling 58-1: Where a corporation is formed to own and operate an apartment
project for profit and its SH are allowed to rent an apt in the project at a lower rental
then charged to general public, the excess of the Fair rental value of the apt over the
amount of rent paid by each SH as a tenant is treated as a distribution under 301. This is
a §301 distribution. Then, you would have to apply all of our old rules for E&P and
figure out how much of the distribution will be a dividend.
 Weigel v. Commissioner: Corporation made numerous “loans” (never written down) to
the sole shareholder over a number of years, corporation never made any dividend
payments. If this was a loan, SH would have no income because there would be an
obligation to repay. IRS won in this case.
o Distribution constitutes a loan if, at the time of its disbursement, the parties
intended that the SH repay the loan. These are not loans (TP wants them to be
loans because loans are not taxable income!) but are instead of dividends!
Dividends are taxable, so TP does NOT want them to be called dividends – he
wants them to be loans.
 Factors to look at for disguised dividends vs. loan: (1) TP’s amt of
control over corp; (2) existence of restrictions on the amount of
disbursements (ceiling) – there is no limit to “borrowing”; (3) Corporate
earnings and dividends history; (4) Use of customary loan
documentation (promissory notes, security agreement or mortgage); (5)
ability of the SH to repay; (6) treatment of disbursements on corp
records and financial statements; (7) creation of legal obligations
(payment of interest, repayment schedule, maturity date); (8)
corporation’s attempts to enforce repayment; (9) SH’s intention or
attempt to repay loan; (10) Maturity date: no maturity date = not a loan.
 Know these factors. These could be good for an essay.
 See Problem #4 Unit IIC
Transfers for less than Fair Market Value: § 1.301-1(j)
See Problem 1 Unit IIC for this illustration. Notes for Problem #1 are below!
 If property is transferred by a corporation to a shareholder which is not a corporation
for an amount less than its fair market value in a sale or exchange 301 distribution
o Why? If the SH can purchase the land for a discount, it is as if the discount is free
money (distribution) this isn’t a true sale
o Note: the regs differentiates between corporate and individual shareholders but
that does not make sense b/c GU has been repealed
 Amount of distribution= FMV- Amount Paid For Property
o Tax Consequences to Shareholders: 1.301-1(j)
 Bifurcate the transaction: Treat this transaction as 1) a sale & 2) a
distribution.
 1) Purchase land for amount sold
o Take cost basis in the land of the amount it was sold for
 2) Pretend that each SH got a distribution of property = value of the
discount (FMV-Purchase)
o Treat this “pretend property” as a 301 distribution triggers
finding the E&P, how much is a dividend (including in
income) and how much would have to reduce the basis
 Interim E&P= **?
 Its like the SH bought the land, and got pretend property = the
amount of the discount
o Tax Consequences to Corp  1.61-6(a) (Gains derived from dealing in property)
 When part of the property is sold but not the entire amount, we allocate a
portion of the basis to the sold part based on FMV.
 And the g/l 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
 Determined @ time of sale (not when entire property disposed of)
 Equation: Total Basis x (Total sale/ Total Sold+ Pretend Property (FMV))
=AB
 #1: Sale of Land
Corp receives $150 cash (AR)
AB= 120 x (150/200) = $90
(75% of the basis offsets the sale)
 150 AR – 90 AB = $60 gain
 150 – 90 = $60 gain on sale of land.
#2: Distribution
o There is pretend property §311(b) (recognize gain on
appreciated property)…
o Distribute $50 in pretend property ($25 each on their
sweetheart deals)
o AB= 120 x (50/200)= $30
o (25% of the basis offsets the distribution)
 Whether any gain has to be recognized? We need to
figure out whether there is any gain/we need basis
 We have $20311(b) gain
 $50AR – $30 AB = $20 gain on distribution
o Then we have $80 in gain total (60 + 20) *35% = $28
The corp paid $60, its worth $200, its selling part of the land for
$150, and then giving away part of the land for $50 in total
 This matters because if there is depreciated property
then you don't recognize losses under 311(a) (if you
don't allocate properly then part of the loss cant be
recognized under 311(a) and you might try and
recognize it)
o
o
o


Lastly, increase E&P by $20, decrease by 7 tax, increase by 60 gain, reduce by $21 tax = 300 + (207) + (60-21) = Interim $352 E&P. Remember, our original E&P was $300.
Finally, for E&P at end of year, §312, reduce E&P by appreciated property, But here, the only
distribution here was pretend party, which was $50. Here, that was $50 ($25 each). SO, we reduce
E&P from $352 – 50 = $302 Final E&P.
Remember, when adjusting Final E&P you are ONLY adjusting for distributions. The only
“distribution” here is the pretend $50 of distribution.
The sale of land does NOT adjust because we already did that in interim E&P!
Unit IID-Dividends Received Deduction
Purpose of DRD: avoid triple level taxation
Incentives: If there is a dividend & parent-sub relationship, there is no income
 However, gains from sale of stock by corporate parent are not exempt (still might have a
triple taxation event- sub taxed on income, parent sells sub stock, then makes distribution
to of parent, triple tax)
 Dividends are much better for corporations then capital gains.
o Result: Corporations structure transactions to take advantage of the DRD
Dividend stripping
 Company purchases stock in corporation, corporation makes a dividend payment, company
can maximize on the DRD, and then sell the stock on the open market at a lower price (because
stock price goes down after a company makes a dividend) and then use the loss on the sale to
offset any unrelated gains.
§ 243 Dividends Received Deduction
Companies are able to subtract, as a deduction, the amount of dividend income they earn.
 70% DRD
o If corp receives dividends where it owns LESS than 20% of paying corp’s stock
§ 243(a)(1).
 80% DRD
o If corp receives dividend where it owns between 80% and 20% of paying
corporations stock § 243(c).
 100% DRD
o If corporation receives “qualifying dividends” by member of same “affiliated group”
(ex: corporate parent-corporate sub)
 Affiliated group:
 1) Has to own at least 80% of the other corporation in vote and
value – §1504.
 2) ALSO have to file an affiliation election – 1.243-4(c).
o BUT this does not mean that they file consolidated tax
returns.
Recharacterization Factors- Using Dividends to Avoid Capital Gains Rate
 Timing
o If transactions happen all in the same day, it looks like the main motivation for the
transaction was to avoid the tax
 Written Plan
o If everything is planned out, looks like tax avoidance.
 Source of the Funds
o Where is the money coming from to pay the note? Who provided the funds for the
dividend? (e.g., note issued, stock sold)
o This is relevant because it just looks like purchase price that Hamilton paid
originally
 Non-Tax Related Business Purpose
o Business purpose reason besides avoiding taxes?
o If there is no non-tax related business purpose then it looks abusive
Classic Cases- Using Corporate Dividends to avoid Capital Gains Tax
Waterman Steamship- Parent wants to sell Sub to Purchaser. Large difference between basis and
FMV in stock would trigger large gain. The transaction: Sub distributes note to parent (= FMV-AB),
Then Parent sells stock to purchaser for the amount of adjusted basis, then purchaser gave amount of
note to the sub, then sub pays of parent, all within 90 minutes.
 Timing (bad); Written (bad); Source (from purchaser-bad); no bus. purpose
Litton Industries- Parent owns stock of Sub, wanted to sell, couldn't find buyer so decided to do an
IPO. Sub distributes a note to Litton b/c of the IPO to have bankers price stock correctly. 6 months
pass, and purchaser arrives, and buys stock from Parent. Purchaser then owns sub, and eventually
pays back the parent.
 Timing—(cite case for 6 months rule)


No plan to get to get to a good tax result.
Source- still from purchaser (bad)
o BUT court says that Sub could have paid off the note if necessary
 Business purpose for note was for IPO (they were already gearing up for an IPO, thus not
trying to avoid taxes).
Revenue Ruling 75-493- Corporation makes distribution to individual SH and then Individual sells
to Buyer, Buyer pays amount to individual. Here, TP wants it to be integrated (DRD was not an issue)
as purchase price (b/c at the time of this, dividends were ordinary income)
 Buyer didn't want corporation with a lot of cash- If corporation has cash, and owner wants
to get to it, there might be SH tax due-trapped cash problem- if you ever want to get the
money out, you don't want cash sitting in it.
 Timing (not great, close together); Plan (good- not tax avoidance plan); Source (good- from
corp- real dividend); Business purpose (reason for dividend was to make the sale happen)
 Steps were respected here.
 The difference here is that the TP here was an individual, not a corporation like in Litton.
Timing
Plan
Source of Funds
Business Purpose
Waterman
X
X
X
X
Litton Industries
Good
Good
Good
Good
Rev Ruling
X
? (He didn’t know)
Good
Good (buyer didn’t
want to but the
company with a ton
of cash in it)
“X” Means that the parties DID intend for this action to happen, which is not a good thing
because it looks like they were manufacturing tax results.
Rules to address dividend stripping (results from Corp’s ability to take DRD):
 (1) Always start with 246(c)
o Prevents DRD from being claimed unless the corporation owns the stock of the
subsidiary for a certain amount of time:
 1) Take ex- dividend date (first date on which you can buy stock but wont
get a dividend)
 2) Count 45 days before and 45 days after (91 days total)
 3) 246(c)(1)(A)- Corporate owner must hold stock for at least 46 days
during this period
 If 246(c) applies, everything is shut down (regardless of percentage
of ownership, amount of dividend, etc)
**OK, if 246(c) applies, NO need to go to 1059. ONLY go to 1059 if 246 does NOT apply. **

(2) Second Line of Defense: § 1059
o 1059 (a) If a corporation receives an extraordinary dividend and hasn’t held the
stock for more than 2 years prior to the dividend announcement date (date dividend
actually announced by corp)…
1059(c)(1) - Extraordinary dividend any dividend with respect to a share
of stock, if the amount of such dividend equals or exceeds the threshold
percentage of the TP’s adjusted basis in such share of stock.
 Analyze this amount before going through 301(c)(2) (reduction in
basis)- duh.
 1059(c)(2)- if the amount of dividend exceeds
 5% of the basis in the stock that is preferred
 or 10% for common stock extraordinary (IF TPs basis is equal to
or more than 10%).
o …(a)(1) Reduce basis in stock (but not below zero) by the nontaxed portion of such
dividends (DRD), and,
 (Note: if div. announcement date is 1/1/10 then must hold stock for 2 years
before 1/1/08)
o (a)(2) Once we hit zero any excess is gain from sale or exchange
If 246(c) applies, then the DRD is disallowed and there will be no non-taxed portion of the
dividend (gates are shut)
If 1059 applies…
o 1) DRD is STILL CLAIMED.
o 2) Reduce basis by the amount of the DRD
 If they sell stock for the same value, then the result will be a loss of $300 (It
allows them to save $105 in tax) (but b/c of 1059 they have paid $105 on
the distribution)



Redemptions – UNIT IIIA
302(b)(1) & (b)(2) “Not Essentially Equivalent to a Dividend” and “Substantially
Disproportionate Distributions”
Why does a corporation redeem stock?
 Increase share value
o Note: redemption is better than a cash distribution to one SH to buy stock
from another because there is only 1 instance of tax rather than multiple
instances.
 Change % holding
 Cash
 If the company wants to go private
 Take out a disgruntled/angry/activist SH
 Show financial strength
 Allows you to avoid paying double, triple taxes when eliminating SHs (more “tax
efficient”).
Start with 317(b)- Defines Redemption:
Whenever a corporation acquires its stock from shareholder in exchange for property (whether or
not stock acquired is cancelled, retired or held as treasury stock)
 Redemption changes the legal entitlements of the shareholder and is treated as a
sale/exchange for property
o Individual: Historically wanted a SALE instead of DIVIDEND (but with preferential
dividend treatment individuals are indifferent)
o
Corporation: Would WANT a DIVIDEND, BUT, 1059 catches that. Maybe they want a
sale (to offset a pending capital gain)
Redemptions of stock  §302(a)
**Remember, if 302(a) applies, then we get SALE treatment (this is what the TP wants). If it is not a
302(a) sale treatment, then it is a 301 distribution.
 Check §302(b)
1) Safe Harbor: Check § 302(b)(2): Substantially Disproportionate Distribution
 1) After redemption the SH owns less than 50% of total combined voting power of all
classes of stock entitled to vote (302(b)(2)(B))
 2) SH’s ownership of voting stock is LESS THAN 80% of ownership of voting stock before
redemption (302(b)(2)(C)(i))
 3) SH’s ownership of common stock, by value, is less than 80% of ownership of common
stock, by value, before redemption (same test as (2) but applied to value of the stock) (Flush
language)
o IF DO NOT MEET 302(b)(2) MOVE ON TO 302(b)(1)
2) Next: Check § 302(b)(1): Not Essentially Equivalent to a Dividend
 Key: Was there a “meaningful reduction in ownership”
o US v. Davis:
 D owned 100% of corp due to attribution rules, lent corp cash in exchange
for non voting preferred stock and tries to claim exchange, but due to
attribution rules, no meaningful reduction
 Sole stockholder- always a dividend (never redemption)
 Attribution rules of 318(a) apply (this comes up later)
o Rev. Rule 85-106: Meaningful Reduction:
 Redemption must reduce:
 (1) right to vote (most important), (2) right to participate in
E&P,(3) right to share in net assets in liquidation
 If the redemption reduces these rights may qualify under
302(b)(1)/Davis
o Rev. Rule 76-364
 4 Shareholders: A owned 27%; B, C, D owned 24.3%
 Now SH A’s holding goes down to 22.27% and B,C and D each own 25.1%
(note 1 SH decrease, others increase)
 Holding: Not essentially equivalent to a dividend (is a meaningful reduction)
because A could have had voting majority before with the cooperation of 1
other SH, but afterwards this is not possible
 There was a meaningful reduction here!
o Rev. Rule 75-502
 A owns 57% and B owns 43%; After redemption, A owns 50% and B’s
ownership goes up to 50%  not essentially equivalent to a
dividend/meaningful reduction b/c A lost control of the company
 Business purpose is not relevant to the determination
 “reduced estate’s voting rights…reduced right to participate in E&P
and share it net assets…and now 50-50 ownership).
 This WAS a meaningful reduction.
o Rev. Rule 78-401
Redemption reduces A’s shares from 90% to 60%= no meaningful
reduction/301 treatment. Even if some power is lost under some state laws,
still has majority vote.
 This was NOT a meaningful reduction.
o Rev. Rule 76-385 (or de minimis rule)
 If SH in a public company and corporation redeems shares, even though they
might technically meet the safe harbors, they do not apply b/c never had
control in the first place.
 Went from .0001118% to .0001081% WAS a meaningful reduction.

3) Last: Redemption in COMPLETE TERMINATION OF INTEREST (b)(3)
4) Redemption in PARTIAL LIQUIDATION (b)(4)
 Failure to meet any of the safe harbors will trigger 301 distribution rules

Tax Consequences to Shareholder (individual & corporate shareholders)
 IF Redemption Under Safe Harbors
o If we satisfy one of the safe harbors (302(b)(2)(B)&(C)  Redemption,
Sale/Exchange under §302(a)
 Shareholder: Recognize gain/loss on the sale @ cap gains rate
 Corporation: Recognize gain/loss (but no special cap gains rate)
 IF NOT Redemption §301 Distribution
o Individual Shareholder
 301(c)(1) Calculate the amount that is a dividend with E&P and tax as
ordinary income
 301(c)(2)
 FIRST: Increase basis of remaining shares by basis in shares that
company just purchased (i.e. if SH owns 240 shares w/ $40 basis and
company buys back 40 shares,  basis= $8000+$1600= $9600
o “Disappearing basis” – 1.302-2(c)
 THEN: Reduce basis by the amount of the distribution that was not a
dividend (if company purchases for $3200 and current E&P is $2000
then $1200 is not a dividend)
o If $1200 of the distribution was not a dividend, then we
reduce basis from $9600 to $8400
 301(c)(3): Excess of the basis is included as a capital gain/loss
o Corporate Shareholder
  §1059(e)(1)(A)(ii) Limitation (for non pro-rata redemptions)
 301(c)(1): Amount that is a dividend is taxed as ordinary income
 Reduce amount by the DRD
 243(b)(1)(A): measure the ownership based on the corp’s
ownership at the CLOSE OF THE DAY (i.e. measure ownership after
the redemption when calculating the amount of DRD)
 301(c)(2):
 FIRST: Increase basis of remaining shares by basis in shares that
company just purchased (i.e. if 200 shares @ $40 and company buys
back 40 shares @ $40 basis= $8000+$1600= $9600
o “Disappearing basis” – 1.302-2(c)
 THEN: Reduce basis by the amount of the distribution that was not a
dividend.

THEN: §1059(e): If non pro-rata redemption which fails safe
harbors and is a corporate SH then reduce basis by amount of
basis not taxed i.e. FURTHER REDUCE BASIS BY DRD
Tax Consequences to Redeeming Corporation
 IF Redemption Under 302(a)
o Adjust Earnings & Profits: § 312(a)
 (Typically would reduce by amount of money distributed)
o § 312 (n)(7): For Redemptions in which 302(a) applies, the part of the distribution
taken from E&P shall be an amount NOT IN EXCESS OF the ratable share of E&P
attributed to stock redeemed (i.e. Calculate amount of stock redeemed in percentage
terms)
 1) Amount of stock redeemed/Total stock outstanding before redemption
 2) Current E&P * % stock redeemed
 3) Reduce E&P by the lower of the # in 2 or amount of $ distributed
 if NOT a Redemption §312
o 312(a): Reduce E&P to the extent thereof
 §312(n)(7) DOES NOT APPLY
Special “Redemption” Scenarios Unit IIIA, Problem 5
 Series of Redemptions—302 (b)(2)(D)
o 302(b)(2) does 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 is not
substantially disproportionate with respect to the shareholder
o 1.302-3(a): Whether or not there was a plan will be determined by the facts and
circumstances
 Step Transaction Doctrine: Courts will step the parts of the transaction
together and treat them as one:
 1) Binding Commitment
o If there was a binding commitment at the time of the first
step that the parties would share ownership transaction
will be treated as one
 2) Mutual Interdependence
o If the steps are integral to one another, they can be combined
 3) End Result
o If there is evidence of an intention to reach a final result
seems like binding commitment test
o Note: if the transaction is stepped together, then 302(b)(1) can still apply
(subjective inquiry- not essentially equivalent to a dividend)
 Also note: nothing in (b)(1) says to step the transactions together (address
together and not together)
 Non-Voting Preferred Stock— Unit IIIA, Problems 6 and 7
o If Common + NVP Redeemed:
 Piggy Back Rule: 1.302-3(a)(3) – If there is a redemption of both common
and preferred stock, if the redemption of the common satisfies the safe
harbor, then the non-voting preferred stock will be treated the same
 Makes sense because he is truly reducing his share of the company
o If ONLY NVP Redeemed:


§ 302(b)(2) does not apply to the redemption solely of nonvoting preferred
stock
Rev Ruling 77-426- redemption by a corp of any of its nonvoting,`
nonconvertible, nonparticipating preferred stock, which is not section 306
stock and all of which is owned by an individual who owns none of the
corporation’s common stock either directly or by attribution, qualifies as not
essentially equivalent to a dividend under 302(b)(1)
302(b)(3) COMPLETE TERMINATION OF INTEREST: Third Redemption Safe Harbors:
§302(b)(3)—
 If there is a complete redemption of all of the stock, then sale/exchange treatment, the
corporation has no change in its basis (?), and E&P is reduced under 312(n)(7)
 302(c)(2)(A)- Attribution Rules do not apply for complete termination of a SH
interest IF:
o (i) Immediately after the distribution, the distibutee has no interest in the
corporation (including an interest as officer, director or employee) other than an
interest as a creditor
o (ii) The distribute does not acquire any such interest (other than stock acquired by
bequest or inheritance) within 10 years from the date of such distribution, and
o (iii) The distribute, 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
(ii) and retain such records as may be necessary for the application of this
paragraph
 To waive the attribution rules, an additional step must be taken
 Think: if it looks like someone is completely cashing out with a redemption,
HOWEVER, take note with attribution rules because the family member cannot have
ANY remaining interest that violates 302
o Lynch: Any interest is a prohibitive interest in the corporation- even if
independent consultant, it STILL counts.
 Look back rule: 302(c)(2)(B)- Attribution rules WILL APPLY in a COMPLETE
REDEMPTION SCENARIO if – Unit IIIB Problem 2d
o 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
who the attribution rules of 318(a) would apply OR
o ANY PERSON owns (@ time of distribution) stock, the ownership of which is
attributable to the distributee under 318(a), and the person acquired any stock in
the corp, directly or indirectly, from the distributee within the 10 year period
ending on the date of the distribution, unless stock so acquired from the distribute is
redeemed in the same transaction
o BUT the principal purpose of these transactions must be tax avoidance
o Goal: prevent family members (parent-children) to bail out E&P at capital
gains rate by buying and then redeeming shares
o If either of these conditions are met, we apply the attribution rules, and
can see if the redemption meets either (b)(2) or (b)(1) (but probably will
not
o If there is a COMPLETE REDEMPTION AND FAILS 302(b)(3)— Problem 2C of Unit IIIB
o 1) Treat as a §301 redemption
o (i) Amount of distribution that is a dividend is treated as ordinary income
o
(ii) Special basis treatment in complete redemption- 1.302-2(c)- Ex. 2
 Tack the SH’s basis onto the basis of the other shareholder
 New proposed regs: allow the SH to hang on to the basis and
recognize it eventually (See Unit IIIB problem 2C) for this.
Attribution Rules of §318 (a) – UNIT IIIB
 (1) Family Members
o Spouse, Children, Grandchildren or Parents, NOT SIBLINGS
o OPERATING RULE: (5)(B)- Stock constructively owned by reason of paragraph (1)
(members of family) shall not be considered as owned by him for purposes of again
applying paragraph (1) to make another the constructive owner of such stock (this
stops from basically everything being attributed to a person).
 (2) FROM (Upstream rules) Partnerships, Estates, Trusts and Corporations
o (A)FROM partnerships and estates: Stock owned directly or indirectly, by or for a
partnership or estate is considered owned proportionately by its partners or
beneficiaries
o (B) From Trusts: beneficiaries of a trust own what the trust owns in proportion to
their actuarial interest in the trust
o (C) From Corporations: if 50% 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 the
proportion to the value of the stock which the person owns
 (3) TO (Downstream Rules) Partnerships, Estates, Trust and Corporations
o (A) TO Partnerships and Estates—stock owned, directly or indirectly, by or for a
partner or beneficiary of an estate shall be considered as owned by the partnership
or estate. Doesn’t matter if partner owns 1% or 100%
o (C) TO Corporations—if a person owns 50% or more of the stock in the corporation,
the corporation owns that person’s stock
 NOT proportional rules like the upstream (from corporations to
shareholders)
 (4) Options: An option to acquire stock is considered as being owned by such person.
o Thus, if a corporation is owned by 2 brothers, and the father owns an option to
purchase one of the son’s stock, then the father is considered as owning that son’s
stock, and that stock will be attributed to the other son.
 NOTE: even though we attribute the options and treat as owning stock, we
don't increase the denominator- the total amount of shares in the company
 (5)(A)- Operating Rules
o (A) stock constructively owned by a person (i.e. father) by reason of the application
of paragraph (1), (2), (3), or (4) (i.e. options), shall, for purposes of applying
paragraphs (1) (members of family), (2) (upstream) , (3) (downstream), and (4), be
considered as actually owned by such person.
o (B) 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.
o (C) Stock constructively owned by a partnership, estate, trust, or corporation by
reason of (downstream rules) shall not be considered as owned by it for purposes of
applying (upstream rules) in order to make another the constructive owner of such
stock.
o
(D) If stock may be considered as owned by an individual under paragraph (1) or
(4), it shall be considered as owned by him under paragraph (4).
302(b)(4): PARTIAL LIQUIDIATION (Last Redemption Safe harbor)
This was Class #10
So far, all of our rules for redemptions dealt with the view from the shareholder
level. This section now deals with corporations**
302(b)(4): (4) Sale or exchange treatment if such distribution is— ONLY applies to an individual
SH.
 (A) in redemption of stock held by an individual shareholder (not a corporation), AND
 (B) in partial liquidation of the distributing corporation.
o The redemption can be pro rata (302(e)(4))
302(e)(1): Requirements for partial liquidation
 (A) the distribution is not essentially equivalent to a dividend (determined at the
corporate level rather than at the shareholder level), and
o Not Essentially Equivalent to a Dividend AT CORPORATE LEVEL: 302(e)(2)
 distribution has to be attributable to a corporation, ceasing to conduct a
qualified trade or business AND
 immediately after distribution, the corporation has to be actively engaged
in “qualified trade or business”
 302(e)(3): “qualified T/B”- a business actively conducted throughout
5 year period before ending on date of redemption (5 year period
BEFORE redemption).
 AND not acquired by the corp within the 5 year period in a
transaction where gain/loss recognized in whole or in part
o So if they acquired this business in some sort of nonrecognition transaction then it would tack on the existence of
the business from the other corp (i.e., 355 tax free spin offs)
 (B) the distribution is pursuant to a plan (a written document) and occurs within the
taxable year in which the plan is adopted or within the succeeding taxable year.
o Distributions must be made immediately, represents a contraction of the business
 Example:
o Pursuant to a plan, there is a pro rata redemption in partial liquidation of one line of
a business, and there are 2 individual SHs and 1 corporate SH. The two individuals
will get sale/exchange treatment. The corporate SH will not get sale/exchange, and
it will fail the other safe harbors, so it gets § 301 distribution treatment
 Tax Consequences to the Corporate SH:
 Corporations? They get 302(d) treatment, which means they get 301 treatment: treat it
as a dividend.
 § 1059 (e)- If the redemption was part of a partial liquidation then the
amount treated as a dividend is an EXTRAORDINARY DIVIDEND, regardless
of how long the corporation has held the stock.
 Basis reduced by the non taxed portion, and any excess treated as
gain from sale or exchange
o But if they bust the partial liquidating
o
o

If liquidation of a business that was only acquired 2 years ago for cash and a pro rata
redemption, then the redemption will fail all safe harbors, 301 treatment, and
1059(e) limit does not apply
Thus: if you say it is NOT a partial liquidation, then there is NO 1059(e) treatment!
Tax consequences to the liquidating corporation:
o
o
o
Sale/Exchange treatment on the sale of its assets
311(b)- Recognize gain on appreciated assets but does NOT recognize loss
If in liquidation of a line of business, the corporation fails the safe harbors and
receives 301 treatment, the corporation still recognizes gain (and does not
recognize loss)
§ 304- Redemptions by Related Corporations (Unit IIID)
Certain stock purchases treated differently: Two Requirements:
 (A) One or more persons are in control of each of two corporations AND
 (B) in return for property (as defined by §317, which means anything other than stock),
one of the corporations acquires stock in the other corp from the person in control
1) Are we in 304? : Definition of Control: 304(c)
 304(c)(1): Control = Ownership of stock possessing at least 50% of the total combined
voting power of all classes of stock entitled to vote OR at least 50% of the total value of
shares of all classes of stock. You measure control BEFORE the transfer (see below for
more).
o Constructive Ownership Rules: 304(c)(3): 318(a) applies, with modifications
o Note modified constructive ownership rules (i.e., 5% for 50%) ONLY APPLY for
determining control, which means BEFORE the transfer (not for comparing
redemption).
 Corp attribution (from SH to Corp) (318(a) (3)(C)) – Downstream
 When a SH owns 50% or more stock in a corp, the corp owns all of
what the SH owns
o Once SH has 50% control, all stock owned by SH is attributed
to the controlled corporation. This means FULL attribution.
 If the SH owns between 5 and 49%, then the corp owns
proportionately what the SH owns (304(c)(3)(B)(ii)(II))
 From Corp (to SH) attribution (318(a)(2)(C)) – Upstream
 Substitute 5% for 50%
 If SH owns 5%, SH owns 5% of what corp owns (proportional
ownership of what corp owns)
If Meets Control, then we are in 304, THEN… (brother-sister corps). ** If it fails 304, then it is
simply a sale transaction!!
 1) Pretend that the sale is actually a redemption of the acquiring corporation’s stock
o I.e., SH sells V stock to M. We pretend M is redeeming M stock
 Compare SH’s ownership in V prior to sale (i.e., 100/100), and then after
sale (when calculating ownership after sale, make sure to attribute M’s
ownership in V to the SH.) (50/100) (this is described again below)
 (i) 304(b): Look to issuing corp (stock of corp selling) to see what SH owned before
compared to after and remember to REATTRIBUTE (for purposes of applying 318, must
look at acquiring corporation ownership as well2) 304(B): Determine whether it is a
redemption (USING 302(b) TESTS) based on the SH’s ownership of the ISSUING CORP. If it
fails 302(b) Treat as 301 distribution
o
)
I.e. SH is still in control of the acquiring (purchasing) corp, so that corp’s
ownership of the issuing corp is reattributed to SH.
o Reattribute proportional amt back to SH of what SH transferred (if owns 50% and
transfers 10 shares, then 5 shares must be reattributed)
 BUT SEE: 304(b)(1)- when applying step 2/section 302(b), sections
318(a)(2)(C) and 318(a)(3)(C) shall be applied without regard to the 50
percent limitation contained therein.
 THUS: reattribute any proportion of ownership
 §304(b): “In applying section 318(a) (relating to constructive ownership of
stock) with respect to section 302(b) for purposes of this paragraph, sections
318(a)(2)(C) and 318(a)(3)(C) shall be applied without regard to the 50
percent limitation contained therein.”
** if we say sale treatment, then to figure out gain/loss: simply use the AR to SH, then use the basis
of the distrubtuing Corp (NOT the basis in the acquiring Corp) **


3) THREE POSSIBLE RESULTS
o (1) 304 applies and entitled to sale treatmenti.e., the redemption meets the
302(b) tests, report distribution as amount realized from sale, offset by basis in
shares transferred (i.e. sale/exchange treatment)
 (1) SH recognizes taxable gain (AR-AB)
 Note: this is still a sale of the pretend acquiring shares so technically
there is “transferred basis” of the issuing stock
 (2) Acquiring corp takes a cost basis in the stock purchased
 (3) Acquiring corp E&P= Reduce E&P based upon 312(n)(7) (since this is a
redemption triggering sale/exchange treatment)
 (1) Total amount of initial shares must include the pretend shares
that are redeemed (SH’s original ownership in acquiring corp+ other
SH’s ownership+# of shares sold to the acquiring corp from issuing
corp (i.e. pretend acquiring corp stock that is about to be redeemed))
 (2) Acquiring corp redeems (or purchases) the # of shares being sold
to it
 (3) Reduce current E&P by the lesser of amount paid to SH for the
shares or the “ratable share of the earnings and profits of such
corporation, attributable to the stock so redeemed.”
o Remember:
 1) Amount of stock redeemed/Total stock
outstanding before redemption
 2) Current E&P * % stock redeemed
 3) Reduce E&P by the lower of the # in 2 or amount
of $ distributed
 (4) Nothing happens to issuing corp
o (2) 304 applies and treated as distribution/301 (treat as 351)
o You would do this if it FAILED the 302(b) tests.
 301 (c)(1): Amount of distribution that is a dividend is ordinary income
 1) First reduce (take dividend) from Acquiring Corp
 2) If there is still leftover of distribution, reduce (take dividend) from
the Issuing Corp
 301(c)(2): SH’s basis in stock


o
1) Flush language in 304(a) tells us to treat this as a 351(a) exchange
2) Pretend that the basis in the pretend redeemed stock of the
acquiring corp is the same as the basis in the issuing corp stock AND
increase the basis in the acquiring corp stock by the basis in the
issuing corp stock (pretend redeemed stock)
 3) Reduce the basis by the non-dividend portion of the distribution
(1.304-2(a): “basis shall not be decreased except for as provided in
301.”)
 301(c)(3): Amount in excess of the basis is treated as gain from
sale/exchange of property
 Tax consequences to Acquiring Corp 362
 Reduction of E&P by amount that is a dividend
 Corp takes the SH’s basis in the stock
(3) 304 does not apply  Because they bust the control measures, thus
sale/exchange
 1) Amount realized-adjusted basis= capital gain for SH
 2) Acquiring corp takes a cost basis in the shares
 3) No change in E&P b/c purchase of other corp’s stock
STOCK DIVIDENDS- UNIT IVA- § 305


General rule: Gross income does not include stock distributions of a corporation to its
shareholders w/ respect to stock (i.e. own common, it is the only class of stock, and corp
distributions an extra share of common to all SHs- no income)
o Historic background:
 Eisner v. Macomber: Stock dividend made to all SHs is not income because
there is no realization event
 But see: Koshland v. Helvering: Distribution of common stock to the non voting
preferred stock SHs IS a realization event- NVP SHs get increase interest in
earnings of the company, common SHs losing
 AND: distribution of stock of a subsidiary is not covered by 305(a)
 BUT: distribution of warrant/option to purchase is covered by 305(a) unless it
qualifies for an exception
o Statutory Support:
 1001- only tax realization events (and Eisner says not realization)
 317- stock of a corporation itself is NOT PROPERTY
o FOCUS OF 305 as opposed to 302:
 305: Examine whether there is an expansion in SH’s access to earnings and
assets of corporation (voting rights not important)
 302: Examine whether there was a decrease in SH’s interest as a result of
redemption- think about VOTING rights
If fails 305, then treat as 301 distribution
o Tax consequences:
 To SH: Same as 301
 Basis in new shares = FMV
- Tax Consequences to Corp:
-
Regs .312-1(d) tells us that corp should adjust its E&P by the FMV.


311(a)(1): No gain or loss recognized on a distribution with respect to its own stock or
property
Tax Consequences if 305 non taxable distribution
o To Distributing corporation:
 311(a)(1): No gain or loss recognized on a distribution with respect to its
own stock or property
 E&P: 312(d)(1)(B)- as long as 305(a) applies, no change in E&P
o To Receiving SH:
 Basis: 307(a); Regs 1.301-1: SH’s basis in such new stock and in the old
stock, shall be determined by allocating between the old stock and the new
stock the adjusted basis of the old stock.
 Old Basis/Total Number of Shares after distribution= Basis per
share after distribution
 I.e. If the Shareholder has 10 shares with $100 basis and receives 1
share, then the total basis does not change and the new basis in each
share is 100/11= $9.09. 100 x
 E.g., Old Common basis = $1,000; New Common basis = $100
 SO, 100/1100 = 9.09%.
 Now, take that 9.09% and X $100 = 90.90 basis in new share of
common stock.
 1000/1100 = 9.09 x 1000 = $909.09 basis for the old common stock.
** Notice how the overall basis is STILL $1,000, we just apportion it
now.
 Holding Period: 1223(4): holding period of old stock tacked onto new
stock
 I.e. If the SH has held the 10 shares for 5 years, and receives 1 new
share from corp, then the holding period of the old shares is “tacked”
onto the new share.
Exceptions: 305(b): Distribution will be taxed as a 301 distribution if any of these apply:
o (1) Distribution in Lieu of Money: If SH can choose to have distribution paid in
either stock or property 301
 Rationale: a shift in proportionate interest occurs because some can increase
interest in company and some receive property
 Example: If the SH has 10 shares, and has an option to receive 1
share or cash, if the share is worth $100 per share, then the amount
distributed = $100, and taxed under 301. The basis in the property is
its FMV.
 To The Distributing Corp: Treat as a distribution of money
(312(d)(1)(B))
o Reduce E&P at the end of the year- 1.312-1(d): decreased by
the amount of money, principal amount of obligations and
the adjusted basis of other property of the distribution
o No gain on distribution of own stock/dealing in own
stock No gain or loss recognized on distribution of own
stock (311(a)) & a corp does not recognize gain when
it sells its own stock (1032) combine & get this
conclusion
o
o
o
o
(2) Disproportionate Distribution (Companion distribution) (very similar to the
first exception, except in this case there is NO election).
 (i) If there is a receipt of property by some SHs AND increase in
proportionate interest of other SHs in assets or E&P 301 (on SHs who
receive property)
 Example: Corp has Class A and Class B common stock outstanding,
Declares dividend payable to Class A Shs in additional Class A shares,
and payable to Class B in cash
o The dividend to Class A SHs is taxable stock dividend under
305(b)(2)
 Note: if the corp has 2 class of stock, 1 which only
pays cash and 1 which only pays stock, this would fall
under (b)(1) & (2)
 (ii) Distributions need not be simultaneous taxable whether or not the
distributions are steps in an overall plan
 1.305-3(b)(4)- If the distributions are more than 36 months apart,
then presumed not to be a companion distribution UNLESS made
pursuant to a plan
o NO definition of plan in code.
o 1.305-3(b)(2)- For example, if a corporation pays quarterly
stock dividends to one class of common shareholders and
annual cash dividends to another class of common
shareholders the quarterly stock dividends constitute a series
of distributions of stock having the result of the receipt of cash
or property by some shareholders and an increase in the
proportionate interests of other shareholders.
 (iii) No requirement that companion distribution come from the corporation
itself - 1.305-3(b)(3)
 Example: SHs receive a stock distribution and others sell shares in a
prearranged plan to a related corp for cash stock dividend taxable
under 305(b)(2)
(3) Distributions of Common & Preferred Stock
 If some common SHs receive preferred stock and other common SHs receive
common stock taxable distribution
 Rationale: SHs receiving preferred shares not receiving the same
right to E&P/assets as those receiving the common shs
(4) Distributions ON Preferred Stock
 ANY distribution (including pro rata, including pro rata distribution of
more preferred stock) on preferred stock taxable (other than an increase
in conversion ratio)
 Note: a distribution of cash to preferred SHs does not
(5) Distribution of Convertible Preferred Stock
 If the distribution is of convertible preferred stock then it will be taxable
unless the IRS believes that everyone will convert/wont convert (i.e., wont
result in some SHs owning property and some owning an increased interest
in E&P/assets)
 1.305-6(a)(2)- Factors to determine whether it will result in a
disproportionate distribution:
(i) If right must be exercised within a relatively short period
of time after distribution  Disp. Dist.
o (ii) When factors like the dividend rate, the redemption
provisions, the marketability of the convertible stock, and the
conversion price, suggest that some will convert and some
wont  Disp. Dist.
 But if long period of time to exercise right, and
dividend rate is consistent with market conditions @
time of distribution, no basis for predicting when and
extent it will be converted unlikely that disp dist.
Exceptions Con’t: 305(c): Certain transactions treated as distributions
o 1) Trigger Transactions:
 #1 - Change in conversion ratio,
 1.305-3(d)
 #2 - A change in redemption price,
 #3 - A difference between redemption price and issue price,
 #4 - A redemption which is treated as a 301 distribution (i.e., a redemption
but it failed 302 tests). In this case, you pretend that the person gets a
pretend stock dividend.
 Note: if we have a redemption, run through the 302 tests to see if
they apply, if no 302 tests apply, check 305(c)
o Note, if it is a pro rata redemption, and SHs own same amount
before & after (just less total), then there is no worry that
someone’s interest is increasing while another is receiving
property
 Example: J holds 90 shares of Class A common; B holds 180 shares of
Class B common. Each have 1 vote per share & equal dividends, but
2:1 ratio on assets in liquidation. Corp redeems 1/3 of B stock
o Thought Process: redemption, go through 302(b) tests.
 B has 60 shares redeemed, so B owns 180/270
120/270= 66%  57% (fails all 302(b) tests re: rev
ruling ____)
 Triggering event: redemption as 301
 Now check whether SH has an increase in
proportionate interest in E&P OR Assets.
 Check E&P (note dividends are equal)
o J went from 90/270  90/210= 33%
 43%
o B went from 180/270  120/210 =
66%  57%
 J’s interest increases by 10%
b/c B redeemed stock for cash
(received prop)
 Check Assets (note: assets 2:1)
o Total assets= (J’s shs * 2) + B’s shs=
(90*2)+ 180= 360
o J goes from 180/360  180/300=
50%  60%
o

B goes from 180/360  120/300 =
50%  40%
** You only need to meet ONE of these tests (E&P or asset tests) to trigger
305(c)! **
 Or any transaction having a similar effect on the interest of any SH
shall be treated as a distribution with respect to any SH shall be treated
as a distribution with respect to any shareholder
o 2) whose proportionate interest in the E&P or assets of the corporation is
increased by such change, difference, redemption, or similar transaction.
 Thus, we need one of the trigger events AND interest to increase
 So, a pro rata redemption of all SHs may be treated as a 301 but it is
not 305(c) b/c no one’s interest increases
 If the trigger of 305(c) is pulled then treated as receiving 305(c) stock, and,
 If we have a SH who MUST be treated as receiving 305(c) stock:
o MUST SEE IF MEETS ONE OF THE EXCEPTIONS of 305(b) APPLIES (now that we
have a pretend distribution of stock- remember, no stock was distributed before)
 Re: example above: 305(b)(2) applies - B received cash and J received “stock”
o 1.305-3(b)(3)- If the redemption of stock is in an isolated redemption, then 305(c) is
NOT triggered (i.e. we don't have to do this every time there is a 301 distribution)
 (or maybe 305(c) would apply but 305(b)(2) would not)  but if this is only
a 1 time redemption, might be isolated, but if redeemed every year by this
amount, 305(c) may apply
 ** On exam say ASSUME ISOLATED**
o Note: wont have to calculate the amount of tax to the SH who receives “305(c) stock” –
but just in case- SEE 1.305-3(e), ex 8
305(d): For Purposes of 305(c), stock includes the RIGHT to acquire stock
 Example: There are 100 shares of common and 50 shares of convertible preferred stock, with a
conversion ratio of 2:1. Corp distributes 1 sh of common on each share of common
outstanding. The preferred contains no anti-dilution feature (i.e., no adjustment to the
conversion ratio to reflect issuance of common shares).
o So: Convertible preferred = 100 shares (50*2, b/c right to convert= stock) + now
200 (100+ 100 distribution)= 300 total shares
 Preferred goes from 100/200 100/300= 50%  33%
 Common goes from 100/200 200/300= 50%  66%
 No 305(c) trigger applies!!
o In theory- looks like common on common/stock split, but, DISTRIBUTION, so check
305.
o Here, common SHs get more shares and a greater interest in the company because
convertible SHs are not entitled to more common shares.
 305(b)(2)- receipt of property- common preferred get an annual dividend of
$6 per year, and common SH’s interest increases enough to tax common
SHs on the distribution of stock
 See also: 1.305-3(d)(1)(i) & 1.305-3(e) ex. 4
 “If, however, the conversion ratio of the securities or stock were fully
adjusted to reflect the distribution of rights to the class A shareholders,
the rights to acquire class A stock would not increase the
proportionate interests of the class A shareholders in the assets or
earnings and profits of the corporation and would not be treated as a
distribution to which section 301 applies.”
o
Unit IV B- Disposition of Tainted Stock- § 306



§ 306: Preferred stock bailout
o Potential for arbitrage: SH can receive stock tax free under 305(a) (since everyone
receiving same “slice of pie”), and its preferred stock, and then sell and recover part
of the basis without being taxed initially (& at cap gains)
 If 306 did not apply, allocate basis between the two sets of shares, ratably,
based on the FMV of each share (if FMV of common is $4 and preferred is $1
then allocate 20/100 to preferred stock and 80/100 to common stock)- §
307
 Then sell the preferred stock for a capital gain (basis of old stock tacked on),
and so only pays $12 in tax (whereas if they had gotten the preferred as cash
distribution, would have paid ordinary income tax on the full amount of
distribution- no offset with basis)
Definition of § 306 stock 306(c)(1)(A)
o (1)Stock that was initially tax free under § 305(a)
o (2) Not common stock issued to common SHs [PREFERRED STOCK]
 Note: 306(c)(1)(B): stock other than common stock received tax free in a
reorganization if it was basically a stock dividend or in exchange for 306
(BUT WE AREN’T FOCUSING ON THIS)
 If new preferred shares replace previously owned preferred shares,
replacement isn’t 306 but if preferred shares are additional
preferred interest 306
 Section 306(c)(1)(B) of the Code provides, in part, that ‘section 306 stock’ is
stock which is not common stock and (1) which was received by the
shareholder selling or otherwise disposing of such stock, in pursuance of a
plan of reorganization (within the meaning of section 368(a)), and (ii) with
respect to the receipt of which gain or loss to the shareholder was to any
extent not recognized by reason of Part III, but only to the extent that either
the effect of the transaction was substantially the same as the receipt of a
stock dividend, or the stock was received in exchange for section 306 stock
Definition of PREFERRED STOCK for purposes of 306(c)(1)
o (1) IF THERE IS NO E&P AT THE TIME OF DISTRIBUTION- NOT 306 STOCK
(306(c)(2)). 306(c)(2) does NOT include distributions when the Corp does NOT
have E&P.
o (2) Rev. Rule 76-387: Nonvoting stock that participates in the residual (not limited or
preferred with respect to dividends or distributions in liquidation) is NOT preferred
stock:
 Preferred stock required attribute: no chance to participate in the upside of
the corporation
 If the only difference between the stock is voting rights, the lack of
voting rights is not determinative of preferred stock status
o A bailout occurs if the SHs can dispose of their stock in
question without a loss of voting control and interest in the
unrestricted equitable growth of the corporation
 The nonvoting common stock can be disposed of without a loss of
voting control in X, but it cannot be disposed of w/o the SH parting
with an interest in the unrestricted equitable growth therefore, it
is common stock (not 306 preferred)
(3) Rev. Rule 79-163
 Key aspect of preferred stock is a limit in what the SH can participate in- in
either dividends (sit 2) or other forms of value assets (i.e., upon liquidation
of corporation if 1 is limited)
 Determinative factors:
o (1) Whether the stock is redeemable by the corporation
o (2) Whether the stock represents an unrestricted
interest in the equity growth of corp
 I.e., entitles holder to unrestricted right to share both
in dividends and liquidation proceeds
o (4) Rev. Rul. 76-386
 Shs received new voting common in pursuance of a plan of reorganization
(recap under 368(a)(1)(E)), no gain/loss (under 354) and effect was
substantially the same as a stock dividend- so they decide whether it is
‘common stock’
 RR 57-132: new class of common stock issued in a reorganization
was redeemable at discretion of corp- so sale/disposition would
lessen the interest, a later redemption of that class would restore the
‘lost’ equitable interest of the disposing SH, achieving the bailout
 New Voting Common Stock is not redeemable, only subject to a corporate
right of first refusal that is exercisable only on an individual shareholder
basis is common stock for purposes of 306(c)(1)(B)
 If a SH wanted to dispose of some or all of the new voting common
stock, giving rise to corps right of first refusal the SH will necessarily
part with some or all of interest in growth of corp- this happens b/c
corp will exercise the option or it will not, and disposition will be
completed
o Cant be used to complete the preferred stock bailout
 Corp had right of first refusal to buy the stock at a certain value and
SH didn't have to give up interest
WHEN 306 stock is received, make sure to allocate the basis/spread the basis across the
FMV shares and the Preferred stock shares! ALWAYS, even if the 306 stock sale wont be
306 stock anymore (i.e., cashed out common first)
Tax Consequences of the Disposition of Preferred stock Operating Rules
o Disposition by Sale: 306(a)(1)
 (a)(1)(A) Amount realized= Ordinary income to the extent of pro rata
portion of issuing corp’s E&P at the time SH received §306 stock
 requires us to go back in time, figure out how much E&P would have
been entitled to, and use that figure
 Treat this Ordinary income to the extent it exceeds what would
have been a dividend at the time of distribution.
o


o (1) AR MINUS (i) Amount treated as Ordinary
Income AND (ii) SH’s adjusted basis in § 306 stock =
GAIN from sale of Stock (306(a)(1)(B))
o AR-OI (@ time of receipt)-AB= Gain

 No loss recognition on the sale of 306 stock (306(a)(1)(c))
Adjusted Basis in § 306 stock= § 307: allocate basis in the SH’s hands
between old and new stock (see below)
Character: 306(a)(D)- statute tells us to treat it as a dividend (even though
it is ordinary income) and treat it as the dividend rate in 1(h)(11)- 15%
dividend tax rate
Disposition by Sale Example:
 In ’97, A & J contribute $100 to T and receive 100 of common. In ’01, T
declares preferred stock dividend, with a value of $1/sh. Value of common
after dist $4/sh. ’01 T had AE&P $130 & CE&P $30. ’07, T AE&P at $280 and
CE&P $20
 Dec ’07, A sells preferred stock to M for $85 and in June ’08 sells
common to O for $500
o 1) Is this 306 Stock? At time of distribution, positive E&P so
she would have received dividend (306(c)(2)
o 2) §307(a)- allocate basis of old stock to new stock- (1/5
preferred; 4/5 common) Total FMV= $500.
 $100/$500; 100 basis * 1/5= $20 basis allocated to
preferred; $80 basis for CS
o 3) Sale: 306(a)(1)
 OI= Ratable share that would have been a dividend in
an amount that equals FMV…
 In ’01, $30 current E&P, $130 AE&P = $160
 Amt of Dist= $200 ($1 per share, 100 shares
belong to A and 100 to J)
 Ratable Shares= would have been $80 dist to
each sh (each owns half)
 Taxed as Ordinary Income at current rate306(a)(D)- treat income as dividend taxed at
rate in 1(h)(11)
 AR= $85-80-20=-$15
 NO LOSS RECOGNITION- 306(a)(1)(C)
o But, preservation of loss by tacking on
the loss to the basis in the common
stock- 1.306-1(b)(2), ex. 2
o (regs state as: amount received-OI, and
then reduce the basis by that amount
and tack it onto common…)
 If gain, recognize; if loss, tack onto common
o 4) Sale of stock in June for $500
 Basis = $95; AR= $500
 $405 gain @ capital gains rate
 Tax Consequences to Distributing Corp: None
 When SH sells to a 3rd party, NOTHING happens to the distributing
corporation b/c no change in their cash on hand (1.306-1(b)(1))
 Not a Disposition of 306 Stock:
 (1) If the order of the transactions are switched: SH sells all of the
common stock prior to selling the 306 preferred stock, then 306 no
longer applies
o Why? She is no longer maintaining control & bailing out at
capital gains rate- by selling all common before preferred,
she is relinquishing control

o
Granted, with equal rates for dividends and for capital
gains the tax ends up being the same
 (2) If there was NO E&P in the distributing year, then the preferred
stock is NOT 306 stock
o Thus: if Sale to 3rd party, normal sale
o Thus: if Redemption by Corporation, then 302 redemption
(go through tests)
 But must be 0 E&P- even if 1 penny at time of
distribution, then preferred is 306 stock, and if Corp
redeems, then must treat as 301 distribution using
the E&P at time of redemption
Disposition by Redemption: 306(a)(2) ** Problem #3 Unit IVB **
 (2)(A): Treat as distribution to which § 301 applies
 AR= § 301 distribution, using all available E&P from time of
redemption (rather than ratable share)
o Difference: the issuing corporation is the one who is paying
the cash for the stock (rather than 3rd party), so use different
timing of OI/E&P.
 Disposition by Redemption
 Same facts as above but Corp Redeems for $85
 1) Calculate amount of distribution that is a dividend by looking first
to CE&P, then Accumulated E&P (in 2007)
o Note, difference from above where we totaled the E&P
 2) Current E&P= $20, AE&P= $280 so there is enough E&P to cover
the entire $85 distribution
o Now, $85 is income taxed at dividend rate *15%
 3) BASIS
o No basis recovery in 306 transactions (1.306-1(b)), but the
amount of her basis that was portioned off to the 306 stock is
tacked onto the basis on the common stock- 1.302-2(c) ($20
of basis in preferred stock bumps common stock basis up to
$100
 Tax Consequences to Redeeming Corporation
o Reduce Current E&P to extent thereof

o
306(b) – Use if 306(a) does NOT apply! ** These notes were NOT in this outline **
1 – 306(b)(1): Disposition totally terminates SH’s Interest
2- 306(b)(2): Disposition is in complete liquidation of Corp
3- 306(b)(3): Disposition is a non-recognition transaction
4- 306(b)(4): Disposition is Not a principal purpose of tax avoidance.
UNIT V- Liquidations
Liquidation: Business ceases, corp may stay in existence, winding up & paying bills (but might not
happen immediately)
 Purchaser wants to buy another Corporation: Three Sale Possibilities
Sale Followed by Liquidation
Liquidation followed by Sale (in-kind liquidation)
Sale of stock
 Sale of stock gives rise to difference in inside (in corp’s assets) and outside
(in corpo’s stock) basis resolved w/ 338 (next unit)
Complete Liquidation 346(a):
o For purposes of this subchapter a distribution is treated as in complete liquidation if
the distribution is one of a series of distributions in redemption of all of the stock of
the corporation pursuant to a plan
 SH is seen as selling their stock back to the corporation in return for
corporate assets (in kind distribution) or cash
 Corporation is seen as selling its assets to the SHs
Analyze liquidating corp first…
Tax treatment to SHs in complete liquidation (331)
 Before doing this, check if anyone (corporation has 80% power, then
liquidation of a subsidiary (337)
o 331: Gain or loss to SHAREHOLDERS in corporate liquidations
 331(a): Amounts received by SH in complete liquidation of a corporation
shall be treated as in full payment in exchange for the stock
 SHAREHOLDER CAN RECOGNIZE GAIN OR LOSS (no restrictions for
complete liquidations at SH level)
 #1- Amount realized for in-kind distribution
o FMV- liabilities
 If in kind, then SH has to assume liability (both
mortgage & tax liability)
 Rev Rule 59-228- Sh’s amount realized
reduced by liabilities in complete liquidation
 SH inherits tax liability from corp- §6901transferee liability
 THUS: REMEMBER TO REDUCE BY TAX
LIABILITY THAT WILL BE INCURRED AT
THE CORPORATE LEVEL AS WELL
 Liabilities includes not only mortgage but tax
liability.
o When we think about tax liability, the
AR-AB is always going to be the FMVAB (even tho no one would pay FMV
for the property b/c it has a liability
attached).
o Alternatively, you could write it as
(FMV-mortgage)+DR (debt relief)AB=Gain.
 Note: if the SH receives property in kind, we
need to take into account that the corp
disappears
 #2- Amount realized for sale of assets followed by cash proceeds
o AR= (FMV – liabilities) – tax liability paid
 Tax Liability= AR-AB * 35%
o
o
o



This step is necessary to compute how much cash is
available to distribute to the SH after the corporate
level tax is recognized **
o Amount recognized= AR- AB
 E&P is not relevant for determining gain/loss
 (b) Non-application of 301 (331(b) turns off 301): Section 301 shall not
apply to any distribution of property (other than a distribution referred to
in (2)(B) of 316(b)) in complete liquidation.
 Relating to effects on SH of distribution of property
o 334 (a): Basis in received property= FMV at time of distribution (NOT REDUCED
BY LIABILITIES OR ANYTHING ELSE)
 If in kind distribution, the basis is FMV of property (since receipt of
property was taxable event- cost basis)
 Effect: If in kind distribution & SH sells property:
o No gain/loss on sale b/c SH’s basis = FMV and AR= 60
building+ Debt relief 40= 100-100=0
o ** See Problem 1b, Unit VA **
Tax treatment to Corporation in Complete Liquidation (336)
o (a) Gain/loss recognized by the liquidating corporation on the distribution of
property in complete liquidation as if sold to distribute at FMV
 Note: under old General Utilities rule, corporations did not recognize gain
or loss upon liquidating distributions (in kind, but rules also equalized sale
of assets then distribution)
 Parallel to 311 (non-liquidating distribution)
 Allowed to recognize loss b/c presumably not picking to retain
gain property & recognize losses
o (b): Liabilities: Amount realized must include full liability, even if liability exceeds
FMV (Crane)
 Amount realized cannot be less than liability FMV of prop = amt of
liability if liability > FMV
 (1) if D holds building worth $60 subject to $40 mortgage, then AR =
$100 (re: Crane)
 (2) if D holds building worth $30 subject to $40 mortgage, AR= $40
(re: Tufts)
 Note: Loss CAN be recognized, subject to limits
o 336(d) limits losses that a corporation can recognize
o ** These are the exception to § 336 **
o 336(d)(1)(a) Can’t recognize loss if distribution is to a related person…
 “Related person” -- Can’t recognize loss!
 Related if directly/indirectly owns more than 50% of the
outstanding stock (controlling SH) or a member of the same
controlled group (267)
o If one SH needs loss b/c they have gain from another
transaction, they want to recognize loss, the corp wont be able
to recognize that loss
o Gets at: disproportionate distributions of loss property to
related SHs, corp might choose to make a dist to related to get
a double loss, and leave others w/ none


o
o
o
o
o
If distribution is (i) non-pro rata or (ii) of disqualified property (prop
received in a 351 contribution or a contribution to capital during the 5 years
prior to liquidating distribution) no loss
 Gets at: disallowing loss where corp distributes back out to related SHs prop
recently contributed in nontaxable 351 transaction  built in loss
 Note: 362(e)(2) does not allow the corp to take the SH’s basis of BIL
property- harsher result than anti stuffing under (d)(2)
 It also disallows loss on 351 even if it was NOT a built in loss
property – if both (d)(1)(A)(ii) and (d)(2) apply- apply harsher rule
336(d)(2) Anti Stuffing Rule: Property acquired in a 351 transaction/contribution
to capital (gets at double loss concern). There is no related party requirement here!
It is simply about § 351 distributions.
 2 requirements:
 (1) Property acquired in a 351 transaction/contribution to capital
 (2) Acquisition is part of a plan to recognize loss
o Presumption: if it was contributed within 2 year before
liquidation, it was part of a plan
If it applies:
Can recognize SOME loss adjusts basis of distributed property (allows only
built in loss at time of contribution)
 1) Reduce basis back to FMV at the time the corporation acquired it
 Do this if they got the property in 351 and (2) if property was
contributed as a plan for the corp to recognize a loss
 If property worth 10 today, basis of 100, and lets say corp got the
prop in a 351 transaction & when it got the prop the FMV was 10
o RESULT: Reduce the basis to what the FMV was at the time
they got it- 10, for purposes of determining the loss
 So only the SH will recognize the loss on the
property here, not the corporation
 Note: doesn't 362(e)(2) disallow this tho?
There is overlap between the related party rule and anti-stuffing rule: If the
liquidation would fall within (d)(1) or (d)(2), the harsher rule, (d)(1) will apply
UNIT VB- PARENT SUBSIDIARY LIQUIDATIONS
Liquidation of subsidiary corporation not taxable to either the liquidating subsidiary or to its SH
parent corp (note difference between 331/336 and 332/337)
 Rationale: a distribution in liquidation does not cause assets to leave the larger corporate
family, so no immediate tax (deferral of gain/loss)
 Requirements: 332(b)
o (I): Corporation must own at least 80% of vote and value on the date of adoption of
the plan
 1504(a)(2): 80% of the total voting power of the stock & total value of the
stock
 Note distinction between 1504 & 338
o (II)and has continuously, held that amount until the liquidation is completed
 good requirement for tax planning- if we want to tax recognition, purposefully
break continuity
(III)- Timing- 332(b)(2): distribution must take place within the taxable year the
plan is adopted OR (b)(3): within 3 years from CLOSE of taxable year when first
distribution is made
 (III-I)- must be in COMPLETE CANCELLATION or REDEMPTION of the
liquidating corp’s stock
 DATE OF ADOPTION:
 Riggs:
332(b) is effectively elective:
o The 80% control test makes 332(b) effectively elective
 Ownership Example: if parent disposes of enough stock to reduce ownership
below 80% (after liquidation declared) then fails control test and liquidation
not covered by 332
 Significant question was wither or not the transactions were true
sales (does not matter that tax avoidance prompted the sales- in this
section)
 Granite- Court validates selling off 21% after adopting plan
 Riggs- with advance planning & properly structured transaction, a
corp can effectively elect 332 (TP wanted liquidation treatment,
issue was when the liquidation started b/c needed right amount of
ownership)
o Mere intent by a TP corp to liquidate a sub prior to meeting
the 80% requirement of 332 is not the same as the adoption of
a plan of liquidation
o Continuity also makes effectively elective
 Sub can sell property to 3rd party directly, adopt plan of liquidation but take
5 years… or
 Sub merged into another corp, who gets sub’s stock and assets, sell to and
then sell directly back to parent (breaks holding period)
 BUT see Associated Wholesale Grocers: merger of sub with a new
corporation (after the adoption of a liquidation plan- which is called merger
agreement but really liquidation), and parent buys back assets immediately,
 =
 1.332-2(b)- applies only to cases in which recipient corp receives at least
partial payment for the stock in which it owns in the liquidating corporation
 If sub is indebted to parent at time of liquidation, payments in satisfaction of
indebtedness taxable to parent desire nonrecognition (creditor payment) –
1.332-7 (not assigned)
Tax Consequences to the Parent Corporation: 332 (a)
o 332(a): no gain or loss recognized by parent corporation
o 334(b): basis of distributed property now in hands of parent’s hands is same as in
hands of transferor- transferred basis (in kind distribution)
 This defers the gain on the transfer/sale
 Exception: 334(b)(1): If gain or loss is recognized by the sub on the
distribution of property in liquidation, the P’s basis will be FMV
 Rationale: since sub has already reported gain/loss, no need to
preserve for parent
o 381(a)&(c): tax attributes (NOL, E&P, Cap loss carryover, etc) are transferred from
the subsidiary to parent as of the close of the day of the distribution
o





pretend that subsidiary gets consumed by the parent and no on pays
tax, the attributes are transferred up
 1.381(c)(2)-1(c)(2): If parent owns less than 100% of sub’s stock, the
inherited E&P shall be computed by taking into account the amount of E&P
properly applicable to the distributions to minority SHs parent only
inherits portion of E&P
 HMMM- Note: all tax attributes go to the parent b/c it is complete
liquidation (this makes more sense… maybe this just relates to E&P)
o Parent’s basis in the subsidiary’s stock disappears, subsidiary no longer exists after
the transaction
 Note: congressional choice to preserve the “inside” basis (basis in assets)
and get rid of outside basis (P’s basis in the sub’s stock)
 Ex: P corp has basis of $120K in stock, FMV of assets is $100K, and
basis in assets is $25K, P has a $20K loss (stock for assets), but loss
not recognized and takes $25K basis in assets (only the $75K gain
preserved). (And, if the basis had been $10K, there would have been a
$90K gain but also not preserved).
Tax Consequences to Minority Shareholders (of the parent corp) (1-20% SHs): §331
o Either corps or individuals, will recognize gain/loss under §331 and take a FMV
basis in the assets under § 334(a)
 If there is a distribution to a minority SH, then the distributing corp also
recognizes gain on the piece distributed to the minority SH
 Even if there is a Minority SH involved, the tax attributes will all still be
inherit by the 80% owner
Tax Consequences to Liquidating (distributing) Subsidiary: § 337
o On the distribution to Parent:
 § 337(a): No gain or loss recognized to the liquidating corp on distribution
to the 80% distribute of any property in complete liquidation to which 332
applies.
 Note: the exception to the repeal of general utilities
 337(c): “80 % distribute” includes only the corporation meeting the
stock ownership requirements of 332(b) and the determination shall
be made w/o regard to any consolidated return regulation.
 337(b)(1): any transfer of property to the parent in satisfaction of
indebtedness shall be treated as a distribution (sub does not recognize gain
or loss)
 334(b)- parent takes a transferred basis in these and any other
assets
 But- if sub sells of assets for cash, it will be subject to tax on the cash sale, even
if the cash is shortly distributed to parent corp in liquidation thereafter- this
happens because we only preserve gain/loss b/c there is a transfer of
assets- if no transferred basis to attach to, no preservation
o On distribution to minority SH:
 Governed by 336- gain or loss recognized except to the extent provided in
337 (but 337 only limits to 80% distributee- so minority SHs recognize gain
on any in kind assets)
 BUT 336(d)(3): no loss recognition for liquidating sub (BUT still

In the case of any liquidation to which 332 applies, no loss
recognized to liquidating corp on ANY DISTRIBUTION in the
liquidation (no loss recognition to distribution to parent either)
o Concern: distribute gain assets to parent (non recognition
under 337) and distribute loss assets to minority SH (general
recognition under 336)
UNIT VC- TAXABLE MERGER & ACQUISITIONS 338 ELECTION!!!





§338 election to qualified purchasing corporation to treat certain stock acquisitions as asset
acquisitions
Advantages of stock purchase
o For the selling corp- get rid of a subsidiary
o Goodwill comes with stock- depreciation deductions
o Only immediate recognition of gain/loss by SHs (vs. asset acquisition recognize
double gain or loss immediately)
o Whether corp will choose asset purchase depends on extent to which they are
depreciable or would benefit from cost basis.
Disadvantages of stock purchase
o Basis is lower for the assets (worse for depreciation deductions)
o Unfair- Paying a higher amount for stock, and not receiving cost basis in assets
(problem of inside/outside basis difference)
o If they want to sell the asset, recognize gain (again)
o Acquiring corp has to absorb tax liabilities of the target
 To counter act the liabilities problem, the acquiring corp will want to pay
less than FMV for the stock to take into account not only the mortgage but
the future tax liability on the asset as well
 Yet, doesn't necessarily ensure equivalent bases (in the inside and
outside stock). This matters for depreciation deductions.
 Additionally, selling corp will argue that when acquiring corp sells
the building, the building will have gone down in value and they will
not incur as large a tax liability as acquiring corp wants to account
for
o For tax purposes, a stock acquisition is much more complicated than asset
3 types of TAXABLE acquisitions for control
o Asset acquisition see 331/336 for tax consequences (unless liquidation is to
parent corp, then 332/337)
 For cash/notes: Target SHs taxable on sale of stock under §§61(a)(3) &
1001.
o Stock acquisition w/ 338 election
o Stock acquisition w/o 338 election
§ 338 (g) ELECTION:
o Historic background: Kimbell- Diamond Milling v. Comm’r:
o KD structured a stock acquisition of another corporation in order to get at the asset.
Established a subjective intent test and said that since they intended an asset
acquisition, KD had to take a cost basis (they wanted transferred basis)

338(a): Certain stock purchases treated as asset acquisitions (treat stock purchase as an
asset purchase)
o Stock acquisition maybe treated as an asset acquisition pursuant to a § 338
election (explicitly elective)
 Election triggers a deemed sale by T of all its assets at the close of acquisition
date
o Requirements:
 1) QSP (qualified stock purchase): 338(d)(3); 338(h)(1)
 Must acquire 80% control (1504(a)(2)) in one 12 month period
(80% total voting power and at least 80% of total value of stock of T)
 Purchase: must be a cash purchase- 338(h)(3)
o 351 stock does not count or acquisitions of control through a
tax free organization
o stock in which purchasing corp takes a transferred or
substituted basis from transferor or a 1014 basis is not
acquired by purchase
o Acquired stock that would have been attributed to P anyway
doesn't count
Ex: Oct 2010: 5%; Jan 2011: 40%; Apr 2011: 25%; June 1011: 5%; Dec 2011: 10%. When would you
start counting to get to 80%? Well, it would NOT be Oct 2010 because you wouldn’t hit 80% in 12
months. Thus, you would start counting at Jan 2011, because then you would get 80% in the 12
months period. This is a QSP!
 338 only applies to taxable acquisitions
o Why? b/c ordinary stock acquisition, SHs report gain or loss
on sale of stock and SH takes tock w/ cost basis, now
congress permits elective cost basis in the assets upon
transfer of control that was taxable to selling SHs.
 2) 12 month period
 Starts at the date of the first acquisition that contributes to the total
80% in the 12 month period (so if they made an acquisition prior to
the 12 month period in which they acquired 80%, then still ok)
 3) Corporate purchaser
 4) Timely election- w/in 8.5 months after the QSP, under 338(g)
 Corporate purchaser (i.e., the buyer) makes the election- (g) (note
difference between this and 338(h)(10)- joint election).
 What happens if the buyer says, “ we made a mistake – we
should not have made the election”? You are stuck!
 Steps in 338(g) situation:
o Step 1: 338(a)
 Corporation purchases stock for cash (satisfy QSP rules – see above rules)
 Tax consequences to selling SH (one who is selling to purchaser): sale
of stock for cash, recognize gain/loss (simple § 1001 transaction).
o Step 2: ONLY if election is made 338(a)
 Purchasing Corp (P1) now OWNS target corp (T) (important)
 T is treated as having sold all of its assets at the close of the acquisition
date (338(a)) to an unrelated 3rd party for the FMV of the asset.
 Close of Acquisition date matters b/c P1 owns T as opposed to the
corporate seller (CS)
o
o
o

T recognizes gain/loss on the “sale” of the asset at the
corporate level. Huge step.
 Note: T cannot use gains or losses of other members
of a consolidated group to offset any of its
gains/losses resulting from the deemed asset sale
 T is also treated as NOT a member of ANY affiliated
groups involved in the transaction 338(h)(9)- only
applies to 338(g) transaction
338(b)- special rule for finding “sale price.” For our
purposes, sale price = FMV (which takes into account any
liabilities attached)
 Even if doesn't purchase all stock, the old target
recognizes full gain or loss on the deemed asset sale,
reflected in the basis of target assets.
 This happens at the close of the acquisition date,
which means the target is owned by the buyer!
Step 3: 338(a)
 The next day, T is treated as new corp which purchases all assets back in
step 2
 T takes new basis (cost basis, which is FMV) in the asset
o Thus, the only party that pays taxes on the assets is the T
corp, but at the time of the tax, T is owned by P1 (i.e., buyer).
P1 gets stepped up basis and recognize tax immediately.
o This is a problem for P1 because P1 now owns the target and
o that target is paying a tax. P1 thus is effectively on the hook
for this tax liability.
o No effect on CS, the original SH.
o Pros: P1 gets the higher, cost basis. Cons: They are stuck
paying the tax liability for the gain/loss sale.
 When P1 buys T in the taxable transaction and makes the election, the old
attributes DISAPPEAR (E&P, loss carry overs)
 Since it is a new corp, it has lost tax attributes, and unrelated to old target
 But new target is stil liable for old T’s fed income tax liabl- 1.3381(b)(3)(i), (ii)
Why make a 338 (g) election?
o
o
o
If T has substantial capital losses, T can use the losses to help offset the gain T has to
recognize on the sale
 BUT NOTE: P1 cannot use T’s losses to offset its own gains (b/c T’s tax
attributes will disappear)
 P1 cannot use its own NOL to offset gain of T
If T is non-US T, then T will not recognize gain on the capital gain under
international tax rules
 Basically, if there is a way to avoid tax at the T level, then make the election.
If T’s assets are depreciable or include unimproved property that P plans to
sell reasonably quickly, a step-up basis may be attractive to P
 The taxable gain from the deemed sale by T must be weighed against the
value of the basis step up. (i.e., PV of additional depreciation allowances
provided by the higher basis exceeds current tax cost of taxable gain to
target- then elect- but this is rare.)

Typical stock sale
 Selling Shs transfer some or all of T stock to purchasing corp P, or a P sub, in
exchange for cash or notes.
 If P purchases a controlling interest, P becomes a parent.
o T may be retained as a distinct entity
o T may retain its liabilities
 OR
o T liquidated (upstream merger), and P becomes responsible
for T’s liabilities
 Summary of Effect: target corp recognizes gain or loss on either the actual or
deemed sale of its assets and target SHs recognize capital gain or loss on
either the sale of target stock to purchasing corp or the receipt of
distributions in liquidation of the target
SPECIAL §338(h)(10) ELECTION: affiliated corporations
o When a target is a wholly owned sub of a corporate seller (CS), and P makes cash
purchase of T’s stock… CS shs report gain or loss under 301 or 331 when cash received
from P is in the form of a dividend or liquidating distribution. And if P makes election,
T reports gain or loss on the deemed sale.
 T concerned about multiple taxes on old T (gain/loss), CS (gain/loss), and CS
shs (gain/loss on dividend or liquidating distribution from P).
o Requirements of § 338(h)(10):
 1) Target must be a member of the selling consolidated group
 Result: treat parent and sub as one entity for tax purposes, must
elect to consolidate and meet 1504
o **He will say if consolidated, or say ASSUME consol.
 1.338(h)(10)- 1(c)(1)- don't necessarily have to file consolidated
returns together
 2) Election must be made by BOTH PARTIES
 3) 80% qualified stock purchase
o Tax consequences to target: Steps in 338(h)(10) election:
 1) P buys T stock for cash from a consolidated group
 2) Deemed transaction: T is treated as having sold all of its assets at the
close of the acquisition date, but while T is still a member of the CS group
(crucial difference in the fiction- sale happens when part of original group).
 Old T disappears by being liquidated up to seller*
 Cash that CS gets from the sale and subsequent liquidation is tax
free b/c it is a complete liquidation (332/337)
 Accordingly, tax attributes of T are absorbed by CS
o ** difference between 338(g) and (h)(1)- CS can use its own
losses to offset gains recognized on the sale
 3) New T is formed as part of P, and they purchase the asset back for cash
(target repurchases its assets) when it is owned by Buyer/purchase.
o Tax Consequences to CS (parent, not the T that is being acquired):
 1) No recognition of gain or loss on stock sale of T to P (338(h)(10)(a)(ii)
flush languageo

“Generally, a 338(g) election is only advantageous when the target has
substantial net operating loss (NOL) or tax credit carryovers that
the acquirer can use to offset any taxable gain triggered by the deemed
asset sale. These tax attributes are available only for immediate use and do
not survive the acquisition if the target is liquidated.”



“…the target corp…treated as member of selling consolidated group
(CS) w/ respect to step 2, and no gain/loss recognized on stock sold
or exchanged by members of selling consolidated group (CS)”
 2) Gain/loss recognized on (fictional) sale of assets for $ (step 2)
 CS inherits the recognized gain because while the gain occurs at the
T level, the old T disappears/liquidates
o Since liquidated, CS can use any of its own NOL to offset gain
of T, and T has a loss, it can use that to offset any of its own
gains
o Tax Consequences to P (corporate purchaser)
 3) T’s assets take FMV value basis (stepped up basis) on the repurchase
(and new T formation under P)
 4) P takes a cost basis in T stock (re: step one, no gain or loss recognized on
stock sold or exchanged)  §1012 cost basis in prop
338 (g) vs. 338 (h)(10)o (g)- P buys T stock for cash, make election (at right time), P owns T, T has gain that
cant be offset anywhere else in the group, Next day T buys asset back for cash and
takes cost basis
o (h)(10): Joint election & consolidated group. Ignore stock sale for purposes of CS,
almost like the initial sale is a sale of assets. While seller owns T, T sells assets for
cash, recognizes gain, liquidates and all attributes passed up to CS, and can use the
gain to offset its own losses. P takes a cost basis.
 1) Gain Triggered
 2) 338(g)- T & P pay tax on gain
 3) 338(h)(10)- CS pays tax on gain (when still owned of T)
Problem Set, Unit VC, 5(c)
o If, absent the 338(h)(10) election, the CS could not convince P to pay more than $35.50
for T, CS would likely join a 338(h)(10) election provided P pays $60 for stock.
 If $60 paid w/ election, CS will inherit the $24.50 tax liability, but they also
receive $60 from P, 60-24.50= $35.50
 If $35.50 paid w/o election, CS has to recognize gain of $8.92 (35.50-10
(AB)= 25.50*35%), and the lower price means that CS is effectively bearing
T’s tax liability on the building
§336(e) basically gives you an 338(h)(10) election: If P owns at least 80% of voting value
of T, and sells T stock, an election may be made to treat the sale as disposition of all of T’s
assets, and no gain recognized on selling of T stock
o P’s g/l on sale of stock is ignored. G/l is determined solely by reference to
the g/l that the subsidiary would have recognized on a direct sale of its assets
for the amount paid for sold stock
o Subsidiary receives stepped-up basis in its assets
****336(e) is for individuals – NOT TESTED! *****
UNIT VIA- INCORPORATIONS: § 351
Tax consequences to Shareholders:

General Rule: No gain/loss to SHs for contribution of property in incorporation
transaction if 4 requirements are satisfied:
o 1) Must contribute property
 (i) Cash (69-357) and Real OR intangible property
 This can include transferor corp’s own stock, equipment
o Note: 317 property doesn't apply for this section
o

Rev Rul 69-357- American Bantum
o Cash is property for purposes of a 351 transaction
 Accounts receivable (trade receivables/debt owed by
customer) are property Hempt Bros. v. US
o Court says § 351 overrides the assignment of income
rule b/c policy of incorporation of new businesses is
important
o BUT: Accounts Receivable will place Corp with a $0
basis in the account and will give SH a $0 basis in the
stock
 Potential advantage for SH: changing the nature
of ordinary income to capital gain (this is
allowed)
 Debt obligations are considered property as long as they are
evidenced by a security (351(d)(2))- If indebtedness not
evidenced by security, not property
o Not property- Interest on indebtedness of transferee
corp which accrued on or after the date of the
transferor’s holding period for debt- 351(d)(3)
(ii) Services are NOT property (payments for services are taxed to SH
at ordinary income rate) (351(d)(1))
 One individual contributing services will kill 351 treatment for
the entire group
o Contributor will be treated as if getting $25 of stock for
services, Corp treated as purchasing assets for FMV, and
might have business deduction/bus expense for
services received.
 If SH contributes services & cash  non recognition only
applies to cash
o SH recognizes amount received for services as ordinary
income (he gets basis credit for this amount)
o SH will take basis in stock of FMV of services+ cash
 If SH contributes a little bit of services along with property, will
not ruin non-recognition unless primary purpose is to qualify for
351 nonrecognition  1.351-1(a)(1)(ii) (if prop transferred is
relatively small value compared to services)
o Rev. Procedures 77-37: property transferred must be at
least 10% of the vale of the stock received for service
o 1.351-1(a)(2), ex. 3- all of the stock received counts for
control requirement, not just the ones received in
exchange for cash
 (iii) Disproportionate contributions: ok under 1.351-1(b)(1)
 I.e., if both receive 50% of the corporation, but on SH
contributes 90% of the property and one only contributes 10%
of property to Corp.
o If mother/daughter, then might be viewed as a gift
 (iv) Contribution of built in loss property will make the
Corporation take a FMV basis rather than a transferred basis
(362(e))
o 2) By one or more persons
 1.351-1(a)(2)- Analyze contributors collectively as one person to see if
they have control immediately after the exchange (go to 4)
o 3) Solely for stock
 A little boot (property other than stock) is allowed but SH WILL be
taxed on the boot (351(b))
 Gain will be recognized on that boot
o But gain only recognized up to value of the boot
o Gain is computed an on asset-by-asset exchange/
Portion of boot received must be allocated to each asset
based upon FMV of asset (I guess if they are
contributing more than one property)
 Loss will NOT be recognized
 SH’s basis in property received is the same as the property
contributedsubstituted basis (358)
 DOES NOT COUNT AS STOCK (i.e. boot)
 Stock rights or stock warrants
 Notes/securities are boot
 Non-qualified preferred stock
o Defined as stock that is limited and preferred as to
dividends and doesn't participate in corp growth to any
significant extent
o Preferred stock is non qualified if: (351(g))
 SH has right to require corp redeem shs
 Redemption is mandatory
 Corp has right to redeem shs and is more
likely than not that they will
 COUNTS AS STOCK
 A K right to receive additional shs of stock upon corp achieving
a specified net earnings goal
 Sometimes long term corp security reclassified as equity
o 4) Contributors control the corp immediately after the exchange
 368(c)- Control defined- Ownership of 80% of total combined voting
power and 80% total number of shares of all other classes of stock 
must have 80% of EACH CLASS of shares outstanding (i.e., including
80% of non voting stock issued)
 Purposefully bust the transaction by issuing 1 share to 1 SH who
is separate from the control group. If the control group cannot
acquire that share, then cannot acquire control (b/c they do not
have 80% of that class).
** 318 attribution rules are NOT turned on !!! Thus, we do not care about the relations. **
Control can be momentary (when?) – 1.351-1(a)(1)
BUT: Preexisting commitment to sell to someone else violates
control (also noted in regs)
 Judge may use a step transaction doctrine to put these two
together, which will ruin the 351
o Binding commitment test- If there is a signed
contribution agreement where one of the SHs will
immediately dispose of the shares, then binding
commitment/step transaction doctrine will apply and
bust the 351
 To fix this, we could switch the order of the
transaction, so the individual transfers property
to the end recipient before the 351
contribution/receipt of stock
o Momentary interdependence works too- the agreement
would not have taken place unless that step was
included
 §351 applies to allow non-recognition when transferor gifts the stock,
regardless of time span, b/c transferor not legally bound to make the
gift
 Transferor corp can transfer shares received to its SHs and it wont
ruin 351 control (351(c))
Shareholder Basis in new stock
 Always start out by figuring out what is the amount realized (the amount not being
taxed), and what is the realized gain.


Amount realized= amount received in transaction
Realized gain= AR-AB
 Then, we figure out how much of the realized gain must be recognized
BASIS IN NEW STOCK: 358(a)(1)(2) & (d)= SH Basis in stock = basis in old property –
FMV of boot received + gain recognized – liabilities assumed by corp (d).
BASIS IN Boot RECEIVED: 358(a)(2): basis of other property received (boot)= FMV
o
o



If SH receives stock & boot, triggering recognition issues, the SH might recognize
gain on appreciated property, but losses on depreciated property are NOT
recognized – 351(b)(2)
o Boot characterization: based on character of the asset contributed- if cashing
out part of asset: capital gain § 1223
 So if SH contributed AR, then the boot might be OI instead of a capital
gain.


358(b)- Basis determination under 358(a) is allocated among properties permitted to be
received w/o recognition of gain/loss
Basis Rules:
o Preserve the gain recognition by reducing the basis
Corporation’s Basis in Property Received


362(a)- Basis is same as it would be in the hands of the transferor + gain recognized
by transferor (think about if boot issue)
362(e)- if SH contributes loss property (built in loss), then the basis of the corp
should be FMV.
o Limits double loss recognition
Contributions with Liabilities §357
 1) Assumption of liability is not boot and doesn’t prevent 351 exchange- 357(a)
o i.e., if property assumed w/ mortgage attached, wont ruin the exchange
o BUT, 358(d), considered boot (money received) for computing stock basis
 Reduce basis by the liability


358(a) & (d)= Basis in stock = basis in old property – FMV of boot
received – amount of loss recognized + gain recognized -liabilities
assumed (d).
2) Two Exceptions to 357- 357(b)&(c)
o 357(b) i) Was the principal purpose of the taxpayer to avoid tax on the
exchange through assumption of liability? (Tax Avoidance)
 The assumption of liability is boot (money received) if the TP’s
principal purpose was avoidance of federal income taxes or not bona
fide bus purp (transforming liability into boot)
 Consider: Nature of liability & circumstances in the light of the
arrangement:
o EXAMPLE: Plan, Timing, purposes of borrowing
o I.e., personal obligations cant be transferred to corp (by
borrowing against property and then transferring
encumbered asset to corp)
 Improper purpose ALL liabilities=boot- 1.357-1(c)
o 357(c) ii) Negative Basis: Do liabilities exceed the basis?
 If they do, the excess of sum of liabilities over total basis is treated as
gain from sale of a cap asset (does not create boot, just makes you
recognize gain)
 I.e., if mortgage =$20 and basis is $10, then $10 gain realized
o IF 357(c) APPLIES THEN THE BASIS WILL ALWAYS BE
0.
o 10 (basis)- FMV of prop received= 0 + 10 (357(c) gain)
– 20 (liabilities assumed)= 0
o iii) If there was a tax avoidance purpose AND the liabilities exceeds the basis,
then 357(b) applies (b/c harsher results)


3) Exception to 357(c) 357(c)(3), any liabilities that would have given rise to a
deduction if paid directly by TP are excluded from 357(c) (gain recognition rule).
Essentially, 357(c) is turned off.
o Wont be considered liabilities for basis purposesaccts payable
 Ex: Employer owes employee money for services (normally deductible as
-O&N BE), and employer also owns a cart, with a FMV of $40 and basis
of $20. Employer incorporates and contributes the liability to employee
& the cart.
 Basis= $20- 0+0-0 (b/c not treated as money received)
 Congress did this because we want people to incorporate even
if they contribute assets that are subject to liabilities.
4) CONTINGENT LIABILITY TAX SHELTER (Black & Decker)
o Contingent liabilities- Accrual basis TP can have contingent liabilities that do
not necessarily give rise to a deduction nor created a basis.
 Service- doesn't count for considering whether liabilities exceeds
basis b/c no deduction had been taken nor resulted in creation of
basis but the fact that it would give rise to a deduction, said it
counted (95-74)
 The Abuse: Black and decker Idea: 351 contribution of cash along with substantial
contingent liabilities to create high basis, low value stock,
which the corp could sell at a substantial tax loss
o B&D transferred $561 M in cash plus $560 in contingent employee health
claims for all of the stock of a newly formed sub 351.
 First, claimed that 357(c)(3) applied, and that b/c these liabilities
would give rise to a deduction.
 AND claimed that under 358(d)(2), that it was not required to reduce
its basis in the stock by the amount of liabilities (because it fell under
the 357(c)(3) exception)
o RESPONSE: § 358(h) governing liabilities transfer to a corporation when
the transferring SH is not required to reduce basis in the stock received
under 358(d)(1) (Effects a statutory override to 358(d)(1))
 358(h)- if, basis of the property (stock) exceeds the FMV of the
property (stock), then the basis reduced by the amount of any liability
assumed BUT NOT BELOW FMV, and (d)(1) doesn't apply (fixed or
contingent obligation to make payment w/o regard to whether the
obligation is otherwise taken into account for purposes of this title358(h)(3)), but not below FMV [of the property]
 As applied to B&D: Basis in sub stock = $1M, no loss
 (i.e., contributing cash (property) and the liability, but the liability
wont reduce basis, so the basis would be artificially huge, but the
FMV of the property still very small b/c the corporation only has
cash + big liability).
 “Liability” = Fixed OR contingent
Key differences between taxable acquisition and non taxable reorg
 1) seller recognizes gain/loss in taxable acquisition but eligible for non recognition in tax
free
 2) Purchasing corp in acquisition entitled to 1012 cost basis in assets. In tax free,
transferred basis (not cost basis)
 3) In taxable stock acquisition, P entitled to cost basis in T shares purchased, in tax free,
takes stock with same basis as in SHs hands (historic basis).
REORGANIZATIONS: § 368
Initial Question: Tax Free Acquisition vs. Taxable Acquisition of control:
 Main issue: Consideration used by the purchasing corp
o Tax free: seller receives compensation in the form of stock of the acquiring corp—
(the “issuing corp”)— or an acquiring corporation affiliate – retains a proprietary
interest in the reorganized or restructured corporate enterprise
 Mere change in form- not cashing out their investment (Marr)
 Hardship imposed upon those who have to pay tax when they receive stock
in a reorg and may not have cash to pay it (and for minority SHs who have
no choice)- liquidity
 Similar to 351 tax free incorporation rules
 We have same substituted basis rules in 358 and 362 here
o Taxable: Sellers typically receive cash (or other fairly liquid assets) in exchange for
stock— ends investment with the corp
 When SHs sell stock in a T corp for cash or notes from purchasing,
immediate recognition of SH gain or loss appropriate
Anything exchanged for 306 stock is treated as a 301 distribution—cant get rid of 306 stock w/out it
being treated as a dividend.
1.368-2(b)(ii): One corporation acquires the assets of the Target by operation of merger statutes
and that target corporation ceases to exist.

368(c)- Control defined- Ownership of 80% of total combined voting
power and 80% total number of shares of all other classes of stock 
must have 80% of EACH CLASS of shares outstanding (i.e., including
80% of non voting stock issued)
§ 368 Roadmap (For all reorgs):
 1) § 368 Requirements
o 368(a)(1)(A)-Type A- Statutory merger/consolidation
o 368(a)(1)(B)-Type B- stock for stock
o 368(a)(1)(C)- Type C- Stock for assets
 2) Judicial Requirements
o Continuity of Interest Requirement
 Whether target SHs retain an interest in the new parent corp/combined
entity
 Measured based on voting stock in corp
 A reorg- 40% voting stock in new corp= continuing interest
 B&C reorgs- explicitly stated in statute
o
o
o
Continuity of Business Enterprise Requirement
 Individual continues the business of the target corp
Business Purpose Requirement
 Must be another business purposes besides avoidance of tax
IF TRANSACTION FAILS ANY OF THESE TEST= SALE= COMPLETE LIQUDIATION
 336 taxable sale of T’s assets for prop of acquiring corp then 331 T
liquidated
THE HUB: 368
 3) Tax Consequences to SHs
o 354(a)(1)- General Non recognition rule:
 If in pursuance of a plan of reorganization, SH will not recognize gain/loss if
only stock or securities are received.
 1.368-2(g)- must be a plan of reorganization
o 354(a)(2)- Limitations:
 Any excess principal amount of securities received exceeds principal amount
of securities surrendered (but doesn't tell us the exact operating rule here)
 must go to 356(d)
 354(a)(2)(C)- certain non qualified preferred stock will not be treated as
stock or securities (basically preferred stock subject to boot gain)
 Non qualified preferred stock same as definition for 351
o 356- Basic Boot Rule: Boot gain is recognized but not in excess of the sum of money
received and FMV of other property (i.e., boot is taxable to the extent of the gain
realized)
 If Target SHs get boot (part stock, part cash) the boot itself might be taxable356
 356(d)(2)(B)- for securities, “other property” that is considered for boot
gain is only the excess of new principal over old principal
 If any securities are received, and no securities are surrendered,
securities received will be boot- flush language of 356(d)(2)(B)
 Non qualified preferred stock counts as other property
o Thus, Non qualified preferred stock is boot, but it will be
counted toward measuring continuity of interest
 AR-AB= Realized gain, find out what part must be recognized of the
realized gain vs. boot received.
 Losses- If SHs exchange heavily depreciated stock, cant recognize losses on
the exchange- 356(c)
 i.e. if basis in stock was $400 and only receives $300 in the exchange,
no loss recognition.
 Characterization of the Gain:
 Capital or Dividend Gain 356(a)(1) = Treat the boot as a capital gain
 356(a)(2) = Treat the boot as a dividend
o If the boot has the effect of a dividend distribution
recognized gain (gain up to the amount of boot received)
treated as a dividend (ordinary income) ** But, even though
treated as ordinary income, the qualified dividend rates are
essentially the same as capital gains rate – so it really doesn’t
matter.
o TEST:
1) Pretend SH received only A stock
2) Pretend redemption by A of the stock that SH
holds in exchange for the value of the boot received
 3) Test the redemption w/ 302 Safeharbors
 Idea: ensure that SH receiving boot in a reorg
should experience a significant reduction in
their proportionate interest before being
entitled to capital gain treatment
 Generally, if publicly held corp, then they will
receive cap gain treatment
 1223(1)- tack on holding period, if the same basis in whole or in part
becomes the basis in the new property
o 358- Basis Rules Basis in stock 358- same 358 rules (see 351 transaction)
 Not recognized prop takes substitute basis= original basis in
surrendered property decreased by amt of cash and FMV of other
boot received plus amount of recognized gain (or dividend)
 Basis in boot: 358(a)(2)= FMV (unless cash, in which case no basis)
4) Tax Consequences to Corporations (Target & Acquirer)
o Acquirer:
 No gain/loss on its own property- 1032
 362(b)- takes carry over basis increased by gain target recognizes
 381- Tax attributes carry over, A absorbs T’s NOL, E&P, etc
o Target:
 Tax fiction most at play here
 1) Exchange: 361(a) Issue: transfer of assets for stock, non recognition on gain (if they
had sold it for FMV, they would have recognized gain)
 Transfer of liabilities to A corp does not create boot for T corp b/c
357applies to 361 transactions
o And, no issue if Liabilities EXCEED the basis in assets(357(c))
 357(c) Does not apply to A reorgs/361 (only
368(1)(1)(D)/355)
 Thus, liabilities even in excess of assets is ok and
nothing realized for target
 2) Liquidation: 361(c): general non recognition of gain or loss to a party of a
reorg
o Carryover of Tax Attributes: §381/382
 §381: Tax attributes of T will continue after T’s stock or assets have






been acquired in an A, C or nondivisive D tax-free acquisitive reorg or
332 subsidiary liquidations—acquiring corp take NOLs, e+p, cap loss
carryovers of acquired corp
381 NOLs: See § 172 – 2 Years back, 20 years forward
381: 1st limitation: says how much of NOL can be used in year of
acquisition
382 says there is a 2nd limitation for NOLs
A Reorganization: 368(a)(1) REQUIREMENTS: “ Stock and securities.”
1) Statutory merger AND
 Corporate law- basically T entity, owned by T SHs, A entity, owned by A SHs, and T merges
into A, T delivers shares to A’s agent and agent delivers A stock to T shs
 STEPS IN A STATUTORY MERGER FOR TAX LAW
o STEP 1) EXCHANGE: A acquires assets and liabilities/stock of T for A’s
stock/securities (361(a))
 Securities: Rev. Rule 2004-78: Securities are DEBT, with a term of 5 or more
years (5-10 yrs, probably), over 10 years, yes.
 Securities not boot
 Boot received, 361(b): If something else is received, i.e., an obligation (2
year bond), then no gain to corp recognized but, they must distribute the
boot to SHs (otherwise corp recognizes gain).
 Gain will not exceed the sum of money and FMV of prop
 Note: SHs will recognize the gain (basically eliminates double tax
issue but SHs still recognize)


o
Shs must have an unfettered right to the P equity stock for at
least 5 years but are free to sell off the shares voluntarily
Consequences to P in exchange
 No g/l to P if transfers qualified prop
o QP: A corp’s own stock/securities
 Gain if transfers not qualified prop, i.e., stock of a 3rd party
 Same basis as T on assets PLUS gain recognized to T on
transfer- 362(b) (no change for liabilities)
STEP 2) LIQUIDATION: A causes T to liquidate MUST LIQIDUATE (361(c)), and T
ceases to exist. A & T SHs jointly own A.
 General Rule: T recognizes no gain or loss on the distribution to its SHs
pursuant to a plan of reorg- 361(c)
 361(c)(2)- if the corporation distributes property other than qualified
property… like Real Property, basically anything other than stock.
 QP: 361(c)(2)(B):
o stock or obligation in distributing corp or
o stock (or right to acquire stock) in the A corp in the reorg or
o obligation of A corp IF the distributing corp (T) received it
from A in the exchange portion
 As long as T distributes QP it received from A, then no g/l
 361(c)(2) (cont)- If it is not QP, and FMV greater than AB, then gain
recognized as if sale/exchange to distribute at FMV
 If liabilities > A/b of assets, then
 Shareholder: No gain or loss on stock in exchange for stock or securities in
exchange for securities- 354
 If boot- taxed, generally as cap gain (usually will meet the de min
safe harbor of 302)
o Characterization
 1) Pretend only received A stock
 2) Pretend there is a redemption by the A of some of
the stock that SH holds in exchange for the value of
the boot she received
 3) test the redemption with 302 safe harbors


If principal on securities > securities given up, excess is gain
If stock given up and securities received, 354(a)(3)- we have an
exchange of stock for securities…directs us to 356
o 356(a)- NO § 354 nonrecognition treatment to the extent
that the principal amount of the securities received exceeds
the principal amount of the securities surrendered -- this
amount would be taxable boot gain under § 356.
2) Meets Judicial Requirements: 1) Continuity of Interest, 2) Continuity of Business
Enterprise, and 3) Business Purpose requirement (all reorgs must have good business purpose
besides tax avoidance)


#1: Continuity of Interest in A reorg: If T shs receive at least 40% of stock in the A corp
(along with other consideration), then COI is met
Tres Regs 1.368-1(e)(1): “the purpose of the continuity of interest requirement is to
prevent transactions that resemble sales from qualifying for nonrecognition of gain or loss
available to corporate reorganizations.”
o Authority on 40%: Tres Regs 1.368-1T(e)(2)(v), ex. 1
 Southwest: Out of the mix of cash stock and bonds received by T SHs, the
amount of total consideration that was A stock was only 1%
 Rev Ruling: 66-224: Measure continuity of interest based on all of the
shareholders.
 If there are 4 shareholders, and 2 shareholders receive 100% stock
and 2 receive 100% cash- then of the total consideration, 50% was
stock and meets COI
 If there are 4 SHs, and for each of their interest, they receives half
stock and half cash, then of the total consideration, 50% was cash
and 50% was stock- so meets COI as well
 Nelson- 38.5% was enough stock to satisfy COI. Continuity of Interest does
NOT require that the acquired corporation retain voting interest in the
modified corporate interest – nonvoting preferred stock is OK.
 1.368-1(e)(2), ex 1- 40% STOCK WILL MEET COI
o What is Stock for COI Purposes?
 Must grant a continuing interest- must be stock
 Bonds NOT STOCK (even 11 yr bonds)– LeTulle
o Must be a SH of the acquirer, thus, the T SHs must acquire
STOCK of the acquirer, 20 year bonds not good enough either
 Conversion Feature- bonds into stock? Convertible bonds don’t
matter!
o NO b/c measured @ time of transaction
 If it is Non-voting stock/Preferred stock= OK!
 Note this is different w/ C reorg
 If T SHs only own 1% of A entity after the reorg= OK!
 Only measure the proportion of A stock contributed as part of the
bucket of consideration
 Minnesota Tea- interest in acquirer must be definite and materialbut 1% still meets this.
o Apply test in the aggregate- look at the SHs as a whole and
what they received not just what each individual received
 MUST BE THE ISSUING CORPORATION’S OWN STOCK, NOT THE STOCK OF
ANOTHER Treas reg 1.368-1(b)-




First: Treas reg 1.368-1(b)- issuing corp generally is the acquiring
corp, except in certain triangular merges in which the issuing corp is
the corp in control of the acquiring corp
 Second: And stock furnished by the acquiring corp should not be redeemed
 If the purchasing corp (OR a related corporation) immediately
redeems for cash, then it has effectively made cash purchase. See
1.368-(e)(8), ex. 4 and this screws up the COI.
 But, if acquiring corp announces a general repurchase plan, even
before negotiations of the merger, than that is ok, as long as no clear
understanding that SHs are only transistory – Rev Rul 99-58
o If the mechanics are just open market and does not favor any
of the people who sold their stock, no problem
 1.368-1(E)(7), ex 1: If acquirer helps facilitate the T SHs to sell their
shares to 3rd party, that is still ok, no predetermined plan about who
is going to purchase it
 Bottom Line: SHs can sell their stock immediately to unrelated
persons!
o Measuring Continuity of SH Interest: When?
 If the value of the stock drops between the time of the deal and the time of
the closing, then there might be a problem in meeting the continuity of
interest requirement/40%
 Could write in the agreement that they would add more stock if
value drops or adjust other consideration
 1.368-1T(e)(2)- Just look at the value at the time of the signing
 As long as you have fixed consideration, we are allowed to use the value of
the acquirer stock on the business day immediately before the signing of the
merger agreement (even at the time of the closing it is $6)
#2: Continuity of Business enterprise (i.e., the Target’s business): 1.368-1(d)(1)
o A continues T’s business (thus, effecting the “mere change in form”)
o By: continuing historic business or using a substantial portion of its assets in the
new business
 1.368-1(d)- example (4)- if the target, tiny corp, takes all assets and sells for
cash and then tiny merges into buddy and the answer is NO because buddy
is not obtaining any of Tiny’s assets (they are gone) and if Buddy uses the
cash in its own business, that's not ok either (cash does not symbolize a
mere change in form)
 Tiny merges into buddy, and buddy quickly sells all the assets for cash- not
good- cash is not a historic asset.
#3: Business Purpose- Can’t just do it to avoid taxes
- § 354 and 361 both require that the transfers must be “in pursuance of a plan of
reorganization.”
Step-transaction
o If w/in 1 year then IRS will likely invoke step transaction doctrine
 If binding transaction to take transaction 2collapse transactions
 if it appears sep transactions are really prearrangedcollapse

Tax consequences Summarized (A reorg)
o T shs who receive only P stock will have no g/l and same basis in the
shares
o T shs who receive P stock and boot will be taxed on boot gain
 Recognized gain can go up to the amount of realized gain.
 Either cap gain or dividend boot under 356
 Pretend the shs got stock and the stock was redeemed for
cashdo a 302 analysis
 If it IS considered dividend, dividend can’t exceed each sh’s
ratable share of e+p (Y corp+ X corp’s)
 Normally not going to be a dividend
o P reports no g/l on receipt of money or property in exchange for stock of
corporation
o P’s basis will be same as in the hands of T
 Decreased by FMV of other prop received, $ received and loss
recognized
 Increased by amount which is treated as a dividend and amt of
gain recognized
o T doesn’t recognize any g/l even for boot because boot is immediately
distributed to shs as well
 Must distribute it though to not recognize gain
o Up to 60% T’s stock can be acquired for cash
C Reorganizations
 (C) the acquisition by one corporation, in exchange solely for all or a part of its voting
stock …of substantially all of the properties of another corporation, …
o A purchases all…no merger occurs (Merger occurs in A Reorgs, NOT C reorgs),
just an acquisition of substantially all of the assets,
o Looks exactly like an A reorg for tax purposes except in A stock could be non voting
preferred stock, there is an actual merger in the A reorg which doesn't happen in a C
reorg, and specific “substantially all” requirement
 Consequences: THE HUB
o Target SHs: 354
o Boot: 356 / 358
o Acquirer: no gain/loss- 1032 on issuance of its stock, transferred basis
o Target: T/P exchange/liquidation- 361
 LIABILITIES PLAY A SPECIAL ROLE IN THIS TYPE OF REORG
368(a)(1)(C)
 1) Acquirer has to acquire substantially all of the target’s assets
o Note: This is separate issue from the solely or part of voting stock, you can satisfy
this and still fail substantially all requirement. Take note if the Target holds on to
some of its assets.
 “Substantially All” – RP 77-37 (GOOD C REORG)
 90% of FMV of Target’s net assets (assets-liabilities) AND
o 1) Net assets prior to transactions
o 2) Calculate net assets after transaction
 Assets retained- liabilities retained
As long as net assets after transaction are 10% or less
of the assets prior to transaction, then ok
 (Net assets prior-Net assets after)/ Net assets
Prior= 90% or more
 70% of FMV of Target’s gross assets
o .7*total Gross= X
o Voting stock > X
 TWISTS w/ Substantially all issue?
 2) If T sells off part of operating assets to 3rd party, and then
transfers all assets (including the cash) to acquiring corp, in
exchange for voting stock and debt relief, then OK
o Rev Rule 88-48: b/c the cash proceeds are not retained by
the target, not given to SHs, its just like Acquirer got assets
that it also could have sold for cash as well.
2) solely in exchange for all or part of its voting stock
o Different then A reorg- ONLY voting stock counts in C reorg
 Bonds = no good
o But, in determining whether the exchange is solely for stock, the assumption of
liability of the acquirer shall be disregarded
 IF we are dealing with ONLY voting stock being transferred, or ONLY
voting stock + liabilities, the relaxed rule does not come in
o Additional Consideration? 368 (a)(2)(B)(iii): Relaxed “Solely for stock” Rule In C
Reorgs If the acquiring corp acquires property, having a FMV which is at least 80%
of the FMV of all property of the target corp
 Total FMV of Target Properties
 & ask, did Acquirer acquire for 80% voting stock
 Liabilities do NOT count here (flush language 368(a)(2)(B)) so Liabilities
will not ruin the C reorg, but they do not count for purposes of “solely for
voting stock” rule
 Voting stock > 80% * Gross value of assets
 If target has $200,000 of assets, $160,000 of voting stock must be
transferred in exchange
o If liabilities, voting stock AND other property is used in the exchange, then the
liabilities WILL be treated as boot and recognized as debt relief
 Probably will ruin the C reorg but still test the 80% rule
 If no liabilities and still other property (like NVP, then still test 80% rule)
o If Cash is received/boot: 361(b)- Target must distribute all and they will not
recognize any g/l on the boot (Shs will recognize tho)
 No loss recognition on boot- 361(b)(2)
3) Target MUST liquidate- 368(a)(2)(G)
o T must distribute assets to SHs and creditors
 For a distribution to creditors, the transfer of qualified property “in
connection with” the reorg is treated as dist to SH- 361(c)(3)- no strict
definition of “in connection with” – NO gain/loss when distributing to
creditors/bondholders. Just treat it like a distribution to normal SHs.
 Security holder may surrender securities and receive securities in the same
or lesser principal amount without the recognition of gain or loss to him.1.354-1(a)



o
o
o
T shareholders not taxed on receipt of stock b/c exchange
Pretend that T shs are giving their shares to T, and then when T liquidates, the
acquirer holds T’s old shares (or is this B reorg?)
TWIST on holding back assets (both a liquidation/sub all issue):
 1) No problem w/ not distributing to shareholders either b/c Rev Rule 57518- as long as there is a reason for holding back non operating assets, not a
problem to the reorg
 Potential issue:
 I.e., holding back the non op assets to pay off liabilities will not ruin
the reorg
Judicial Doctrines: C reorg must still meet the COI, COBE, and BP rules, but COI less important b/c of
the more stringent statutory requirement.
 We care about the OPERATING ASSETS in regards to substantially all requirement b/c of
the COBE requirement
Tax Consequences of C reorg
 T recognizes no g/l on the exchange of assets for stock & securities– 361 (a)
 T recognizes no g/l on the distribution to its SHs- 361(c)(1) and T can distribute to
creditors in liquidation, and it shall be treated as to creditors- 361(c)(3) (and so no
g/l to T)
 If T distributes boot to SHs immediately, then no g/l to T- 361(b)
o 361(b)(3) any transfer of other property or money received in the exchange
by the corporation to its creditors in connection with the reorganization
shall be treated as a distribution in pursuance of the plan of reorganization
 If T distributes property other than qualified property, and the FMV > AB, then g
recognized as if property sold to distribute at FMV- 361(c)(2)
o (c)(2)(B)- qualified property= stock in distributing corp or obligation of the
distributing corp or stock in another corp which is party to reorg or
obligation of another corp party if received by distributing corp in the
exchange
o Thus, if T distributes cash to the creditors (or shareholders really) ,
then 361(c)(3) does not work to protect the corporation from recognizing
any gain on the distribution
o HOWEVER, because cash cannot be appreciated, there will still be no gain for
T in this transaction
 NOTE: if the boot has some appreciation, and not qualified property,
then FMV – AB recognized to the corp
 T Shs have no g/l on receipt of stock for their stock or securities for their securities
 T Shs take basis in new stock that they had in their old stock- 358 (a)(1) (if there is
no boot)
 If there is boot received, then the basis is reduced by boot received, increased by
gain recognized, and increased by liabilities assumed- 358(a)&(d)
 If debt holders/creditors receive anything in the exchange,
o 361(c)(3)- allows them to be treated as SHs for purposes of the
corporation’s distribution of qualified property to them…
o 354- does not specify that SHs receive tax free treatment, just a “party to” a
reorg, in pursuance of a plan- so creditors ok
1.354-1(a): Creditors get tax free treatment the same- even if they give up
securities and receive stock
 What if they receive securities back? Recognize gain in difference of
principal? How is that fair if its ok for securities for stock- do they
have gain?
o If Creditors receive NON QUALIFIED PROPERTY in the exchange, then
361(c)(3) does not apply
P not taxed on receipt of assets under 1032
P exchanges stock for assets, takes T’s basis in assets- § 362(b)
Debt eliminated, T paid off the debt with B’s voting stock
o



* If we bust the C reorg, we tax as a liquidation under 331/336 & recognize g/l
B REORGANIZATIONS (“Stock for stock”)
** Use the SAME Hub as for A and C Reorgs**
Basic Transaction/Difference:
 Acquirer exchanges its voting stock for the stock of the corporation, directly from the target
SHs (before, there was an exchange with the target itself)
 Biggest difference: Target REMAINS IN EXISTENCE at the end of the transaction (with T
and A Shs jointly owning A, which owns T as a sub)
o Note: Judicial doctrines still apply here but the COI is always going to be met b/c
Congress came up with a stricter requirement then judges and COBE prob since stays
in existence
Requirements: 368(a)(1)(B)
 1) Solely for all or part of its (the acquiring corp’s) voting stock
o (i) Only voting stock allowed
 Voting preferred stock still counts- JUST NEEDS A VOTE
 Why Vote? Represents power in the corporation
o (ii)NO BOOT IN A B (to SHs) (none.) – See Chapman
 Shareholders can’t receive boot, regardless of whether A acquires 368(c)
control with solely voting stock
 Rev Rule 75-12- EVEN IF BOOT IS NOFN PRO RATA, it still ruins the B reorg
o **BUT, Rev Ruling 68-285: Redemption (by T corp) of a dissenter’s (T SH) share of
stock prior to the B reorg WILL NOT RUIN THE B REORG….
 as long as the funds distributed to the SH in the redemption come from T,
not acquiring corp – Rev Rule 75-360
 Funds ($) to pay dissenting SH CANNOT come from a wholly owned
sub of the acquirer either- 85-139
o (iii) DIFFERENT RULES FOR BONDHOLDERS:
 Rev. Rul: 98-10: If acquiring corp exchanges its own securities in exchange
for T’s debt (debt for debt), TREAT THE EXCHANGE AS SEPARATE FROM
THE B REORG (and doesn’t ruin reorg)
 Tax consequences to creditor?
o 354(a) applies and protected b/c its still “in pursuance of the
plan of reorg” – no g/l
o The bondholder also has Shares- wont ruin the reorg (but
will still recognize gain if difference in principal amounts)
If there is excess principal, creditor recognizes gain, but still
doesn't ruin reorg
 Rev Ruling 69-91: If creditor receives cash, still wont ruin the reorg, but she
will pay tax on the entire receipt of cash
 Make sure that but only bondholders can receive cash
 And getting in exchange for debt, paid out in pursuance of the
general reorg
o Ultimately, transactions w/ debtholders wont ruin a b reorg
o (iv) Creeping B Reorg:
 (a) Treas. Reg. 1.368-2(c): If acquiring corp acquires 80% control, solely in
exchange for voting stock, within a short period of time (i.e. 12 months) then
treated as a good B reorg
 (b) ON THE FLIP SIDE: If one of these acquisitions was for cash rather than
stock- RUINS THE B REORG, unless the stock purchased is “old and cold”1.368-2(j)
 Old and cold- Example in regs says 16 years in between purchase for
cash and B reorg wont ruin the B reorg
o If less? Say that there is a “risk”
 (c) Fixing an Earlier cash purchase: Rev Rule 72-352: If acquiring corp sells
off the recently purchased stock to an unrelated party, then it can still have a
good B reorg after- as long as they can still acquire 368(c) control (80% of
vote/each class)
 68-562:
2) For the stock of the target corporation,
o Purchase directly from T SHs
o No 338(g) election allowed (to take into account the difference between the
acquiring corp’s basis in T’s stock vs. T’s assets- inside/outside basis)
o B/c 338(h)(3)(A)- disallows 338(g) election if you take a carry over basis in
the stock (you didn't purchase it/cost basis)
 Basis in T’s assets remains the same & Acquiring corp takes basis in the
stock of the T SH’s (362)
 RP 81-70: If publicly held corp then purchaser can take statistical
sample of bases to figure out what A’s basis should be
3) Acquiring corp has CONTROL of the target immediately after the acquisition (regardless
of whether they had control immediately before)
o Control: 368(c): 80% of voting stock and 80% of EVERY OTHER CLASS OF STOCK
 Not a problem if the acquirer does not assume all of the liabilities/
outstanding debt of a creditor, for purposes of control.
o



Tax consequences
o No gain/loss to T shs
o Substituted basis (substitute old basis as their new basis)
o P is new owner of Tnew subsidiary
o P has no gain/loss upon receipt of T stock in exchange for its own stock
o P’s basis in new T shs will be same as basis old T shs had
o Debt-for-debt exchange doesn’t ruin a B reorg (& cash ok- 69-91 rev rul)
o If the corp acquired stock for some boot in the past, make sure it won’t be
considered an integrated transaction
o If P liquidates/merges T


If reorg+liquidation are separate, T’s liquidation will be governed by
subsidiary liquidation rules of 332
If merger of T is part of an overall planmay be recast under steptransaction as a type C asset acquisition
TRIANGULAR REORGANIZATIONS:



Difference: Each basic acquisitive reorg before included only 2 corporate parties,
this involves a subsidiary acquiring (3 parties)
o Why?
 Non tax business reasons
 Corp might not want to own T assets or stock directly (inherit them)
 Federal regs
 Liabilities unsure about
 Acquirer might not be a US corp, so cant engage in 368
 T or SHs might not wish to sell to P
Drop Downs Generally:
o P acquired T stock/assetscontribution of T s/a to P subsidiary
o A,B, C reorg not disqualified if stock/assets are dropped-down to a
subsidiary- 368(a)(2)(C)
 A transaction otherwise qualifying under paragraph (1)(A), (1)(B), or
(1)(C) 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.
C Reorg w/ Drop Downo 1) The transaction: Not a merger under local law, Acquiring corp exchanges
voting stock for T’s assets and liabilities, and then Acquiring corp transfers
the T assets (and liabilities) to a wholly owned Sub for additional Sub stock
 This looks like a C reorg, but there is a subsequent drop down of
assets and liabilities
 The subsequent drop down of assets and liabilities looks like a 351
transaction b/c Acquiring corp is in control of the Sub
 And after the transaction in control
 Used to be a problem under Groman & Bashford but…
 368(a)(2)(C) fixes this-- a drop down involving an A B or C is ok!
o 2) Tax Consequences:
 Target Entity:
 No g/l recognized- 361(a) & assumption of liabilities don't
prevent from being w/in 361 (357(a))
 Target SH:
 No g/l on receipt of stock- 354, except for boot (356)
 Parent Entity:
 1) Transfer of T assets to P for P stock
o 1032- no recognition of g/l




Sub:




o Takes T’s basis in the assets- 362(b)
2) Contribution of T assets from P to Sub
o 351 contribution- no g/l
o P receives new stock in Sub
o P’s new basis in Sub stock = Old basis in stock+
o 358 (a)&(d) calculation= Original basis in assets-boot
received + gain recognized – liabilities received
o Old basis in stock+ Calculation= new basis
Now holds T’s assets & liabilities
351 transaction- no g/l
1032- no g/l when corp issues own stock
362(a)- basis in property contributed is basis in hands of
transferor + gain recognized to the transferor
 381- takes the tax attributes from Target b/c now has assets
Drop Down following a B reorg (stock acquisition)
o Step 1) P acquires T stock—no recognition
o Step 2) P acquires subsidiary stock in exchange for T stock
 not eligible for 354 non-recognition but eligible for 351 nonrecognition
Triangular Reorganizations
o Triangular C Reorganization:
 1) Not a merger under local law,
 2) P creates Sub and contributes voting stock + cash in exchange for
stock of Sub.
 3) T transfers its assets & liabilities directly to Sub in exchange for P
stock (which had been previously contributed by P to Sub for this
purpose in step 2).
 Note: this can be a pre-existing Sub, but need to take into
account the historic ownership
 2) T liquidates & distributes P stock to T Sh.
 Note: it is ok that Sub is transferring P stock in the exchange
b/c the parenthetical in 368(a)(1)(C) allows sub to do so and
not ruin C reorg
 Cannot use a MIX of VOTING P stock and VOTING Sub stock
(Must be all of P stock- “the corp in control of the acquiring
corp (Sub)”).
o Note- if all of Sub voting stock was used, would also be a
good reorg, just not triangular- straight C
 Triangular C- Alternative structure w/ boot:
 BUT IF YOU HAVE Non voting Sub stock and you have voting P
stock, then YOU ARE STILL OK
 And don't be thrown off it says that it is a
merger- if there is sub stock CANT be a fwd
subsidiary merger

BOOT RELAXATION RULE:
o If we have nonvoting of sub and voting of P, make sure
that we satisfy the boot relaxation of 368(a)(2)(B)
 1) uses voting stock to acquire 80% of assets
(solely for voting stock)
 (remember: substantially all is a diff
requirement then 80%)
o Tax Consequences:
 Target Entity:
 No g/l under 361; 357(a) says liabilities not a worry
 361(b)- no g/l on other property as long as its all distributed to
SHs.
 T SH:
 354, no g/l; except boot under 356
 P:
 No g/l on transaction
 Basis in sub:
o “Over the top” Construction: 1.358-6(c)(1) (fwd
triangular & C reorgs)
 1) Pretend that P engaged in the exchange with T
(transferring its own stock for T assets/liabilities
in reorg)
 2) P’s basis in those assets are determined under
362(b) (i.e., carry over + gain recognized)
 3) P transferred T assets & liabilities (the
liabilities that S actually assumed) in a 351transaction in which P’s basis determined under
358
 4) If the amount of liabilities = or > aggregated
adjusted basis in assets, then adjustment is zero
o P recognizes no gain under 357(c) as a result of
triangular reorg.
 Sub:
 1.1032-2(d)- Sub need not recognize g/l when it uses stock from P if

engaging in the reorg
But 1.1032-2(c) If using P stock that was not received in pursuant of
a plan of reorg, then must recognize g/l
o Forward Subsidiary Merger- 368(a)(2)(D)
 A statutory merger of T and S, w/ S surviving, would have qualified as
an 368(a)(1)(A) by reason of 368(a)(2)(D)
 Requirements:


1) S acquires “substantially all” of the properties of T
o If T sells off 50% of assets before, prob not substantially all
o Substantially all: (C requirement): 70% of gross assets and
90% of net assets
2) No stock of S is used in the transaction
Can only use P stock (corp that has 80% control of the sub
that is acquiring T)
 Can be non voting preferred stock (A reorg)
 Can be sub debt issued as well too
 If this happens, when finding the new basis of
parent in sub stock, we have carry over basis,
then reduce for consideration provided by
sub (after going through the over the top
method)
o Cant use S stock (in addition to the P stock transferred) but
can use S debt
 3) The transaction would have qualified as a Type A reorg if T had
merged directly into P
o Basically boils down to whether the transaction meets the
COI test
o Type A permissible consideration: 40% basket of stock
consideration
o Boot is Permissible here: Sub can transfer P stock and notes,
etc
Tax consequences:
 Sub:
o No g/l even though using stock of P- 1.1032-2(c)
o If sub goes out on market and buys stock of P for the reorgok, no g/l
 Its “in pursuance” of the plan
o But if Sub owns “old and cold” P stock, then recognize
gain “S recognize g/l on exchange of P stock as
consideration… if S did not receive the P stock from P
pursuant to the plan of reorganization” – 1.1032-2(c)
o




1.1032-2(d), ex 2: T has assets w/ AB of $60 and FMV of $100. S
is an operating co w/ assets. S owns P stock already w/ a $20 AB
and $30 FMV, acquired in an unrelated transaction. Under the
plan, P transfers $70 more of P stock to S and T merges into S.

T shs receive $100 of P stock ($70 from new provision
& $30 of old)

$70- in the reorg- no g/l for P or S

But, S recognizes $10 of gain on exchange of P stock b/c
S did not receive P stock in plan

1.358-6(d)- P’s basis in S stock will be increased by any
gain recognized (358).
Target:
o No g/l on exchange/liquidation: 361 (?)
Target SH:
o No g/l on receipt of stock- 354
o If Receives boot:
 1) what is the amount realized in transaction?
Compute realized gain
 2) figure out whether has to recognize any of realized
gain
 Note: 354(a)(3)- we have an exchange of
stock for securities…tells us to go to 356

356(a)- gain recognized but not in
amount, excess of amount realized money
& fmv of other property received
 3) Tax on less of realized gain or boot received
Basis in boot received = FMV (358(a)(2))
o
 Parent:
o 1.358-6(c)- same rules as above for basis adjustment
o Over the top construction
o Note: Reduce the adjustment for the amount of consideration
provided by the sub (if the sub issues its own debt along with
the parent stock + assumption of liabilities)
** What if these transactions happened in the open stock market?
o Reverse Subsidiary merger- 368(a)(2)(E)
 A reverse triangular merger is a statutory merger of S and T, with T
surviving, that qualifies as a reorganization under section 368(a)(1)(A) by
reason of the application of section 368(a)(2)(E).
 Rev Rule 67-448 Wants STOCK, not the assets- the assets of the target cant
be moved, regulatory reasons, the entire T had to be moved and so, wanted
stock. And, for a B reorg, only need 80%, and in this ruling, they didn't want
minority SHs.
 1) S merged INTO T so the T SURVIVES the merger and S disappears
 Steps:
o 1) P creates S (or could use an existing sub w/ ongoing
business activities- T’s bus would just be augmented)
 Sub only exists for a short time (in the rev rule)
o 2) P contributes P voting stock + cash
 This will allow P to contribute some boot
o 3) S mergers into T, S contributes w/ T surviving and P
receiving P stock in exchange for T stock
 And in the rev ruling, target pays off SHs who didn't
want to participate in merger with cash. (67-448)
 Formalistic rule- Sub merges into Target with the P,
and then T uses its own cash
o 4) P stock in Sub automatically converted into T stock (as a
matter of local law)
 REQUIREMENTS:
 1) Surviving corp T hold substantially of the properties formally
held by BOTH corporations (S & T)
o T has
 2) The former T SHs exchange stock constituting control (80%/80%
test in 368(c)(1)) for P voting stock
o So T SHs must give up 80% for P corp voting stock (must be
P stock, not the Sub stock)
 Control rule different then fwd (a)(2)(D)
 And it has to be acquirer voting stock to get
the control (not non voting)
 But better than B b/c can use boot
Boot allowed- because only 80% of T stock must be
acquired for P voting stock, the rest can be for cash or other
property,
 OR simply not acquired (don't have to own whole
thing) if P is willing to put up w/ minority SHs
 As long as Shs exchange 80% control for voting stock
NO CREEPING REVERSE SUBSIDIARY MERGER:
o If P had already owned part of the T, this wont work because
MUST acquire control in the reverse sub merger transaction
o


Tax Consequences:
 T Shs: 354- no g/l, may have to pay tax on the boot- 356
 T entity: Exchange of assets for stock and distribution of cash
and stock to T Shs- 361(a)/(c)
o Receives T SH’s stock in return on this distribution of
cash/stock of P (this is pretend keep in mind)
o Ultimately, the T stock had to go back down to the T
entity, so it could eventually travel back to P
 Sub: transferring assets + stock & cash
o Also merging out of existence, liquidates and distributes
out to P, the T stock
o No g/l under 361(a) and no g/l on liquidation and
distribution to the P under 361(c)
 Parent:
o First contribution to sub- 351, no g/l
o P’s basis in T stock:



Original basis in Clay=$150 (no basis in own stock,
and only contribution was 850 of own stock + 150 of
cash, so only cash counts towards basis)
Then use 1.358-6(c)(2):
 Pretend that P got the assets that T held in a
reorg and these assets carry over basis- §
362(b) and
 Then P contributes down to Sub all of the
assets + liabilities,
 So then we have the 900 less liabilities that
Sub will assume, and so add that to the
original basis of 150= 850
The pretend contribution of the Dolphin assets to A
o Pretend reorg b/c dolphin and sawyer, and pretend that
they contribute to clay, so sawyer takes an exchange
basis
 Dissenting Shareholders?
o Triangular B reorg
 368(a)(1)(B)- the acquiring sub (S) may use solely voting stock of a
corporation “in control of the acquiring corporation”—i.e., a parent—
in a direct triangular B reorg.




Same result could be achieved through a two party reorg
followed by a drop down, no reason to prohibit triangular
form.
Step 1) T Sh transfer T stock to P subsidiary S solely in exchange for P
voting stock
 Can ONLY be voting stock of S or P—CANNOT MIX
o Language- “entirely voting stock of acquiring corp S OR
entirely voting stock of a parent”
o 1.368-2(c)
o All three corps are party to the reorg
 2) S has to control T after the exchange
Tax consequences:
 T shs who receive P stock recognize no g/l- 354
 1.1032-2 (c) S should be entited to nonrecognition on its
exchange of P for T shares, as long as P stock was provided by
P to S or directly to T shs on behalf of S pursuant to the reorg
plan
o S’s basis in the T stock should be substituted bais under
362(b)
 P now indirectly controls T through its subsidiary
o P gets nonrecognition treatment
 1.1032-2(b)- Regs treat transfer of P shares by S
“as a disposition by P of shares of its own stock
for T’s stock”
o P’s basis in its S stock
 “Over the top method” – 1.358(c)(3)
 Only difference is we have a pretend
contribution of stock rather than assets
 Pretend that P first acquired T shares directly
from T, and then transferred R stock to S in a 351
transaction, in which P’s basis in S stock
determined under 358.
 So, P takes T shares w/ substituted basis from T
shs and then P contributed T shs to its subsidiary
so P increases its prior basis in its S stock by
the T shs bases
E&E notes

Historically- parent not considered a party to the reorg and
transaction violated COI interest under “remote continuity of
interest doctrine (T stock was not held by corporation issuing the
stock (P)

D REORGANIZATION- NON-DIVISIVE/DIVISIVE
Non Divisive Type D Reorgs
If a transaction qualifies as both a C and a D reorg, it is treated as a D reorg
D reorg that is Non-divisive (368(a)(1)(D) & 354)
 368(a)(1)(D): A transfer by a corp of
o i) all or part of its assets to another corp if
o ii) if immediately after, the target, or one or more of its SHs is in control of
the acquiring corp immediately after the transfer.

368(a)(2)(H): for purposes of control: (i) where you have d reorg that
satisfies 354- then apply control within 304(c)
 304(c)- either 50% vote or 50% of total value
COI assured by this requirement- transferor corp/shs must retain
control over the purchasing/transferee corp
o iii) But only if, the stock or securities of the corporation to which assets are
transferred [must be] distributed in a transaction which qualifies under 354,
355 or 356
354(b):
o In order for 368(a)(1)(D) to apply:
o A) the corporation to which the assets are transferred acquires substantially
all of the assets of the transferor of such assets; and
 Substantially all= 70% of gross assets; 90% of net assets
 Basis of transferor assets in hands of transferee corp is transferred
basis + gain recognized by transferor on the transfer
 368(a)(2)(A)- if transaction meets both C and D, then treated
as type D (same if its an A also)
o Note: if anything but voting stock, then it will not be a C,
only D
o Thus, greater flexibility w/ respect to boot
 If liabilities > adjusted basis in assets, no issue for the (d) reorg
(357(c)(B) says only for D reorg under 355).
o B) the stock, securities and other property received by transferor, as well as
other properties of transferor, are distributed in accordance of the plan of
reorg (transferor must liquidate)
 No g/l to transferor SHs- 354(a)
 SH must recognize gain to the extent boot received
 Losses no recognized 356(a)(2)
Import of being classified as D rather then A or C:
o Greater flexibility w/ respect to use of boot



Tax Consequences of an Acquisitive D reorg:
o Tax consequences to target Shs:
o No g/l under 354
o Exchanged basis under 358
o Target entity
o No g/l on the exchange of assets for stock or other property- 361(a)
o No g/l on the liquidation- 361(c)
 361 still applies to the target here b/c this is a reorg
 No boot/gain if liabilities> basis b/c satisfies 354
o Acquirer
o Takes carry over basis- 362(b)
o
D Reorgs under 368(a)(1)(D) AND are divisive under 355:
 368(a)(1)(D): A transfer by a corp of
o i) all or part of its assets to another corp if
 In a divisive reorg (here) we will have a transfer of PART of the assets
o ii) if immediately after, the target, or one or more of its SHs is in control of
the acquiring corp immediately after the transfer.

368(a)(2)(H):
 (ii) in the case of a transaction with respect to which the
requirements of section 355 (or so much of section 356 as relates to
section 355) are met, the fact that the shareholders of the
distributing corporation dispose of part or all of the distributed
stock, or the fact that the corporation whose stock was distributed
issues additional stock, shall not be taken into account.
COI assured by this requirement- transferor corp/shs must retain
control over the purchasing/transferee corp
o iii) But only if, the stock or securities of the corporation to which assets are
transferred [must be] distributed in a transaction which qualifies under 354,
355 or 356
355(a)(1) Statutory Requirements (detailed Below)
o (A) Distributing corp distributes stock or securities of a controlled corporation,


which it controls immediately before
 “Controlled Corp”— flush language of 355(a)(1)(A): the entity that actually
gets distributed
 Control = 368(c) control (80%)

If distributing distributes anything other then stock/securities, boot
under 356:
(B) Not a device for distribution of E&P or controlled corp or both
 But, just because stock/securities sold by some or all of distributes does not
necessarily mean it's a device
o (C) Active trade or business (before and after)
o (D) As part of the distribution, distributing corp distributes- all of the stock/sec in
controlled corp held immediately before; or; an amount equivalent to control w/in
meaning of 368(c) (no retention)
 355 reorg must also meet BP, COBE and COI
355 Requirements
 1) Distribution of Control, § 355(a)(1)(A)
o As part of the distribution, the distributing corporation distributes all of stock or
securities in the controlled corp immediately before distribution or, an amount of
stock constituting 368(c) control
o


Split-up/Split-off (sh exchange some stock)
 boot ok but gain will be recognized up to the amount of
boot/FMV of boot (remember characterization)
Spin-off (sh don’t exchange any shares)
 301 applies to the boot
o
Control = 368(c) control (80%)
o If the corp recently acquired control through a taxable purchase, §355 will
not apply to the subsequent distribution of the stock


 See 355(d) & (e)
2) No Device, § 355(a)(1)(B)
o Re: Gregory v. Helvering (ish)
 Abuse scenario where people get the stock and sell it and get capital gain
treatment
 Convert what would have been a dividend into capital gains
o Device Factors: Treas. Reg. 1.355-2(d)
 Pro rata distribution Seems kind of like a dividend….
 Subsequent Sale/Exchange
 It was all a pre arranged plan to bail out the earnings
 Sale creates the actual bail out- if we find out that there was a pre
arranged plan (like in Gregory v. Helvering), seems like a device)
 Nature and use of assets
 If there are assets that aren’t used in an active trade or business- like
cash
 You might be a device if you, you play around so that you don't have
a lot of basis so you get cash distribution disguised as cap gains
treatment… distribute cash to a SH and stock…
o Non Device Factors:
 Publicly Traded
 Evidence that the transaction was not a device
 Distributing corp is publicly trade- if it's a public company and you
get stock, its evidence might not be a device
 Corporate Business Purpose
 Described in the regs in 1.355-2(d)
 Counteract Device characteristics, the stronger there is a device, the
stronger these factors must be
 Distribution to Corp Shareholders
 If there is a distribution to a corporate SH, evidence that there isn’t a
device b/c , a dividend would be cheaper actually b/c a DRD
o Transactions are NOT A DEVICE
 Absence of E&P (306 similar)
 If there is no E&P to begin with, no worry about anyone converting, no one
was going to get dividend treatment to start
 Section 302(a) Transaction
 Turn in distributing and get controlled, the whole thing isn’t a device
b/c originally would have gotten cap gains treatment
3) Active Trade/Business, § 355(a)(1)(C)
o 355(b)(1)
 (A) Distributing and Controlled must be engaged in active trade or business
immediately after distribution OR
 (b)(1)(A)- generally can apply for a split up
 It also applies for split off, when combined with 355(b)(3) –


(B) immediately before distribution, the distributing corp had no assets
(other than stock or securities in the controlled corps) and each of the CCs is
engaged immediately after the distribution in the active conduct of a TorB
 (B)- Special rule for holding corporation (ONLY FOR HOLDING
CORPS)- if distributing was just a holding corp, then controlled has
to be engaged in a T or B immediately after
o Works for split up- when distributing creates 2 controlled
corps, and liquidates after
o For a split off- only 1 controlled entity is distributed—look to
(a)(1)(A) and (b)(3) for it to fit in there
trade or business has to have been conducted for 5 years, ending on the date
of the distribution (355(b)(2)(B)
o 355(b) Active conduct of a trade or business if and only if—
 (A) it is engaged in the active conduct of a trade or business,





355(b)(3)- all members of such corporation’s separate affiliated
group shall be treated as one corporation.
o Helps meet T/B req’m for split off situation
(B) T/B actively conducted throughout the 5-year period ending on
the date of the distribution,
 1.355-3(b)(2)- Perform active or substantial management
functions (merely holding investment/rental prop-not)
(C) TorB was NOT acquired w/in 5 years in a transaction in which g/l
was recognized in whole or in part [TO ANYONE]
 Examine the acquiring transaction and ask whether it would
qualify as a tax free reorg—absolutely No boot allowed
 If acquired in a tax free transaction, the time that T or B
conducted by another owner, tacked on
(D) control of a corporation which (@ time of acquisition of control)
was conducting such trade or business— (problem 2(a))—was not
acquired during the 5 year period, unless it was acquired in a
transaction that was tax free
 For (D) all distributee corporations which are members of the
same affiliated group (1504(a)) shall be treated as 1
distributee corporation.
4) No retention § 355(a)(1)(D)
o Distributing corp (alden) has to distribute all of the stock to SHs in the corporation
 If distributes anything else to SHs, then SHs recognize g/l:

Boot: cash or other property, excess principal in securities over
securities surrendered (or if non surrendered, FMV of
securities received (355(a)(3)(A)), stock of controlled corp if
acquired within 5 years of the distribution in a taxable
transaction (355(a)(3)(B)- like last 5% of a 95% owned
controlled corp for cash), and nonqualified preferred stock
received w/ respect to stock other than Non Qualified
preferred stock (as defined in 351(g))
In 355(a)(1)(D)- if they hold anything back, then they have to establish that it
wasn't trying to avoid tax by doing this- rare that they will hold back any of the
stock of controlled, idea is that they want to separate
5) Business Purpose
o Overall transaction- the distribution of the stock, plus the creation of the entitles,
everything has to occur as a result of business purpose, some good business
purpose reason why they had to do this
o “real and substantial non Federal tax purpose germane to the business”- 1.3552(b)(2)
 1.355-2(b)(3)
 RP: 96-30: Gives all of the good reasons
o Increasing access to capital; Increasing competitive position;
Resolving cost savings; Risk reduction; Protecting one
business from another; Trying to help retain an employee;
bank financing and cost savings; comply with federal
regulations; settle SH conflicts;
 Fit and focus- enhance business success (but will be problematic if
they have a relationship afterwards)
 Rev Rul 2004-23: If increased value expected to serve corporate
business purpose of either the distributing or controlled corp even if
it benefits the SHs of the distributing corporation
 2003-52: resolving family disagreement ok even tho increased estate
planning benfits
 split off for an ipo is ok- 2003-55
o Combat corporate level tax avoidance on distributions of appreciated property
6) COI
o 1.355-2(c)(1)- Both distributing AND controlled must be at least 50% owned after
the distribution by SHs of distributing corp (Alden)—HISTORIC SHs of the
distributing corp
 One or more priori owners own, in the aggregate, an amount of stock
establishing COI in each of the modified corporate forms in which the
entierpise conducted after separation
o Continuity is a sneaky problem, think about how long they have held it
 What if one of the historic SHs sells 80% of his shares to a new SH (so now
the original 50% sh only owns 10% of the corp)
 So now one of the Shs is not a historic SH I.e., in a Split off, if one of the SHs owns 100% of the new corp, then the other
historic SH has to own at least half of the distributing corp
 1.355-2(c)(1), ex 4:
7) COBE
o The controlled corporations have to continue their business after the distribution
o Don't know exactly how long, but long then a second
o



Types of Divisive Reorgs:
 Spin-off
o Step 1) create subsidiary
 But could be a prexisiting subsidiary as well- just careful about
contributing assets
o Step 2) distribute S stock to D shs
Distributing corporation distributes stock of a controlled corporation
(S) to its shs
 Shs generally receive pro-rata rate of S’s stock and do not transfer
anything to distributing corp in exchange but doesn’t have to be pro
rata! Some sh can receive stock and some can receive cash 
 Boot: treated under 301, if D has e+p to cover boot
distribution, then shs have dividend income
 If spin-off fails to qualify for §355, distribution treated as a dividend
to extent of e+p (excess is basis recover/cap gain) and any gain on
appreciable assets is taxable to distributing corp
o Basis: (no exchange of shares) pretend sh surrendered P stock and in return
received P and S stock P+S stock has same basis as P alone had before.
Allocate basis between P+S according to FMV at time of distribution




Split-off
o Step 1) create subsidiary
o Step 2) distribute S stock-D shs exchange some D shares for S shares
 Generally non pro rata distributions of stock in the controlled corp to
distributing corp’s shs
 Boot: governed by 356: unless boot has the effect of a dividend, boot
treated as gain from sale of a cap asset
 If transaction fails §355, distribution will be treated as a redemption
under §302
 Either a dividend under 302d (pro rata split-off) or
sale/exchange under 302a (non pro rata split off resulting in
complete termination)
o

amt of stock retained in distributing corp/ (amt received that qualified for
nonrecognition+amt of stock retained)=% of aggregated basis that is
allocated to retained stock
Basis of property permitted to be received without gain or loss is
transferred basis decreased by FMV of other prop received - $ received –
loss recognized on the exchange + amt treated as a dividend + gain
recognized on the exchange (§358a)
Basis:
 basis of stock or securities received shall be the same as those surrendered
decreased in the amount of any boot received and increased by the amount
of gain or amount treated as a dividend (358)
Split-up
o Step 1) create 2 or more subsidiaries and transfer assets to S’s in return for
stock
o Step 2) distribute S-1 and S-2 stock in liquidation of D
 Original corp effectively disappears
 Boot: governed by 356: unless boot has the effect of a dividend, boot
treated as gain from sale of a cap asset
 If transaction fails §355, distribution will be treated as a complete
liquidation to shs who will report g/l upon the difference between the
FMV stock received and their basis in the original corp’s stock

o Basis:

Corp would be taxable on any gain upon distribution of assets in
complete liquidation
basis of stock or securities received shall be the same as those surrendered
decreased in the amount of any boot received and increased by the amount
of gain or amount treated as a dividend (358)
Tax Consequences for a Divisive D reorg
 Historic Shs
o No g/l to shs on receipt of stock or securities of the controlled corporation 355(a)
o Each SH takes an exchanged basis under 358 in new stock received
o 355 not disqualified if shs receive boot
 boot will be taxable
 if corp already owns tax-free controlled corp but acquires
taxable shares in the last 5 years, this stock is boot (unless it’s a
part of the controlled corp’s SAG)
 boot in a 355 transaction is cash or other prop, excess
securities over securities surrendered (or if none surrendered,
then FMV securities received), stock of controlled corp if
acquired within 5 yrs of the distribution in a taxable
transaction, and nonqualified preferred stock received with
repsect to stock other than NQPS
 Boot in a straight 355 spin-off distribution where sh do not
exchange/surrender shares
 Boot is a 301 distributiondividend to the extent of
distributing corp’s e+p
 Boot in a split-off or split-up where shs exchange some or all of their
shares in return for the stock or securities received (governed by
356a)
 Unless exchange is determined to have the effect of the
distribution of a dividend, the boot will be treated as gain from
sale of a cap asset
 To tell whether it has effect of dividend, look to 302—dos it
satisfy disproportionate redemption?
 If the shs receive securities (355(a)(3)
 excess principal of securities in the controlled corp received
over the principal amount of securities surrendered will be
considered boot
 if securities are received and no securities are surrendered,
then all of the securities received will be considered boot
 Distributing Corp
o Creating 2 new corporation
 No g/l under 351
o Liquidating
When Alden distributes stock to Shs (of the new corps)- 361 still
applies- 361(c), because we are still dealing with a reorg
Controlled Corps
o When corps created
 Got assets, 351 no g/l on receipt of assets
 Take basis from distributing corp- 362(b)
 No g/l when issued its own stock- 1032
o Distributing Corp’s E&P- 312(h), 1.312-10
 Allocated between the two controlled corps
 In proportion to FMV of where the assets end up
 If each entity takes 50% of FMV of assets, then E&P split equally as
well



If any appreciated property, other than stock or securities in the controlled
corp, is distributed as boot in connection with the 355 separation
distribution, the corp will be required to recognize gain upon the
distribution of boot
 No gain recognized at corp level even if all or part of any securities
distributed are treated as boot
 Corp gain recognized on distribution of recently acquired stock of
the controlled corp (taxable transaction)
355 Transaction that is NOT a Reorg
 If the two controlled corporations EXISTED prior to the transactions, then it is not a
REORGANIZATION, but it can still be a 355 transaction w/o meeting the 368(a)(1)(D)
o STILL MUST SATISFY ALL OF THE 355 requirements
o Here, be careful for manipulation by 355(d) & 355(e)
Tax consequences for 355 not a D Reorg:
 SHs
o 355/358
 Distributing corp: treatment changes b/c no transfer of assets by the distributing corp to
the two entities
o 355(c)- no g/l shall be recognized on any distribution of qualified property to which
this section applies and not in pursuance of a reorg (don't have to worry about a
reorg as long as it's a 355 transaction)
 Qualified property: 355(c)(2)(B): stock or securities in the controlled
corporation
 That's the only difference between this and 361(c)- what the
distributing corp can distribute to the SHs (b/c 361(c) says stock or
obligations- so its broader for a reorg)
o Distributing corp’s E&P would disappear (b/c not contributing anything to the
controlled corps)
 Controlled corps
o If their creation/acquisition is apart from this whole thing, then all we have is
distributing corp has controlled corps and just distributing stock in those corps
355(d)
Idea, someone w/ cash trying to buy business w/o gain or loss at the corporate level
o Look for cash acquisition followed by a spin off
E&E Example: Holding company T with 2 subs, T-1 and T-2. X and Y (unrelated
corps) each acquire 50% of T’s stock from the T Shs for cash. T liquidates and
distributes T-1 stock to X and T-2 to Y.
o Basically- T is selling the subs in a transaction that otherwise would have triggered
corporate level gain (no 338 election allowed). T’s liquidation ordinarily would
trigger corporate level gain under 336.
o But it meets the requirement of 355- T is distributing solely stock of two controlled
corps to shareholders.
355(d) combats “disguised sale”
No section 355 at distributing level (the corporate level) if:
 Immediately after, any SH owns at least 50% (by either voting power or value) of
 either distributing or controlled and (disqualified distribution)
o (d)(4)- 50% interest means 50% of voting stock or 50% of total value of shares of all
classes of stock
 Such stock was acquired in a taxable transaction within 5 years prior to the distribution
(“Disqualified Stock”- 356(d)(3))
o Disqualified stock is either any stock in distributing corp acquired by purchase
during 5 year period, and stock in the controlled corp that was purchased during the
5 yr period or that was received in the distribution on distributing corp stock
acquired w/in 5 years or distributions on distributing corp securities acquired by
purchase w/in 5 years of date of distribution.
o
355(e): Morris Trust Rules
o Morris Trust Transaction: Merger of a state bank into national bank, the only barrier
was that the state bank also had an insurance division (and federal law prohibited
national from having insurance) . State spun off insurance by transferring to new
sub and distributing to to shareholders (D reorg). Then the state bank merged w/
the national bank in an A reorg
o Allowed companies to spin off unwanted assets in a Type D reorg prior to a
tax free acquisitive reorg
355(e):
o
o
o
o
355(e)- NO section 355 at distributing level if (only)
50% or greater interest (by vote or value in Distributing or controlled)
Is acquired “pursuant to a plan (or series of related transactions)”
Plan: (e)(2)(B): 2 year presumption (if there is 2 years, presumption that under a plan)
o LOOK FOR: Spin off and within 2 years 50% interest being acquired by another
corporation
o NOTE: Spin off and then Shs CASHING OUT within 2 years (by selling their interest
to another corp through something like an A reorg), then this is a device and the
entire D reorg is ruined
Active Trade or Business requirement: EXAMPLE: 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.