Corporate Tax Outline Spring 2010 An overview of the Taxation of Corporations and Shareholders: Forms of Business Organization (1) Sole

Proprietorships- Businesses operated and owned by a single individual (2) Corporations- fictitious legal entities that offer limited liability to their owners. (3) Partnerships General limited partnerships, LLP’s Joint ventures (4) LLC- provides limited liability for all its members Conceptual Taxation Models (1) Aggregate Concept A business organization is viewed as an aggregation of its owners, each of whom holds a direct undivided interest in the assets and operations of the enterprise Each of the owners takes into his account his or her respective share of income and expenses for tax purposes (2) Entity Concept Corporation is separate and distinct from its owners. Entity is taxed on its taxable income and transactions between owners and entity are taxable events “Double Tax” (3) Hybrid Concept Occurs with S corps and Partnerships Organization is separate entity for things such as filing of tax returns Aggregate  passing through of income, and expenses to the owners, etc Influential Policies Double Tax Rule: Corporation is taxed on its earnings and Shareholders are taxed when they receive dividends. Prior Rule: General Utilities Doctrine Distributions were non-taxable events. DT of C increases the cost of operating a business as a C Corp and often provides TP’s an incentive to choose a partnership or S corp. for business and investment activities

Rate Structure: In Past, Usually, min. individual tax rate has exceeded the corp. tax rate and gave incentive to operate as a C corp. Ex: 1980 and 1987 in class we saw that there was a big difference Current Day: Not as clear because indiv. And corp. rates are approx. 35% and thus it is a fact and circumstance test. Preferential Capital Gains Rates: TP are motivate to devise strategies to convert ord. income into capital gains, such as “bailing out” C corp. profits at capital gain rates Non Recognition Corp. and partnership transactions qualify for no recognition treatment b/c they are mere changes in form which result in continuity of investment.

Classification of Business Entities Corporation Defined Defined under §7701(a)(3) Associations, joint stock companies, and insurance companies Certain unincorporated entities “associations” are treated as corporations for federal tax purposes Pre-1997 Regulations Six Characteristics of a “pure corporation” Associates An objective to carry on a business and divide the profits Continuity of Life SH goes bankrupt or dies, no affect on corporation Centralization of Management BOD has power and responsibility of operating the business. Liability for debts limited to Corporate Property SH not personally liable Free Transferability of interest SH can dispose of shares at anytime Ex: You own GM, and you can transfer your interest to someone else and that transferee will step into your shoes. So if there was an unincorporated entity, and it characteristics EXCEEDED any non corporate characteristic, it was a corporation for tax purposes State laws created LLC and now there was a blur b/t a corp. and unincorporated entity New Regulations were proposed and “check the box” regulations were finalized in 1997. Check The Box Regulations: Began in 1997

Reg §301.7701-2(b)(1) Corporation means a business entity organized under a federal or state statute or under a statute of federally recognized Indian Tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate or body politic Reg §301.7001-3(a) A business entity that is not classified as a corporation can elect its classification for federal tax purposes. Does not apply to publicly traded entities Publicly traded partnerships will be taxed as a corp. §7704(b) Partnership whose interests are traded on an established securities market or are readily tradable on a secondary market. No matter what, once you are publicly traded you are a corporation for tax purposes. Existing Entities: An entity in existence before 1997, generally retains the same classification that it had under the prior association regulations Exception- Single owner entity that claims to be a partnership Election under REG§301.7701-3(c) An entity wishes to change its classification must file an election, which is effective up to 75 days before or 12 months after it file Must be: (1) Signed by each member of the entity, including prior members affected by retroactive elections OR (2) AN officer, manager or member authorized to make the election. Can not change for 60 months, unless Service p[permits the change and 50% of ownership interests are owned by persons who did not own any interests when the election was first made Check the Box Hypos: See attached

FORMATION OF A CORPORATION IRC: §351(a), (c), (d)(1), (d)(2) §358(a),(b)(1) §362 §368 §1032(a) §1223(1) §1221(2) §1245(b)(3) Reg: §1.351-1(a) §1.351-1(b) §1.358-1(a) §1.358-2(b)(2) §1.362-1(a) §1.1032-1(a)(3) A. Introduction: §1001(a) a TP who transfers property to a newly formed corp., in exchange for stock would recognize a gain or loss measured by the difference b/t FMV and AB. AR – AB = Gain (loss) Also, Corp may realize on issuance of stock for property. §351 Allows no G or L to newly formed S or C Corps. §1032(a) provides that a corp., does not recognize a gain or loss when it receives money or property in exchange for stock. Rationale these transactions are mere changes in form of SH investments and thus nontaxable events. §351 preserves unrecognized gain or loss in the SH stock’s basis under §358 and in corp.’s basis in the transferred property under §362. Recognition of Gain or Loss (Transferor) §351 states: Certain transfer of property to a newly formed or preexisting controlled (80% owned) corporation are not taxable events. Unrecognized gain or loss is preserved through transferred and exchanged basis rules Basically no gain or loss will be recognized if property is transferred and all elements are met. Normal §1001(a) Rule does not apply. Rationale Congress felt that a gain or loss should not be recognized because the transferor still has a financial interest in the property and still has control.

and as of the issue date. Preferred stock (does not participate in corp. interest reates. inventory.. commodity prices or similar indicies Even though boot for gain purposes. partnerships. (a) Control . growth and limited to dividends) with any of the following debt-like characteristics (1) SH has the right to require the issuing corp. but does not include: Stock rights. families. or other entities) must transfer property to a corporation (a) Property Cash. etc) to redeem or purchase stock (2) Corp.351-1(a) (1) Exception: Nonqualified preferred stock Treated as other propertyboot rather than stock under §351(g)(1) §351(g) defines nonqualified preferred. (continuing investment) Remember the gain is not forgiven. Elements for Non-recognition under §351 (1) One or more persons (including individuals. accounts receivable.set by reference to mkt. issuer (or a related affiliate) is required to redeem or purchase stock (3) Issuer has the right to redeem or purchase the stock.There is a continuity of proprietary interest. or convertible debt securities”boot” (see below) Reg 1. it is more likely than not that such right will be exercise or (4) Stock’s dividend rate is variable. patents and other intangibles such as goodwill and industrial know-how Property does not include: Past. present or future services (b) Transfer All substantial rights in the property must be transferred So if you transfer a limited license element has not been met. (2) The Property must be transferred solely in exchange for stock of the transferee corporation (a) Solely in Exchange for Stock Must be for stock. warrants. (3) The transferors. rather it is deferred until Transferor sells corp.still stock for control test purposes. corporations.. Under §351(g). or related person (ex. as a group must be in control under §368(c)of the corp. B.’s stock. immediately after the exchange..

351-1(a)(1) Simultaneous exchanges are not required where the rights of the parties have been “previously defined” and the agreement proceeds with an “expedition consistent with orderly procedure” Example 1: A receives 50 shares of voting stock. Control test is satisfied because the property transfers. a TP can always transfer stock for a preferential capital gain treatment (since stock is always a capital asset)…so it makes sense that there is no tack on.--> Tacking! Rule 2: Holding period of stock received in exchange for an ordinary income asset (inventory or services) begins on the date of exchange. . A and B must recognize gain and loss on their property. No tacking for Inventory Accounts Receivable for sale of inventory or the providing of services is excluded Real property that is used in TP’s Trade of business or depreciable property held for 1 year or less Money Rationale If there was tack on for this type of property. Shareholder’s Holding Period §1223(1) Tacking A transferor’s holding period for stock received in a §351 transaction in exchange for a capital or §1231 asset includes the holding period of transferred property. For more than 1 class of Stock aggregate basis is determined under §358(a)(1) as allocated among all classes of stock received in proportion to the FMV of each class §358(b).358-2(a)(2) §358 (FILL IN) used for determining adjusted Basis in Stock and Boot Received 2. Basis and Holding Period: Shareholder’s Basis §351 Transferor’s basis in the stock received will equal his basis in the transferred property immediately prior to the exchange §358(a)(1). so 100/150 is transferred and this is only 67% and thus not 80% and control has not been met. Simultaneous exchanges: Reg §1.§368(c) defines control as: People transferring property must own at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of each class of nonvoting stock. gets stock for services. and C receives 50 shares of nonvoting preferred stock that is not nonqualified preferred stock. as a group own at least 80% of class of stock Example 2: Now C. B receives 50 share of nonvoting common stock. Reg §1.

Only one party can take the loss.. So can elect if Corp or SH should take the loss and if you pick SH. without regard to whether the property was a capital or §1231 asset in the transferor’s hands §1223(2) See parcel table below. has reduce the basis from 140k to 100. you take that percentage to get what will be capital gain and what would be ordinary income. then SH doesn’t take the basis of the stock. transferor’s basis in the land is 10k. notwithstanding (a) the transferee’s aggregate AB of the property so transferred shall note exceed the FMV of such property immediately after the transaction. and inventory with a basis of 30k and a value of 40k. Here. §362(a) §362(a) states that : If property was acquired on or after 6/22/1954. Issue 3: What is A’s Holding Period? . in connection w/ a transaction to which §351 applies. then basis shall be the same it would be in the hands of the transferor increased in the amount of the gain recognized to the transferor (boot) Exception on 362(e)(2) If transferee’s aggregate Adjusted Basis of such property so transferred would exceed the FMV of such property immediately after such transaction then. Rev Rul 85-164 This says that when you have land and inventory (or another non tack on) you proportion the amount based on the FMV Once you do the FMV by percentage. not both.. corporation and A can agree to elect A have the basis in stock be lower. Hypo 1: A transfer land (§1231 asset) held long term with a basis of 10k and FMV of 60k. Ex: 23AB and 20 FMV. and in the inventory is 30k.000 because the rule under §358(a)(1) is the transferor’s basis in the stock received will equal his basis in the property immediately prior to the exchange. since corp. each share of stock takes a split holding period allocated in proportion to the FMV of the transferred asset. Holding Period includes the transferor’s holding period.Combination If stock is received in combination of capital asset and ordinary income assets. Aggregate AB must exceed FMV of transferred property Allocation §362(e)(2)(b) Allocated amongst the property in proportion to its built in losses. in exchange for 100 shares of Newco common stock with a FMV of 100k. Corporations Basis and Holding Period in Transferred Assets Corp’s basis is the same as the transferor’s basis.351-1(a)(1) 362(c) Now. 3. on exam analyze all the properties and say that it is Issue 2: What is transferor’s basis in the stock? A’s basis is 40. so the total basis is 40k.so 3k difference reduce the basis by 3k in the property §1. by a corp. Issue 1: Is this a §351 transaction?- Yes.

60% of the time is of the land. and 40% of the stock is from the day of the exchange. Under Rev. 1231 asset or ordinary income. except now A receives 80 shares of Newco Common stock and 20 shares of Newco preferred stock. so 32k and 20% is preferred. the land is a 1231 asset and the inventory is ordinary income. what is his gain or loss on the stock? Gain AR. Rul 85-164. So for holding period. 60% is land and 40% is inventory. Total FMV of property is 60k land and 40k inventory so 100k. Holding Period Split Holding Period for each share of common and preferred stock 60% tacked from land and 40% commencing on date of exchange. Issue 4: Say that A sells stock the next day.A’s Holding period depends on whether it is a capital. Remember combined basis in both was 40k so: As basis in both classes of stock is 40k and 80% is common. so 8k.40k= 60k 60k*60%=36k (Land tack on so LTCG) 60k*40%=24k(Ordinary Income so ST capital gain) Issue 5: Newco’s Basis and Holding Period Newco’s basis in land is 10k and 30k in the inventory under §362(a) Holding PeriodTacked under §1223(a)(2) Hypo 2: Same facts as above. Here.AB 100k. there is a split holding period allocated in proportion to the FMV of the transferred asset. .

A transfers 25k for 25 shares B transfers inventory with a value of 10k and a basis of 5k for 10 shares C transfers unimproved land with a value of 20k and a basis of 25k for 20 shares D transfers equipment with a basis of 5k and a value of 25k (prior depreciation was 20k) for 25 shares E transfers 20k note for 20 shares. the depreciation is normally a gain under §1245. B. must allocate loss based proportionally .New Holding PeriodB-Inventory5k10k2010k05kTack on! C-Land25k20k20(20k)020kTack On! Capital asset (c). Yes 3. D. C. In two years at 4k per year plus market rate interest Issues: What are the tax consequences (G or L recognized) Does 351 apply? 1. The note is payable over a 5 year period beg. E received the note in exchange for land with a 2k basis he sold last year. Yes 2.Page 64 Problem: A.Parcels ABFMVBuilt in G/LAdjustmentRevised ABParcel 115k10k(5k)(3k)12kParcel 28k10k2k-8k23k20k(3k)What if there were two parcels with loss. (find out rule if AB>FMV) For the equipment. X issues 100 shares of common stock. but under §351 it will not be an actual realized gain! (b)Effect on Corporation for shares ABFMVAmount of sharesGain realizedGain RecognizedBasisHolding PeriodA-Cash--25k2525k0N/ANo Tack on. E form X Corporation to engage in a manufacturing business. Key Things to rememember: Transferor takes basis.New Holding PeriodB-Inventory5k10k205k05kNo Tack on because does not fit categoriesC-Land25k20k20(5k)025kTack On! Capital assetDEquipment5k25k25 shares20k05kTack onE.Note2k(amount paid)20k2018k02kOnly tack on if land is a capital improvement land. In control yes Effect on Transferor: ABFMVAmount of sharesGain realizedGain RecognizedBasisHolding PeriodA-Cash--25k250025kNo Tack on.

Double tax here! Rationale. (d) If there is an inherent gain and also a gain to the SH.Corporation will take the adjusted basis unless they make an election that SH is taking the adjusted basis. both will be taxed.else everyone would try to make it a capital gain and always escape ordinary gain. .

A must recognize a 50k gain on the transfer of land because this is not a §351 transaction Intermountain Intermountain Lumber Argued that trans was not a good 351 (bc it wanted higher basis to depreciate). since C was not a transfer or property to Newco. Case Law about two transfers that are interdependent Binding Agreements to Dispose of Stock If a SH disposes of stock received in exchange for property pursuant to a prearranged binding agreement entered into prior to an incorporation exchange. rather it imposes an obligation.351-1(a)(1)page 1146 of code . not a good 351 transaction RJ This case does not further §351 policy for formation of corporation.does include time where rights of parties were previously defined and completed in a reasonable time frame. and A only owns 60% of NEWCO immediately after exchange and thus 80% is not satisfied. §1.here there is more than a mere change of form. Technically this happened but there was an agreement for Shook to sell 50% of stock (over time) to Wilson. Control test is applied after the transfer to C. Issue when a transferor disposes of stock shortly after an incorporation exchange. Bc lower depreciation deduction (taking shooks basis) Rule §351 – no gain or loss recognized if prop is transferred for stock IMMEDIATELY AFTER the exchange. Only applies if there is a binding obligation. .CONTROL Immediately after the exchange Transferor’s of property must have control of “NEWCO” immediately after the exchange. there is a pre-existing binding agreement where transferor will see so he loses control.immediately after exchange does not require simultaeneus transfer. Example: A transfers land with a basis of 10k and value of 60k in exchange for 60 shares of Newco (60%) and B transfers equipment with Basis and FMV of 40 for 40 shares (40%) Two months later. Court justifies this holding by – saying that 351 affects non-recognition of gain or loss that is only a change of form --. IRS argued it was a good 351 trans. Prof says this is a bad decision If prior to time you make transfer to a corporation. her ownership cannot be counted in testing for control. Ct says control must include freedom of action – was contracted to sell 50% of stock. Can be at different time and considered the same transaction . the control test is applied after the stock disposition So look at situation immediately after the transfer! A disposition of more than 20% of voting power or more than 20% of any class of nonvoting stock will cause a loss of control because the person ultimately acquiring the stock was not a transferor of property to NEWCO. pursuant to a prearranged binding agreement B transfers all her Newco stock to C for 40k cash.

if Newco issues the stock DIRECTLY to the transferee’s donee. 77-37 Property is not relatively small if it equals to or in excess of 10% of the FMV of stock already owned by the transferor. probably won’t be §351 transaction Hypo: A receives 70 Shares of CS (70k) in exchange for land (FMV-70k and basis-20k) and B receives 30 shares (FMV-30k) in exchange for 1k cash and services. and now B says A you get 100%. pursuant to agreement A agrees to transfer 30% of stock to B . HYPO: TransferorTransferred AssetAdjusted BasisFMVStock ReceivedCLand20k50k50%SCashN/A10k10%ServicesN/A40k40% Here. and if the property is relatively small.351-1(a)(1)(i) Tax consequences of this transaction is determined under §61 and §83 Problem: A person who receives stock solely in exchange for services may cause the other parties to the incorporation to recognize gain or loss.. thus all stock received can be counted for purposes of 80% control requirement.351-1(a)(1)(ii) If the value of the property transferred is of relatively small value relative to the stock received for services and the primary purpose of the property transfer is to qualify the exchanges of other transferor for non-recognition. Exception: Reg §1. transfer will not cause the transaction to fail the control requirement.3 * 10) = 27k A does not want this so A transfer biz to new corp called X. Result is same.thus this is not a good 351 (intermountain says this is not 351 but 1001) A would recognize a gain of 90K Heta go see RJ Voluntary Donatives Dispositions of Stock A voluntary disposition of stock (ex: gift) after an otherwise qualified §351. so now A only has 70%. A70% (property) . this works as a good §351 transaction under §351(a) Because both C and S make up 100%. and thus this is a taxable event! §351(d)(1) and Reg §1.Hypo: A owns property with a FMV of 100 and Basis of 10k and sells B an interest of 30%. So Compare the other property to the services. A has to recognize the 27k (30k . Example Corporate Transferors The fact that a corporate transferor distpurtues part or all of the Nexco stock that it receives to its SH is not taken into account under 351(c) Special Problems: Stock for Services §351(d)(1) stock issued for services is not considered as issued in return for property. so B has a gain of 3k. then CANNOT use for 80% RELATIVELY SMALL VALUE under Rev Proc.

Page 73 Problem 1: CONTROL issue Does the following qualify under §351? (a) A and B are unrelated individuals. and 29k services.look at A and B collectively. on Jan 2 of the current year by transferring property with a basis of 10k and value of 50k for all shares of Newco CS. so the cash is of a relatively small in comparison to the services. except the transfers by A and B were part of a single integrated plan. B receives 5 shares (5k) for 5k cash and 25 shares for 25k services. cash is for 5k and it is 10% of 25k which is 2. so will be a 351 transaction. (less than 10%) so not a §351 transaction. A is control of more than 80% and thus he qualifies under §351 He will not recognize a gain or loss and will be able to tack on. B transfers property with a basis of 1k and value of 10k for 10 shares Newco nonvoting preferred stock (this is not nonqualified preferred stock) A A’s transaction qualifies as a §351 transaction. Here. except A transferred 25 of her 50 shares to her daughter as a gift on 3/5 (3 days after B’s transfer). §1231..500. B B’s transaction is not a §351 transacton because he only has 10 shares of nonvoting preferred stock which is not 80%. Inc.B’s basis is 1k and corp takes basis of 1k. because A does not have more than 70% Hypo 2: Now.real estate with trade or business. but B STILL RECOGNIZES a gain on the stock received for services So there is a gain of the 25k as ordinary income. §368(c). On March 2. What if A’s gift was on 1/5? A get shares on 1/5 and then transfers to daughter . so B can tack on if property is either a capital asset or 1231 property and the corp.B 30%. No tack on and qualifies under §1032 so basis in property is FMV (b) Same as (a) above. in an unrelated transactions. and both A and B recognize gain and loss. A forms Newco. can take the same basis (c) Same as (b) above. and now they own 100% of voting and nonvoting so they both qualify under 351 this transaction A has same consequences as above B. B receives 1k cash.

50% so not 80% and thus no control (d) Same as (b) above.Here.) However.. and M will enter into 5 year employment agreement Java wants control. 15 shares were sold. except that two months after B’s transfer. wants to be fairly compensated (believes her services are worth 80k/year) (a) J will get 200 shares and V will get 150 shares. raise 150k of addl’t capital and hire.Say A received it as a binding contractual relaton No §351. so not a §351 transactions. What if C transfers ppty for 50% and S transfers ppty 10% and services 40%. A sold 15 shares to E pursuant to a preexisting oral understanding w/o which Newco would not have been formed. Reg 1. M will get a salary of 40k/year and receive 150 shares. he wishes to incorporate. who has agreed to serve as chief operating officer if the terms are right The parties have decided to join forces and form Java Jyve.. Interdependent Test If two transfers are interdependent they will be treated as part of the same transaction Here. then that person does not qualify as transferring property for the transaction. Here S would be counted as a property transferor. (does not matter that services were used to transfer also. V wants a guaranteed investment but wants to share in growth of business. To do so. Rev proc 77-37 ( FMV of stock received >= 10 % FMV of stock received for services. there is no change and A still has control – because intermountain says that there need be only a freedom of action with regard to the stock after completion of the initial transaction. an experienced person to manage the business.351 does not apply and must pay tax on the gains. so now only 70% and requirement has not been made. FMV of stock is 1k/share. What if A transfers services for stock (20%) A pays taxes as ordinary income B transfers property and retains 80% thus meets 351 test What if A transfers services for 30% stock A still pays ordinary income tax B does not retain 80% . inc Java will transfer assets with an AB of 50k and FMV of 200k Venturer will give 150k Cash. . mgr.351-1(a)(1)(ii) if property transferred for the stock is so small compared to stock transfer for the property and purpose is to create a 351 situation for another person. 10% of 40% is 4 and 10 > than 4 thus transferred property. He has located Venturer. Hypo.b/c under binding agreement there is no control Here he was OBLIGATED to sell. who is willing to invest 150k cash and Manager. (this is a deminimus rule) Problem 2: Java has operated a chain of coffee houses as a sole proprietorship over the past three years and is now interested in expanding his horizons and limiting his liability. (thus 60% of stock transferred for Does this qualify for 351 treatment? Yes both C and S both transfer property and retain 100% of stock ownership.

so nowstock for property is are more than 10% of amount of services and this will be a §351 transaction. documents specify she is getting shares in exchange for her cash contribution rather than for future service Stock is worth 150k and so here FMV of stock is 1k and services is 149k. Qualifies as a §351. 10% of 130k = 13k 20k>13k manager pays ord income on 130k but Java is off the hook for the transaction. but M gets compensation of 80/year and will pay 150k for her stock.500 shares Java wants >50% of stock. so here 1k is relatively small and under regulation not a §351 transaction. . so he has a gain of 150. here he only gets 40% so it doesn’t satisfy Java’s goals J and V have 70% and not 80% so this is not a §351 transaction and will be taxed on gains. So here J’s AB is 50 and FMV is 200. Where as. (d) Same as (c) except M will pay 20k rather than 1k Now she pays 20k and 130k in services. Here J and V. and Basis of 200k (FMV) VBasis of 150k Manager ordinary income of 40k. when she pays.. V still does not own or have control Now mgr. will not have 80% because cannot use it for these purposes. and 150k of Shares (b) same as (a). because now it is cash and not services. gives a note this is still property (unlike services) but manager has to pay the note eventually and pay service (c) same as(a) except M will pay 1k for her 150 shares and the incrop. Managers share do not count because she gets services instead.

Rule Recognize the lesser of the boot or realized gain Rule: S351(b) NO LOSS IS RECOGNIZED ON BOOT! Transferor’s Basis in Stock Formula under §358(a)(1) Transferor’s Adj Basis in property Transferred (-) Amount of Cash and FMV of Boot (Debt and other non-stock property) (+) Gain Recognized by transferor = transferors AB in stock received More than one class of Newco Stock Aggregate basis determined above is allocated among the various classes in proportion to fmv of each class§358(b). so here. in a §351 transaction. so here. Gain Rule Gain recognized on boot is limited to the gain realized (so it is the lesser of the boot received or the gain realized) If property transferred is capital then the recognized gain is capital. AR-AB 100k-70k30k Realized Gain. §351(b) provides that the transferor’s realized gain is recognized to the extent of the cash and FMV of any other boot received No Loss Rule Even if boot is received by transferor. but YOU CAN ONLY RECOGNIZE 30k. e. land with FMV is 100k and 70k is AB. §351(b)(2). but here cash is 60k. §1. RECOGNIZE 20k Recognized Gain EXTENT OF CASH!!!!!!!!!!!!!!!!!!!!!!!!!!! §351(b) says gain recognized is to extent of cash AND FMV of boot. Example 2: A gets 60k cash and 40k stock and gives corp. If part capital part ordinary – then you bifurcate the transaction by capital and ord Step One: Determine the realized gain on the exchange Example: A gives property with an AB of 70 and receives 80k stock and 20k cash. AR-AB 100k-70k30k. boot. securities.358-2(a)(2) So In example 1 basis is70k – 20k +20k70 K basis §358(a)(2) Boots basis is FMV . nonqualified preferred stock or other property. no loss is recognized.Treatment of Boot In General If a transferor receives property other than stock. Character of Gain Determined by reference to the character of the transferred asset to which the gain is attributable taking into account the depreciation recapture provision under §1245 and other applicable characterization rules under §1239 Gain is triggered by the receipt of boot results in increases to the SH basis in the stock received and the Corp’s basis in the transferred property. corporate debt. cash.g. the extent of it is 20k lesser of boot received or realized gain of pproperty transferred.

so 60% goes to land and 40% goes to equipment So 6k of Capital Gain on capital asset and 4k on ordinary income. corp.453-1(f)(3)(ii) Handout Example: A transfers property (AB. Hypo 1: A transfers 50k cash in exchange for 50k stock B transfers a capital assets with Basis of 5k and a value of 30k and equipment with a basis of 5k and a value of 20k (10k is recapture under §1245) in exchange for 40k stock and 10k cash Issue 1: Where is the boot allocated for B? B has boot of 10k and it is allocated b/t capital asset and equipment in proportion to the FMV. on the capital asset. but no realized loss may be recognized under §351(b) Rev Rule 68-55 Boot allocated to a loss asset will not cause gain or loss recognition. Here. Two Parts: (1) A §351(a) recognition exchange to the extent of the stock (“permitted property) received by the transferor and (2) a taxable installment sale to the extent of the boot received Basis of the transferred property is first allocated to the nonrecognition exchange and any remaining basis (“Excess basis”) is allocated to the installment sale.’s basis in the property received is TRANSFEROR’s BASIS + ANY GAIN RECOGNIZED. income on the equipment but may not recognize any loss. The 10k cash boot is still allocated 6k and 4k to the equipment. B recognizes 4k of ord. except that B’s basis in 30k capital asset is 40k rather than 5k. Allocation of Boot Rule. 30k is land and 20k is equipment. Boot is allocated among the transferred assets in proportion to their relative FMV Realized gain on transferred asset is recognized to the extent of the boot allocable to that asset. Installment Boot §453 A transferor who receives boot in the form of a newco debt instrument may be allowed to defer recognition of any §351 gain. may increase its basis under §362(a) only when that gain is recognized§1.When several assets are transferred in exchange for a combination of stock and boot.Corporation’s Basis §362(a) If the transferor recognizes gain b/c of the receipt of boot The corp. Installment Method If transferor defers any gain recognized under the §453 installment method. cash of 5k and a note of 45k Step 1: AB of transferred property to the stock up to the amount of the stock FMV . Hypo 2: Same as Hypo 1.20k and FMV-60k) to X in a transaction under §351 and receives an exchange stock (FMV-10k).

FMV of Boot + gain Recognized So here 20k-50k (note+cash)+40k10k gain Step 5: Corp’s AB in property received: AB in the property is equal to the transferor’s AB. which is 20k. so you end up applying the installment sales method: AR which si 5k cash and 45k note50k Subtraict AB allocated-10k Now there is a gain for 40k Step 3: Gross Profit %--> Gross Profit (Gain) / Total Sales Price 40k/50k 80% Gain on cash received is 4k (80% of 5k) and Gain on recognized payments of not is 36k (80*45k) Step 4: SH AB in stock: Elect as though there was no installment method and compute under §351 AB of Transferred Property. and the FMV is 10k. Is then allocated to the installment sales portion Here. the AB is 20k. . and increases AB when S recognizes gain. so AB is 10k Step 2: Remaining amount.Here. it is 10k.

no G/L recognized Boot Formula is AB + gain recognized. just be aware of services and that they don’t count.Ab. Note. Step 2 A A is getting boot in this transaction. need to spit up by FMV. exchange property. so you have 75% of common 25% of preferred or 1$ 1. so here it is 15k +2k. A- not qualified preferred stock (a) What are the tax consequences of the transfers to each SH and to X corp? Step 1 Is this a §351 Transaction Yes. So here need to do formula: Gain Realized is AR. Gain Realized 20k(k) Amount of stock given b/c it is the FMV of the stock. so in this case 2/3 goes to inventory and 1/3 goes to land Boot 15k 2/3 Inventory10k 1/3 Land 5k (1)Gain or Loss Realized on Boot (Inventory) . So 15+2 which is 17k. so here.AB (which is 0 to corporation §1032.Page 83 problem A. Holding period = if held for more than one year its 1231 and tack on permitted. Holding period is based on the proportion received.S (10k) 5k cash and X’s note for 35k payable in two years. by transferring the following Assets. 100% and control. B.of ordinary income (due to recapture of depreciation) AB of property given is 15k less 2k(amount of cash) + 2k So here the AB is 15k. Step 3 B has two properties. and C form X corp. But you need to proportionate by the type of stock. 80) Corp AB + Gain Recognized.. 17k (15+2) – 15k2k Here 2k is recognized! . because we have common and preferred. or 17k.250 basis in common stock and $ 3. A receives 15 shares of X common stock (value-15k) 2k cash and 100 shares of preferred stock with value of 5k) B receives 15 shares of X Common stock (15k) and 15k cash C receives 10 shares of X C. Land and Inventory.When you have two properties.750 AB in preferred stock. (p. each of which has been held long-term TransferorAssetABFMVAEquipment §1245 gain15k22kBInventory7k20kLand25k10kCLand20k50k In exchange. 15k/20k is common and 5k/20k is preferred. Here 2/3 gets a new holding period 1/3 gets a tack on period.

AR(20k). income on 10k. C.AB(7k)13k Boot10k.250 =30k Step 3: Tax payer Basis in stock received is: AB in property( 20k (-) Boot----- 40k (Note +Cash) (+) Gain recog 30k Basis.750 and then increases AB when gain is recognized. There was no recognized boot here. (gain is ordinary) (2) Gain or Loss Recognized on Boot (Land) AR (10k).750 75% of note is 26.15k (fmv of stock) (2) Recog.To get value of stock must do Aggregate Basis: AB in property 20k (-)FMV of boot (15k) (+) Gain recognized 10k Basis in stock is 15k (3) Effect on Corporation: (1) Realized Gain.10k. 23. or 5k is 3. so recognize ord.AB(25k) (15k) Loss No loss is recognized on boot! (2).0 (3) Basis in Assets Inventory: Basis + Recognized gain 7k+10k. 26250 + 23750 = 50k .Land of 20k AB with FMV of 50k C gets 10 shares with 10k FMV and 5k cash and 35k Note Step 1 with Installment Method: Allocate basis in stock up to FMV = 10k to the 20k AB in land So here AB of the stock is 10k Step 2: Remaining amount Allocate to installment sales portion AR40k (Note and FMV of boot received ( here. Corp AB of 20k+ 3.750 cash. cash)) AB allocated-10k Gain is 30k GP% is 30/40 or 75% Gain Recognized in year 1: 75% of cash received. so need to adjust the AB of land by 10k so 25k-10k is 15.17k Land: basis + Recognized gain on boot Here you have to do §362(e) adjustment Land and Inventory have an AB of 20k and FMV of 30k.

G/LBasisHolding PeriodG/LBasis in AssetsHolding PeriodRealizedRecognizedReal.11.250 PS-3750Tack on b/c §123120k017kTack onB(2k)10k ord.RecognizedA7k2k of Ordinary Income from BootCS.Effect on TransferorsEffect on Transferee-Corp. income on inventory boot. 27kTack on 1/3 for land (fmv) New 2/315k0Inv-17 .

Land-13kTack onC30k3. Non-Recourse §357(d)(1)(B) A nonrecourse liability is treated as having been assumed when an asset is transferred to Newco subject to the liability . Unless the assumption was for the purpose of avoiding gain – then total amount of liabilities is treated as boot (recognized gain). a company assumes a liability of the transferor SH. preserves 40k in land (60-20=40) Determination of Amounts of Liabilities assumed: Recourse §357(d)(1)(A) A recourse liability is treated as having been assumed to the extent that. (1) What is A’s gain? 0. whether or not the transferor-SH has been relieve d of it.because the transfer of liability under §357(a). is not boot received and no gain or loss is recognized.750 and 26.358-3 In General: §357 (a) Rule: If under §351 exchange. the assumption is not boot received by the transferor.750Tack on ASSUMPTION OF LIABILITIES IRC: §357(a)-(c) §358(d) §357(d) Skim Regulation: §1. the transferee has agree and is expected to satisfy the liability . §358(d) Transferor’s basis: Liability is treated as boot for purposes of determining transferor’s basis in the Newco stock So only use liability in boot equation Example: A transfers land with a basis of 30k and a FMV of 100k and subject to a 10k liability in exchange for Newco common stock worth 90k (mtg of 10).357-1 §1.25010kTack on10k023. (2) what is A’s Basis in Newco Stock? Formula under §358(a)(1) Transferor’s Basis in property Transferred (-) Amount of Cash and FMV of Boot (Debt and other non-stock property) (+) Gain Recognized by transferor Applied to this formula: Basis20k -10k – 010k basis 10k basis. based on all the facts and circumstances.357-2 §1.

Applied sep. to each transfer or property Purpose: prevent a negative basis to stock Rule: §357(c)(2)(A) if §357(b) and §357(c) both apply. then. .55k (Debt relief) + 25k (gain recognized)- 0 So if §357(c) applies. the excess is treated as a gain from the sale or exchange of property. accruel based) cash. but basis in stock would be 30-55 and thus negative so §357(c)(1) A must recognize 25k gain (excess of liabilities over debt) A’s basis in the Newco stock is 30k (basis of land) . §357(b) (tax avoidance) takes preference Hypo: A transfers land with Basis of 30k. Reg §1. a FMV of 100k and subject to a 55k liability in exchange for stock worth 45k §357(a) A would have no gain. the amount of the liability treated as assumed must be reduced by the lesser or: (1) The amount of that portion of the liability which an owner of other assets not transferred to Newco and also subject to the liability has agreed to and is expected to satisfy. basis in stock will ALWAYS BE 0! (cash basis based v.357-1(c) all the relieved liabilities.reports income when receives it and takes deduction when pays the expense. and 10k boot under §351(b) As basis in stock is 20k-10k +10k20k Exception 2Liabilities in Excess of Basis §357(c)(1)Sum of liabilities assumed in §351 transaction exceed the aggregate AB of the properties transferred by a particular transferor. TP has burden of proving the absence of an improper purposes by the clear preponderance of evidence§357(b)(2) Improper Tax Avoidance Ex: (1) company assumes personal debts. Exception 1Tax Avoidance Transactions §357(b) Assumption of liability is treated as boot if the TP’s principal purpose transferring the liability was the avoidance of federal income taxes or not a bona fide corporate business purposes.S357(d)(2) But when more than one asset secures a nonrecourse liability. not just the abusive debts are treated as boot. FMV of 60k and subject to a 10k liability in exchange for 50k stock A encumbered the land shortly before the transfer in order to raise funds to pay personal expenses here this is tax avoidance. And basis is zero. A/R are greatest asset. or (2) the FMV of the other assets to which the liability is subject Purpose: Foreclose abusive result by preventing the liability from being counted more than once to make an upward adjustment under §362. or (2) Encumbering personal property for personal Reasons Hypo: A transfers land with a basis of 20k.

570 IRS says No you can’t do this b/c it is just a note and an IOU.If created corp would assume trade payables say 300 – thus would recognize a gain of 300 amount of boot including assumption of liability. Commissioner: A transferor does not avoid §357(c) gain by remaining personally liable for debts encurmbering property transferred to Newco in a §351 transaction Avoiding §357(c) by Transfer of Note Peracchi: Facts.060m and now liabilities doe not exceed basis Liabilities of 1. RJ’s issue with case what is a “bona fide debt” It was a legitimate 351 transaction – he was a 100% owner of stock after the trans. This is not fair. However bc of 357c assumed liability here is not treated as boot. so he decides to gives his note of 1. Ie 300 gain. Here IRS says that TP has 0 basis but this is an unsettled part of the law! Character of §357(c) Gain §1.550 (-)AB . Would get offsetting deduction to when paid the trade payables and recognize no gain. If given cash instead ot assuming liability taxed on the lesser of fmv or the amount of boot.357-2(a) The character of gain is determined by allocating the gain among the transferred assets in proportion to their respective FMV . Accruel Transferor Remains Liable to Creditor Case: Owen v.P’s liabilities would have exceed basis. income. Thus real and substantial increase in TP’s corporate investment. Lessinger Rule: A TP who transfers his own enforceable note to a controlled corp. – note has a basis of Zero Court TP had a basis equal to face value in his own note transferred to a wholly owned corporation b/c the note was a corporate asset subject to the claims of creditors in the event of a bankruptcy. Statute does not support this rationale.980 = . in a §351 transaction may avoid recognizing gain under §357(c) Sine the corporation took the note with a basis equal to its face value. LIMITED to notes that have economic substance and have a FMV roughly equal to face value in his own note transferred to a wholly owned corporation b/c the note was a corporate asset subject to the claims of creditors in the event of a bankruptcy. the TP should not be required to recognize any gain. and he would have ord.

§357(c) may be characterized by reference to an asset who has no built in gain Hypo: A transfers inventory with a basis and FMV of 10k and a capital asset with a 25k liability with a basis of 5k and a FMV of 30k. Gain Recognized Basis of Assets 15k-25k (Liability)10k Gross asset value is 40k10/40 (25%) is inventory, and 75% is capital asset. So 25% is ordinary income (inventory) and 75% is capital gain even though A had no built in gain realized on inventory. Excluded Liabilities: Liabilities assumed by Newco that have not yet bee taken into account by the transferor for tax purposes (either §162 or increasing the basis for property) are not treated as “liabilities” for purposes of determining gain recognized under §357(c)(1) or basis under §358. §357(c)(3) and §358 (d)(2) Example 1: A, a cash method TP, transfers 50k cash and 200k AR (0 basis) in exchange for 150k and Newco’s assumption of 100k of A’s AP which would have been deductible under §162(a) if paid by A §357(c)(1) A would recognize 50k gain (excess of 100k AP over 50k cash) §357(c)(3) AP are not treated as liabilities, A thus recognizes no gain. A’s basis in stock is 50k and it is not reduced by AP assumed by newco. Example 2: Newco is formed, B, an accrual basis TP, transfers contaminated land w/ associated contingent env. Liabilities in exchange for all of Newco’s stock. B neither deducted nor capitalized any amount with respect to liabilities The liabilities assumed by Newco in the exchange are not liabilities under §357(c)(1) and §358(d) because NEVER DEDCUTED by B and they did not create or increase the basis of property prior to transfer Limit on Basis Increase Attributable to Liability assumption Page 102 A organized X corp by transferring the folliwng: Inventory AB- 20k and FMV-10k Unimproved Land- AB-20k and FMV-40k with a recourse debt of 30k X took land subject to liability and gave 20k of stock to A (a) Assuming that §357(b), is not applicable how much gain does A recognize and what is A’s basis and holding period of the stock? AB is 40k (aggregate 20k + 20k) and Debt assumed is 30k. So here there is no excess No gain or loss is recognized when debt is assumed; it reduces the basis in stock received AB in stock received is: AB – 40k

(-) FMV of boot- Debt- 30k (+)gain recognized = here none So total is 10k basis. Inventory No tack on and it is 50/50 split. You get a tack on where a capital asset or 1231 asset. Inventory not included. So each share you get back there is a split holding period. Ie inventory – each share is 10k = so ten shares for inventory Land – each share is 10k = so ten shares for land Corp takes - basis of property transferred. Ie 20k and 20k (b) and (C) Now basis in land is only 5k Now the problem is that Debt exceeds the AB of the stock, so you need to recognize a gain Liability assumed is 30k and total AB of transfer is 25k, so gain recognized is 5k Whenever this happens basis is always 0, but do the math and: 25k-30k+50 Character of the 5k gain (4/5) 80% is capital gain and (1/5) 20% is ordinary gain §1.357-2(b). Allocate the §357(c) gain between the transferred assets based on the relative fair market property values (without consideration of the debt). (d) What is Corps’s Basis in the properties Received in (b) corp takes transferred basis plus any unrecognized gain. 5k(20% to inventory and 80% to land) so here 1k and 4k are added to the basis reg says - 21k (20k +1) for inventory, and 9k (5k + 4k) for land tax ct says 20k and 10k (e) A could have avoided by: Giving cash of 5k to Corp Paying off some of the debt Giving another asset that would increase basis. Perachi case – can transferor provide a note of the amount (see perachi above)

Problem 2: B organized Y corp. and x-ferred bldg. with AB of 100k and FMV of 400k. Bldg. is subject to mtg. of 80k which was incurred two years ago for valid business reasons. B borrowed 10k for personal purposes with a secured loan on mortgage (this debt is taxable) Y corp will issue 310k of common stock to B and will take bldg. subject to mortgages. (a) What are the tax consequences to B on x-fer of bldg to Y corp. Step 1: Liability is 90k which is less than AB

(2) Is there a tax avoidance purpose so here yes the 10k, under regall liabilities will be treated as boot! AR here is 400k and AB is 100k  so the lesser of 300k gain and boot is 90, so recognize gain of 90k Basis in stock is: 100k -90+90 100k Basis (b) What if B did not borrow 10k and instead Y borrowed 10k from a bank and gave B 310k of Y c.s., 10k cash and will take the bldg. subject to the 80k mortgage Now the 80k is not boot, but there is boot of 10k 10k boot is recognized gain Basis- 100k -90+10 20k basis in stock (c) Is the difference justified In A, it was tax avoidance so that is why it was treated as boot. (d) When might there be a leg. reason for corp to assume a property’s debt? Bona fide business purposes.

SPECIAL PROBLEMS Incorporation of a Going Business (1) Assignment of Income Doctrine Assignment of Income doctrine does not apply to a transfer to Newco of AR by a cash basis TP unless TP has a tax avoidance purposeHempt Bros Ex A transfers the assets of her cash method sole proprietorship, including 0 basis AR, in exchange for Newco stock Here although A earned income, she is not taxed, Co., will have a 0 basis and get taxed when they get the income Accrual Basis Basis is equal to amount already included in income, and newco takes that same basis and recognizes no add’l income when it collects the receivables. Corp takes basis (2) AP and Contingent Liabilities AP transferred to Newco by a cash basis TP or contingent liabilities for which the transferor has not received any tax benefit are not liabilities for §357(c)(1) Purposes IRS permits Newco to deduct the payable when they are paid I they would have been currently deductible by the transferor or to treat them as cap-ex as appropriate under Newco’s method of accounting. Accrual- take this into account when calculating §357 boot and AB of transferor. (3) Tax Benefit Rule TB rule requires a TP who derives a tax benefit, such as a deduction, in one year to recognize income in a sub year on the occurrence of an event, such as a recovery of the amount deducted, that is inconsistent with the earlier deduction

Nash SC held that the tax benefit rule did not require an accrual basis TP to recognize income on the transfer of AR in a §351 transaction when the TP had previously deducted some of the AR as uncollectible by creating a bad debt reserve No recovery because the TP received NEWCO stock equal to the value of the AR less previously deducted debt reserve No longer important because- TP generally may not deduct bad debt reserves §351- override TB rule in situation where the TB can be preserved and later “recaptured” through a transferred basis. Rev Rul-95-74 Page 112 Problem Key Notes: General Rule of 357(c) Liabilities assumed (100k) – AB (60k) = 40k. However, AP is not a liability whose payment by transferor would have given rise to a deduction/is not a liability for §357(c) purposes (if architect paid them they would be deductible as a business expense). So never use AP to increase the basis. Thus liabilities assumed is 30k not 100k and thus basis is not > than liabilities assumed. AB = AB=(60) – liabilities (30K) – gain (0) = 30k What about the toxic liabilities. Rev Rule 95-74- Contingent liabilities whose payment have been deduct do not increase basis and not under §357(c) So: do not use AP or contingent liability to calculate boot and AB of Transferor. (b) Tax of AR that hasn’t been paid yet and is transferred is tax to the receiving corporation (c) For contingent liabilities the rule is: Deductible by the corp., as a business expense under §162 or are capital expense under §263 as appropriate under S’s method of accounting determined as if S has owned the land for the period and in the same manner as it was owned by the P. Reasoning for 357 © TP would get an offsetting deduction from the AR and AP but this would not happen. TP would not recognize gain for AP but Adj basis in stock transferred to TP AB in Transferred Prop = 60 (-) FMV of boot = (30) (+) any gain recog= 0 total = 30 Holding period = nature of assets being transferred AR are not cap or 1231 Supplies are not cap asset or 1231

Peculiarities found in the problem . Here Liab asummed 70 (not 30: 357c exclusiont not applicapble here) AB of transferred prop 120 AB of transferred Prop 120 (-) FMB of Boot 100 (70 + 30) (+ gain 0 = 20k . the liabilities may be capitalized – part of the cost of the underlying capital asset (the land that is polutted) 95-74 Rev. TP would have to incur the income.NO (b) Who pays the Receivables – from hempt bros case. See above. Rul = see above Should tax benefit rule (recovery of money from previous deduction (ie supplies) from sale be applied to a 351 . To the extent those would be deductible (paid by the transferor) they would not be attributed to basis in 357(c). (d) TP is trying to mismatch revenue and expense. Basis for corp = no gain recognized so will take basis that TP transferred.environmental contingent liabilities – in problem corp assumed those.Thus there is a split holding period in each share of stock 120/200 = 60 % tack on 80/200 = 40% new period. (c) Can AP once paid by Design be deducted as an expense – YES design can. – TP wants to deduct the expenses to reduce his tax And allocate all the income to the Corp. What if TP was accruel Assets = what would his basis in the assets be different.

Common and Convertible (B) Debt: Evidence by a written unconditional obligation of the corp. (1) Sources of Corporate Capital Debt and Equity create Capital Structure (A) Equity: Equity is contributed to a corp.. (2) Tax Advantages (A) Debt Interest Deduction .CH 3 Capital Structure of a CORP. to pay a specified amount on demand or on a certain date. in exchange for an ownership interest evidenced by shares of stock Types Preferred..

Is repayment of the loan a dividend payment or loan repayment. fails would lose same amount as if it were a creditor or SHer. Ex. Repayment of Principal A tax free return of capital to the lender §1271 if amount repaid exceeds lender’s basis. 3 SH abc raises suspicion Stock Debt 300k 300k 500k 500k 200k 200k A B C As opposed to Stock Debt A 300 1000 B 500 0 . (3) Deciding Equity or Debt Note Courts use factors. but not dividends – mitigated by consequences to lender. Or 9:1 lenders prefer to lend to the former. excess is generally treated as a capital gain Defense against Accumulated Earnings Tax (B) Equity §351 Non-recognition Character of Loss on Worthlessness Corporate SH Qualified Business stock What happens when a shareholder loans to the company.? 1.Principal tax advantage of debt is avoidance of the “double tax” on corporate profits A corporation can deduct interest paid on its debt under §163. (1) Form of the Obligation An unconditional promise to pay A specific Term A stated rate of interest payable in all events Hybrid Instruments that have voting rights or make interest payments CONTINGENT on earning are likely to be treated as equity (2) Proportionality Debt held by SH in the same proportion as their stock is subject to special scrutiny Rationale SH have no economic incentive to act like creditors by setting or enforcing the terms of the purported debt. The second number in the ratio is called the equity cushion. Only difference was a tax difference. Amount that can be lost and pay the outstanding debt. Debt equity test – compare the debt of sh with SH equity 1:1. Because it signifies how much a biz can lose but pay its debts. but ultimate question is it ”risk capital” or strict debtor creditor relationship viewing the transaction as if it were w/ an o/s lender. If co.

The ratio of SH debt to SH equity is sometimes called the “inside debt/equity” All long-term Liabilities is “o/s debt equity” including inside and outside creditors. Equity Calculation SH ownership interest in the corp.C 200 0 Here the presumption that the debt of 1000 is valid. For exam. debentures. Character of Loss on Corporate Investment: Stock and debt instruments are capital assets. whether the debt is a business or non-business bad debt Debt Evidenced by Security: Security: Bonds.’s debt and equity High D/E is “thinly capitalized” and service will make debt equity on theory that purported debt is really at risk in the venture b/c no rational creditor would loan money to a thinly capitalized corp. Debt Calculation Debt includes loans from SH.” is an ordinary loss! Affiliated Corp . P. notes or other corporate debt instruments w/ interest coupons or in registered form A loss by a corporation of securities for an “affiliated corp. but current value is more accurate Excessive when: Inside 3:1 or lower is normally not excessive Outside Debt equity ratio did not exceed 10:1 (proposed §385) Problem: see shareholder debt problem sheet. (3) Debt/Equity Ratio This is the ration between corp.if sell stock at a profit get cap gain if lose money can treat loss as ord deduction but limited to 50k (100k per married couple) per year. calculate based on AB and FMV §385 used AB. any loss on their sale or exchange is a capital loss Special Issues of Capital loss (1) Loss on Worthlessness of debt See if instrument is a security as defined under §165(g)(2) and if not. 1554-157 1244 stock for small corps ..

Debt not Evidenced by Security: Losses on corp. §1244 Stock §1244 stock is deductible as an ordinary loss Qualifying SH §1244(a). §1. are not deductible!! Business vs. if the stock is a capital asset §165(g)(1) “If stock is security under §165(g)(2)”.Stock issued for services does not qualify Small Business Corp Status Must be a small corp. or (2) a debt or loss from the worthlessness of which is incurred in TP’s Trade or business. estates and corporate SH. debts not evidenced by a security are characterized by bad debt provisions in §166 §166(a) losses from wholly or partially worthless business bad debts are ordinary. any resulting loss is treated as a non-business bad debt on the theory that the loan was made in TP’s capacity as an investor For business bad debt deduction. §165(g)(3). a loss on the worthlessness of stock held as a capital asset is treated as a capital loss on the last day of the taxable year in which the loss is incurred.TP must show that his dominate motivation or making the loan was related to his trade or businessUS v. Gross Receipts Test when Loss Sustained Limit on Amount of Ordinary Loss Reduction of Ordinary Loss . Generes (2) Loss on Worthlessness of Equity A loss incurred by a non-corporate SH on the sale of stock is treated as a capital loss. Losses from partially worthless non-business bad debts.1244(a)-1(b)(2) Partners qualify only if they were partners when the partnership acquired the stock! Qualifying stock CS or PS that has been issued by a domestic corp.individual TP and partnerships who were original issues of §1244 are stock are eligible Does not include trusts..1244(c)-1(d). SH-Employees If a SH is an employee and loans money to a closely held corp. §166(d) Losses of non-corporate lenders from a wholly worthless non-business bad debt are treated as STCL. for money or property §1244(c)(1) §1. Non-Business Bad Debts §166(d)(2) A non-business bad debt is a debt other than: (1) a debt created or acquired in connection w/ the Tp’s trade or business.Corp holder owns at least 80% of its voting power and value and more than 90% of its gross receipts are from sources other than passive investment income.

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. (d) Tax Treatment of Distributions §61(a)(7) and §301(c).Chapter Four. (what if it exceeds E and P – applied to the adjusted basis of the stock of the taxpayer) (what if it exceeds the AB of taxpayers stock – treated as capital gain from sale of the stock) Non-Liquidating ongoing corp. to its SH w/ respect to their stock Dividend is a distribution out of current or accumulated Earnings &Profits of a corp.Dividend is OI for SH §301(c) (1) First include distribution in GI (2) Reduce basis.Non-liquidating Distributions (1) Distribution vs. Current E P Basket 2 Acumulate E & P basket Computed at close of Yr (accumulated basket can No reduction for distributions during the year negative but earnings during the year are can be distributed despite being negative) if there is no E and P it is a reduction in the basis of the stock if that is exhausted then it is deemed a gain. received reduced by any liabilities assumed by the SH in connection w/ the distribution or liabilities to which the property is subject before and after the distribution§301(b) So: (1) Amount of Money received + FMV of other property (2) Reduction of Liabilities (c)Amount of the Dividend §316(a)Distribution is a dividend to extent it is made out of E&P for taxable year in which the distribution is made or (2) E&P accumulated by corp. Dividend Distribution is any kind of payment by a corp.! (2) Distributions under IRC (a) Analysis: (1) Determine the amount of the distribution under §301(b) (2) How much of that is a dividend under §316 (3) Specific tax treatment of those amounts provided in §301(c) (b) Amount of Distributions Cannot be stock of the issuing corp! Cash received by SH + FMV (determined on date of distribution) of any other prop. since 2/28/1913 computed at the close of the year there is no reduction for distribution during the year. The two basket approach 1.§301(c)(2) (3) Excess is capital gain.§301(c)(3) .

316-2(b) Distributions Exceed Current E&P . (-) Subtract Non-Deductible Items Fed tax paid Capital Loss Carryovers you can only deduct to extent of capital gain for tax purpose.316-2(a) Current E&P Exceeds Distributions Current E&P > Cash distributions. so now basis is 1 Earnings and Profits Not defined by statute . life insurance proceeds and fed tax refunds §1.formed by case law. Cash Distributions Cash Distributions are dividends to the extent they are made out of current or accumulated E&P  §316(a) and §1.effect of various transactions on E&P E&P are determined by starting with TI and making Adjustments E&P Formula: Taxable Income Starting Point (+) Items Excluded from taxable Income must be added back Such as municipal bond interest. (+/-) Timing Adjustments (such as depreciation) RJ said he probably won’t test on this.312-6(b) (+) Add Back Certain Tax-Deductible Items §243 dividend received deduction Remember 70% and 80% deduction. (the second co gets the deduction). Page 169 Problem see sheet. then distribution is a taxable dividend Remaining Current E&P is added to the accumulated E&P account§1. Determining E&P §312. so anything in excess should be used to reduce for E&P Remember Carryovers from prior years cannot be subtracted b/c you took it once in the prior year. gets added back in (happens because of subsidiary/parent relationship) §243 dividends rec’d deduction – a deduction where a company that pays dividend to another corp that ends up paying divident to ultimate shareholder.Example: E has 5k of E&P and no accumulated E&P X gives 12k cash to A who has an 8k of basis (1) 5k is income (still have 7k left) (2) 7k reduce basis.

This 2500 is capital gain. has : 12k.12k. so you have 4k left At 4/1. so 3k reduces SH basis in stock.5k9. or 2. so there is 0 basis. so here. Adj basis is 10k.Cash Distributions (10k April 1.5 per Q in deterring the Accumulated E&P at date of distribution 4/1 Accum. 1k can be used from Accum (see above) 3k left. E&P October 1: 10k Dividend. so the entire amount is a reduction to basis.Deficit for Current E&P 20k. E&P. If there is no Accuum. Accumulated E&P but Current Deficit Ex: Beg of Year.5k So here. then it is a capital gain. the deficit would eliminate 10k of the Accum E&P and only 2k would be a dividend PROBLEM p. Answer. out of 4k.A cannot show when deficit was incurred Pro-rate deficit over the year. 9.5k is dividend and the 500 reduces basis October There is no accumulated E&P.Accum E&P (10)k. A) Pelicans current E &P is 5k. . E&P is 12k-2. and 10k October 1) A’s Basis in stock is 40k Issue 1. you had 5k of accum. E&P. Look to current E & P = 5k is a dividend. Example: At beg of year. Accumulated = 0 and distribution is 17. 4k left. Then to Accumulated = 0 thus 12. portion of each distribution that is treated as coming from current E&P is determined by a formula (§1. Year 2 Accumulated Earnings Deficit isIssue 2: A can show when deficit occurred: 10k deficit in 1Q o the year and broke even for 9 months. 173 Ann owns 100% of Pelican co. And 2. Accum E&P-5k Distributes 10k on 4/1 and 10k on 10/2 Formula Amount of Each Dis x Current E&P/Total Current Distribution 10k x 12k/20k 6k is Amount of distribution that is dividend for each payment April 1 Payment: 6k is dividend using formula. all 4k is a dividend! Remember only 1k left of Accum. which is 10k/4. 6k is Dividend based on Form.Cash Distributions exceed current E&P.500.500 left.. E&P available on the date of the distribution. has Current E&P.316-2(b)) Formula Amount of Each Distribution x (Current E&P/Total Current Distributions) Remainder of each distribution is a dividend to the extent of the accumu.500 reduces her basis – (10k).

10/1 5k – (prorated loss = 5k) = 5k and 5k is return of capital. Total distributions for the year = 20k Answer: allocate the 4k among the distributions. (FMV –AB) A recognizes 20k on the distribution. 4k current EP on July 1 sells ½ her stock to baker for 15k on April 1 distributes 10k and then on Oct 1 distributes 5k to ann and 5k to baker. §311(b)(2) and §336(b) . did not recognize a gain on a distribution of appreciated property to a SH even though the SH took a FMV basis in the distributed asset. C) 10k accumulated EP.. Amount of distribution X total current EP / Total distributions 10k X 4k/20k = 2k 5k X 4/20 =1k 5K X 4/20 =1K NOW accumulated distributions = allocate in chronological order. the FMV of the distributed property is treated as not less than the amount of liability. §311(b)(1) Ex: X distributes Gain acre (FMV-30k and AB-10k) to its SH.k is return of capital. and increases X’s current E&P Treatment of Liabilities: If distributed property is subject to a liability or if a SH assumes a liability of the distributing corp.B) 15k Accumulated deficit. Look to current EP = 10k and thus there is a 10k dividend. in connection w/ the distribution.(prorated loss = 2. 10k of accumulated e and p thus 8k allocated to the first distribution remaining 2k allocated to the second distrubitions 10k of first distribution is dividend 2k of second distribution to ann is dividend rest is cap gain (3k) 2k of distribution to baker is dividend rest is cap gain (3k) D) Rule 3 page 170 10k defict in E& P Find amount of accumulated earnings on date of distribution 4/1 10k . Answer.5k is dividend 2.5k) = 7. Property Distributions Consequences to the Corp: (a) Background: General Utilities SC held that a corp. §311(a) only applies to nonliquidating distribution of loss property §311(b) Applies to appreciated property (b) Appreciated Property A corp. 10k of current EP and distributes 10k. recognizes a gain on a nonliquidating distribution of appreciated property in an amount equal to the difference b/t the FMV of the property and its AB.

. 1245(a).(1) Increase current E&P by the gain recognized under §311(b) Accumulated E&P are reduced by the FMV of the distributed property §312(a)(3)(b) If SH assumes liabilities encumbering the distributed property or takes the property subject to liabilities.” Example: X Corp. 1251(c). and (b) increased by the amount of gain recognized to the corporation under section 311 (b). it does not reduce current E&P. create. accumulated E&P as of the beg of the year are increased by current E&P of the prior year. a deficit in accumulated E&P (2) Appreciated Property When corp distributes appreciated property: §312(b)(1).(c) Loss Property §311(a). 30kAB) to its sole SH. or 1254(a). Distribution to SH is 40k (50k-10k) First take. X may not recognize its 20k loss. 617(d). (c). or under section 341(f). To determine accumulated E&P at the beg. and then reduced by the amount of the distribution A distribution may not. decrease in E&P resulting from the distribution is reduced by the amount of the liabilities. X distributes Gainacre (FMV-50k. Of the follow year. has 35k of accumulated E&P and 0 current E&P. 20k from Current and then 20k from Accumulated. . Reg 1. recognized that 20k Loss (which would have reduced current E&P by 20k) and distributed the 10k cash proceeds to A (d) Effect of Distributions on E&P§312(a) (1) Generally under §312(a) Current E&P are determined as of the end of the taxable year w/o regard to distributions made during the year Although a distribution may be a dividend “out of” current E&P.312-3 Liability relief increases E&P “The amount of any reductions in earnings and profits described in section 312 (a) or (b) shall be (a) reduced by the amount of any liability to which the property distributed was subject and by the amount of any other liability of the corporation assumed by the shareholder in connection with such distribution. or (d). §312(c). X should have sold Lossacre.Cannot recognize loss when AB >FMV Ex: X distributes Lossacre (10k FMV. 1252(a). 1250(a). and AB-30k) to SH A who takes the property subject to a 10k mortgage X recognizes gain of 20k under §311(b) and increases CURRENt E&P.

Case: D’Agostino  No E&P and thus no dividend Appellants.Accumulated E&P at 1/1 is: Accumulated – 35k Plus Current E&P. the obligations have a stated interest rate that is below prevailing market rates). distributes a debt obligation with a FMV that is less than its face amount. (4) Corp’s Own Obligations General gain recognized in §311(b) does not apply to distributions of a corp’s own debt obligation §311(a) applies. who were owners of two corporations. (b/c for example.. if Corp gives principal note of 100k with FMV of 5k.20k Minus FMV of distribution. and no G/L is recognized by the distributing corp Effects on E&P§312(a)(20 A corp that distributes its own debt obligation reduces accumulated E&P by the principal amount of these obligations. were convicted of conspiracy to defraud the United States and tax evasion under HYPERLINK "https://www. So. P177 Problem Constructive Dividends Transaction may not be labled as a dividend. it reduces the Accumulated E&P by the “issue price” of the debt at the time of the distribution. reduces accumulated E&P by the AB of the distributed property.10k (3)Loss Property §312(a)(e).com/research/buttonTFLink? _m=dd082851812427c9265b53bb4e20ceac&_xfercite=%3ccite%20cc%3d%22USA . property Transfers b/t commonly controlled corp..lexis. A corp.Current E&P are not affected by a distribution of a loss property and the corp.50k Plus Mortgage Relief. Ex: Unreasonable comp Low-interest loans Bargain sale or bargain leases Payment of SH personal expenses Excessive payment to SH for purchase of corp. reduce Accumulated E&P by 5k. but may be treated as constructive dividends if there is an economic benefit to the SH. Portion that is dividend is determined under the same rules applicable to cash distributions. Consequences to SH – same as a cash distribution except for 301(d) §301(d)Amount of property distribution is the FMV of the distributed property on the date of the distribution reduced by any liabilities to which the property is subject.

� 7201§ and HYPERLINK "https://www.C. on appeal.lexis.C. which appellants had diverted.com/research/buttonTFLink? .com/research/buttonTFLink? _m=dd082851812427c9265b53bb4e20ceac&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b145%20F.3d%2069%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=11&_butInline=1&_butinfo=18%20U. the diverted funds were received as the repayment of a loan from appellants to the corporation.3d%2069%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=13&_butInline=1&_butinfo=26%20U. �� 2§.S.C.com/research/buttonTFLink? _m=dd082851812427c9265b53bb4e20ceac&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b145%20F. no income rule.%201168%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=12&_butInline=1&_butinfo=26%20U. �� 301§ and HYPERLINK "https://www. However.lexis.S. because appellants’ corporation had not realized profits during the applicable tax years.S.%22%3e%3c%21%5bCDATA%5b145%20F.S.C.3d%2069%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=15&_butInline=1&_butinfo=18%20U.C.S. Case. %203551&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=1efcbb4319c4d9579dec04aefe1a1724" µ3551§ as well as four counts of attempted tax evasion in violation of HYPERLINK "https://www.S.lexis. HYPERLINK "https://www. HYPERLINK "https://www. %20371&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=34e0497aba54e4f176689643104dd752" µ18 U. %20301&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=66589bc7a92ea822941ece7d7ed670b2" µ26 U.C.lexis.C. �� 371§. %202&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=bcfb998700538ee7faaae76f70e9966d" µ18 U.S.lexis. were not taxable.C.3d%2069%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=12&_butInline=1&_butinfo=18%20U. Language of HYPERLINK "https://www.S.3d%2069%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=14&_butInline=1&_butinfo=18%20U. %207201&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=d4d49062206bae352f0b268b1fc46208" µ26 U.S.S.S.com/research/buttonTFLink? _m=f41fc4a154533c6a456be3c235d57fdd&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b128%20S.C.com/research/buttonTFLink? _m=dd082851812427c9265b53bb4e20ceac&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b145%20F.C.S. the court reversed and remanded the convictions holding that the corporate funds.S.%20Ct.com/research/buttonTFLink? _m=dd082851812427c9265b53bb4e20ceac&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b145%20F. %203551&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=63a5c05b8f15fde8f70fdb1353aa0787" µ3551§.S.Boulware: “intent of parties” The question was whether a 41istribute accused of criminal tax evasion could claim return-of-capital treatment without producing evidence that either he or the corporation intended a capital return when the distribution occurred.lexis. The court further held that under the no earnings and profits.

purchased a yacht for the child non voting shareholder to use. Herbert was taxed on 75% of the daily rental rate.S. %20316&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=eca9b3277b2a9d6ac135a4e6bcf126ef" µ316(a)§ governed the tax consequences of constructive distributions made by a corporation to a shareholder with respect to its stock. Ct said – bc father was able to confer benefit to son thus he controlled the direction of the funds and thus should be taxed on the dividend.C.C. HYPERLINK "https://www. if it is necessary in order to clearly reflect the income of such entites or to prevent the evasion of taxes . %20316&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=7b8f9f1fcfcf7d4fc63d50e7fe7754ab" µ316(a)§. Ex: Nichols 75% personal use of corp. The corp held the title of the boat. Case – Nicholls. deductions and credits among related org.._m=f41fc4a154533c6a456be3c235d57fdd&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b128%20S..authority to distribute. apportion. The lower court’s view also created a tax limbo or forced resort to an atextual stopgap as the interpretation created a disconnect between civil and criminal liability.lexis.com/research/buttonTFLink? _m=f41fc4a154533c6a456be3c235d57fdd&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b128%20S. The IRS tried to tax the father voting sh (a constructive dividend).%20Ct.%20Ct. yacht was constructive dividend..lexis.%20Ct.com/research/buttonTFLink? _m=f41fc4a154533c6a456be3c235d57fdd&_xfercite=%3ccite%20cc%3d%22USA %22%3e%3c%21%5bCDATA%5b128%20S. trades or bus.%201168%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=13&_butInline=1&_butinfo=26%20U. A defendant in a criminal tax case did not need to show a contemporaneous intent to treat diversions as returns of capital before relying on those sections to demonstrate no taxes were owed. %20301&_fmtstr=BRIEF&docnum=1&_startdoc=1&wchp=dGLbVtbzSkAW&_md5=ef5d28af0c16eb3475cdd239ef99f3ef" µ�� 301§ and HYPERLINK "https://www.C. In sum.%201168%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=15&_butInline=1&_butinfo=26%20U. entertainment) that provide only an incidental benefit to the business and are primarily for the personal benefit of the SH or his family may be classified as constructive dividends. The amount of the dividend was the cost of the yacht. Smaill family co.%201168%5d%5d%3e%3c%2fcite %3e&_butType=4&_butStat=0&_butNum=14&_butInline=1&_butinfo=26%20U. to extent of 75% of yacht Fiar rental value Rev Ruling 69-630 §482.S. Buse Co.S. which stated that the tax consequences of a distribution by a corporation with respect to stock depended on whether the corporation had earnings and profits and the amount of the taxpayer’s basis for his stock. Northy. travel. Personal Benefit to SH Corporate payments of expenses (meals. or allocate GI.

increasing A’s basis in the Y corp Using of Dividends in Bootstrap Sales see TSN Liquidating case. IRS argued that it was part of the sales price. bc UM reinfused the CLIC with assets same as a beginning. If T distributed its own excess liqudi assets. X’s income was understated b/c avoidance of income. Waterman Case disposition was a dividend.the $20 is treated as distributed as Corp dist. A caused X to sell its property to Y for less than arm’s length FMV price. and then A made a capital contribution of 20 to Y corp. X may deduct 100% under §243(a) and realizes no gain on the sale of the stock for 200k If..1.IRS said waterman was different from here. Amount of such increase will be treated as a distribution ot A< with respect to his stock of X and capital contribution by A to Y Thus X income increases by 20 (as though sold for FMV) and thus Y basis increase by 20 (paid FMV) To bring this inline with economic reality . Ct disagreed. A parent corp. it likely will be reclassified as a payment of the purchase price. dividend will likely not be reclassified even if the buyer infuses T with liquid assets shortly after the purchase. to the other entity involved gives rise to §482 Issue. began for the sale of T.bargain sail transaction b/t bro-sis corp that result in shifting of income Amount of allocation will be treated as a distribution of the controlling SH. that is about to sell stock of a sub in a taxable transaction may attempt to convert capital gain on the sale to dividend income by causing the sub to make a large distribution shortly prior to the acquisition Success depends on time of the distribution and source of the distributed money Ex: X owns all the stock of T which has a value of 1m X’s basis in the stock is 200k T has ample E&P P wishes to purchase the Stock If X sells its T stock to P for 1m cash. . X will increase income to reflect arm’s length price of the property sold to Y Basis of Y will reflect arm’s lentgth price. X realizes 800k of gain taxable at 35k If X causes T to distribute 800 to X and the entire amount is a dividend.Strategy may not be viable if X and T file a consolidated return of if distribution to X is extraordinary dividend under 1059. after neg.§482.A owns 100% X and 100% Y. Assume FMV for 100 sold for 80. the distribution were paid in the form of a T promissory note that was later paid off with funds supplied by P. with respect to the stock of the entity whose income is increased and as a capital contribution by the controlling SH. TSN wanted to sell a sub CLIC to UNION MUTUAL UM did not want some small cap stock owned by CLIC – so prior to sale CLIC dividended out stock to TSN sold CLIC to UM and UM invested Bonds into CLIC TSN claimed it was a dividend and claimed dividends received deduction of 85% . Caveat. TSN Liquidating See chart. (301 could be ) to A.

Securities lent PA 2.8 million dollars and satisfied the note to waterman. It differs from TSN bc in TSM the targets assets changed substantially.Facts of waterman – Waterman owned PA with a FMV of 3. PA did not . Ct said it was part of the purchase price.5 Securities wanted to buy Waterman wanted a 2. Securities was using Pan atlantic as a conduit to transfer cash to Waterman.8 dividend ( a promissory note) Securities paid waterman 700k ( the AB in the stock owned by waterman) so there was not gain from the transaction.

Property§317(a) (2) Overview of Tax Consequences Consequences to Distrubutee SH Need to see if distribution is more like a (1) dividend or (2) Sale (1) Dividend if: Corp distributes money or property in exchange for its own stock and the distributee SH equity in the in the corp. §317(b) A redemption is defined as an acquisition by a corporation of its stock from a SH in exchange for cash.302-5(a) §1.318-1(a). is essentially unchanged. (b) §1.. (b) §1. Introduction (1) Redemption Defined Redemption is a repurchase of a corporate security by its issuer.318-4 (1) Generally: .Redemptions and Partial Liquidations: §302: Distribution in Redemption of Stock IRC: §317(b) Regulations §1.Chapter 5. (2) Sale or exchange of stock if: Significantly.302-5(c) A.318-3(a). Constructive Ownership of Stock §302(c)(1) §318 §1.302-5(b) §1. B. whether or not the acquired stock is cancelled . reduces SH equity interest Consequences to Distribution Corporation (3) Tax Stakes To Shareholders Noncorporate SH prefer exchange Corporate SH prefer dividend treatment if 243 dividend deduction or consolidated return. debt securities or other property. retired or held as a treasury stock.318-2 §1.

So can’t attribute from parent to child and then to child’s spouse. A specific bequest) and the possibility that the person must return the property to satisfy a claim is remote§1.318-3(a). A. and C each are considered to own 40 shares of X. (2) Family Attribution: §318(a)(1) An individual is treated as owning stock owned by her spouse. siblings or in-laws. but not. however small or remote. Example: X Corp’s 100 o/s shares are owned by H (10). stock.318-3(a) Ex 1. estates and trusts under the attribution rules in §318. B and C are equal partners in ABC Partnership.A. (b) Trusts §318(a)(2)(B)(i) Stock owned by a trust (not qualified employee retirement plan) is considered owned by its beneficiaries in proportion to their ACTUARIAL interests in the trust.Stock constructively owned by one family member may not be reattributed to another family member. §318(a)(2)(B)(ii) Stock owned by a grantor trust is considered as owned by the person who is taxable on the income of the trust . §318(a)(2)(A) Reg 1. but F remains a beneficiary until the estate is closed.1010%40% (W +C)W-2020%60% (H+C+WF_C-2020%30% (H+W)WF-3030%60% (C+WS+W)WS-2020%30% (WF only!)Total. his wife (20).B. (for §302 purposes) §302(e)(1) Rationale. E is no longer a beneficiary for attribution purposes after she receives her bequest. Ex 2. their child (20). The partnership owns 120 shares of X corp. Life estate in proportion to their beneficial interest. Grandchildren are not considered to own stock owned by their grandparents §318(a)(5)(B).related individuals and entities have a unity of economic interest.An individual or entity is treated as owning stock owned by certain related family members. corporations. children (legally adopted). partnerships.100100% (3) Entity to Beneficiary Attribution (a) From Partnership or Estates Stock owned by or for a partnership or estate is considered as owned by the partners or beneficiaries with present interests  ex. grandchildren and her parents.A person ceases to be a beneficiary of an estate when he receives all property to which he is entitled (ex. Wife’s Father(30) and Wife’s sister(20) SHActualConstructiveH.D dies leaving a 50 k specific bequest to E. and his residuary estate to F.

(4) Beneficiary (or Owner) to Entity Attribution (a) To Partnerships or Estates All stock owned actually or constructively by partners or beneficiary of an estate is considered as owned by the partnership or estate §318(a)(3). Example: A is the income beneficiary of Trust. A is considered to own 60% or 60 shares of Y corp. owns 100 shares of Y corp. If A owned 40% of X corp. Remote 5% or less of the value of the trust property. Ex: A. X corp. actually and another 20% constructively (ex. A owns 100 shares of X corp. A and B’s actuarial interests are 60% and 40% collectively.through family member).. all of which is considered owned by the trust. actually or constructively. §318(a)(3)(B)(i). W. So A owns 60 shares and B owns 40 shares of X corp. A owns 60 shares of X corp. 50% or more in value of the corporation’s stock. (b) To Trusts All stock owned by a trust beneficiary is attributed to the trust unless the beneficiary’s interest is both remote and contingent. and C are equal partners of the ABC general partnership. So ABC is considered to own 100 shares of X corp. A owned only 40%. A is the income beneficiary of the trust and B is the remainder person.B. actually and is considered owning 40 shares from his wife.. If A had only a contingent remainder which was 5% or less of trust property. assuming the trustee will exercise minimum discretion in favor of the beneficiary.. A would be a 50% or more SH and thus would constructively own 60 shares of Y through X.Example: Trust owns 100 shares of X corp.. (c) From Corporations §318(a)(3)(A) Stock owned by a corporation is considered as owned proportionately. So. none of A’s shares would be attributed to the trust (c)To Corporations .. A would not be considered. Now say. §318(a)(3)(B)(i). Ex: A owns 60% (by value) of the stock of X corp. form A as well as any shares owned actually and constructively by B and C. owning any shares of Y through X. (by reference to value) by the SH who owns.Grantor trusts are considered as owing stock owned by the grantor or other person taxable on the trusts income.

he would still be considered as owning family attribution shares. But daughter does not constructively own the fathers constructive share. from A. A owns 100 shares of Y corp.. §318(a)(5)(E) If stock may be considered as owned by an individual under either family attribution or option attribution. is considered to own 100 shares of Y corp. but if he did not hold the option.All stock owned by a SH who actually and constructively owns 50% or more of a corp. but can not reattribute to other members. Option attribution takes precedence. Parent son and daughter Son owns 100 shares. Ex. X owns 100 shares of Y corp. If A owned less than 50% of X.’s stock is attributed to the corporation§318(a)(3)(C) Ex: A owns 60% (by value) of X corp. X corp. however. H can reattribute these to other family member. . Example: A and B (unrelated) each own 50 of the 100 o/s shares of X. Example: H has an option to acquire 100 shares of X corp. Permits reattribution of the optioned stock to another family member despite the no double family attribution rule. (b) No Double Family Attribution Stock constructively owned under family attribution rules of §318(a)(1) may not be reattributed to another family member under §318(a)(5)(B). Daughter does not constructively own Father does. stock owned by Child. A is 50% partner in the AC partnership B is the sole beneficiary of Trust A and B each is considered as owning 50 shares of Y through . (6)Other Operating Rules (a) Reattribution Stock constructively owned by a person under §318 is considered as actually owned for purposes of reattribution that stock to another person. stock.. none of A’s shares in Y would be attributed to X. (5) Option Attribution §318(a)(4) A person holding an option to acquire stock is considered as owning the stock. H is considered to own Child’s 100 shares under the stock option attribution rules. A’s shares of Y are reattributed to AC partnership and B’s shares are reattributed to the trust Partnership and Trust each is deemed to own 50 shares of X directly from A and B respectively.

unrelated. Mother’s daughter. and remaining 30 shares are owned by Gma’s estate of which mother is 50% beneficiary. A’s wife. are equal partners in the AB general Partnership A owns 100 shares of X corp stock Partnership is considered to won A’s 100 share of X corp under §318(a)(3)(A). W. that is attributed to an entity may not be rattributed from the entity to another beneficiary. §318(a)(5)(C) Example: A and B. and Grandma estate own after application of S318 Analysis: Grandfather: Owns own shares 25 Mothers 20 Grand daughter 15 Grand son 10 Mothers beneficiary shares – (owns 50%) thus 15 Total 85 shares Mothers daughter Own share 15 Mother 20 Mothers share of gm estate 15 Mothers option to purchase son shares 5 Total = 55 GM estate Own share 30 Attribution from mother (bc beneficiary) 20 + GF (25) + 15 + 10 = Total 100 = all the shares.D are equal partners . in which A.(c) Anti Sidewise Attribution Stock owned by a beneficiary partner. I: How much Wham stock to Grandfather. are owned by A. Mothers (2) All of the 100 Shares of X corp. 10 Shares are owned by Mother’s adopted Son. 25 are owned by G. (a) How many share. of X corp. owns all of the 100 shares of Y corp. but those shares may not be reattributed to B from the partnership under §318(a)(2)(A) Problem page 213 (1) Wham Corp has 100 shares of CS Outstanding. W and M (W’s Mom) . 20 are owned by GF’s Daughter (Mother). are owned by a partnership.B. Mother also has the option to purchase 5 of son’s shares. or SH. partner or SH. 15 shares are owned by Mother’s Daughter.C.

A owns Own shares 25 (100 shares * . All of those are attributed to Partnership BCD Wife owns 100 A constructively owns 100 Then go to Partnership But bc of anti sidewise – those don’t get attributed to BCD X Wife owns 100 A owns 100 constructively P owns bc a partner Then it is attributed to X bc P is a beneficial owner of X. = 0 (c) How many shares. Otherwise §301 applies (§302(d)) and it is a distribution .A distribution in redemption is treated as an exchange if it is “substantially disproportionate” with respect to the SH. But bc not 50% or more there is no flow to Y.302-3 (1) Substantially Disproportionate Redemptions A redemption that is described in §302(b)(1)-(4) is treated as an exchange. Redemptions Tested at the SH level Redemption in §302(b)(1)-(4) is treated as an exchange §302(a).25) W owns Her husbands shares 25 shares M owns Nothing (b) How many shares if any of X are owned by Y? Would Y constructively own any shares of X if W owned only 10% of Y Y owns Flow from A to wife to Y. There are Three requirements for substantially disproportionate: . C. and X? Partnership = Wife owns 100 shares A constructively owns 100 through family. if any.follows dividend rules (1) Substantially Disproportionate Redemptions §302(b)(2) §1. If W owned 10% Flows from A to wife. = 100. Otherwise §301 applies and it is a distribution §302(d) (a) Requirements for Exchange treatment §302(b)(2). = 25 shares. of Y are owned by B. §302(a).D.C.

RevRuling 85-14 – does not have to have an explicit agreement. or 33 1/3% . (b) Y also redeems 60 shares of A’ CS Alice owns 80 shares so her percentage is 80%.. So here this is 50% SO remember.S. has 100 shares of CS and 200 shares of nonvoting preferred stock o/s. SH must own less than 50% of the total combined voting power of all classes of stock entitled to vote (2) Percentage of Voting Stock owned by the SH immediately after the redemption must be less than 80% of percentage of voting stock owned by that SH immediately before the redemption Need to do 80% of voting percentage before Ex: 60% x 80% (3) Percentage of C. So now the first step doesn’t work because it is NOT less than 50%. O/S. Does redemption satisfy the §302(b)(2) requirements? (a) 1/15. you need to subtract from the total shares. (60%) X redeems 20 of A’s shares so that after redemption A owns 40 out of 80 shares still o/s (50%) Redemption is not substantially disproportionate b. (c) Y also redeems 70 shares of A’ CS Y now has 10/30. owned by the SH immediate after the redemption must be less than 80% of the percentage of C. A owns 80 shares of Y CS and 100 shares of PS. Rev Rule 87-88. So dividend treatment under 301 would apply.(1) Immediately after the redemption. So if no voting shares are NOT redeemed . §032(b)(2)(D) A plan exists if a series of redemptions are “casually related” even if they are not part of a joint plan or arrangements. Problem page 217 Y corp. Example: A owns 60 out of the 100 shares of X Corp. this test is applied in the aggregate by reference to FMV.S. redeems 75 of A’s PS This does not qualify b/c it is not voting power. the redemption cannot qualify as a substantially disproportionate redemption (b) Series of Redemptions: A redemption is not substantially disproportionate if it is made pursuant to a plan which has the purpose or effect of a series of redemption. Y corp. Cathy owns remaining 20 shares of Y CS and 100 shares of Y PS.S owned immediately before the redemption. result in distributions that are not substantially disproportionate. that taken together. Her new percentage is 20 shares are remaining so this is 20/40. A and C are not related. F there is more than one class of C.c: A does not owe less than 50% of X’s voting power This focuses on a significant reduction of voting power.

3 * . (2) Z Corp has 100 shares of voting CS and 200 shares of nonvoting CS.Before 60% or 48% or less or step (2) D. so A has 50% voting power. this is a plan and thus this would be a dividend. If Z redeems 30 of Don’s voting CS (now Don will have 30)¸will redemption qualify under §302(b)(2) for exchange treatment? D. and in anticipation she would be related b/c if one SH schedules a redemption to temporarily satisfy 302(b)(2) but with knowledge that voting interest would increase. (3) Now she owes 33 1/3 %. J owns all the remaining stock of Z40 Voting. D owns 60 shares of Z voting CS. that is a plan and thus.3% so this step fails to qualify. Alice has <50% and it wouldn’t qualify. If a corp.100 and 200 Non Voting D. redemption would not satisfy 302(b)(2)(d). and IRS may contend that SH has not terminated their equity interest.40 Voting and 100 Non Voting Common Stock. (d) What difference would it make in (c) above if on 12/1 of the same year.After 30/7042. this would not apply under the first prong! Alice would not reduce less than 50% (2) Was there a plan to defeat the requirements of §302(b)(2) What if Alice knew that Kathy would have 10 shares redeemed. and 100 Non voting. (1) Need to see if there is a plan if we take into consideration Kathy’s redemption.60 Voting and 100 Nonvoting (60%) J. Every share of ZCS has a FMV of 100..842 2/3 % Don After 130x10013k and CS after is 270 x 100k27k which is 48. distributes its debt obligations in exchange for the redeemed stock the SH may recover the stock if Corp defaults. and this is exchange treatment. and 100 of Nonvoting CS. . If she knew it would be temporary. D and J are not related. Y redeems 10 shares of C’s CS? Y redeems 10 shares of C’s CS A started with 80% voting power. (2) Complete Termination of SH interest In General A redemption that completely terminates a SH actual and constructive interest in the corporation will be treated as an exchange under §302(b)(3).1% This is not less than 42.First step is made because <50% <64%. 80/100 A reduced by 70 and C reduced by 10 thus20% and now it would be 10/20.9% Step 1 <50% Step 2 <48% Step 3 Common Stock FMV is 100 per share CS Before 300 x 10030k Don owned 160 x10016k which is 16/3053.

9th circuit/holdingCongress wanted to establish a bright line test. Commissioner: Parents wanted to turn co over to son. Two Prong Analysis by tax court 1. . §1. Independent K Employer has right to determine rights of employee and not the independent K.302-4(d) the retention or acquisition of an interest as a creditor is permitted. A person is considered to be a creditor only if her rights are not greater or broader in scope than necessary for enforcement of the claim. does this have an interest (under Lynch yes) Hypo: Father owns a filling station and trucks stop and get their tanks filled. Whether there is a significant financial stake or 2. and no financial stake (500/month fee) thus waiver was satisfied. Corp sold 50 shares to son (16k was a gift) Corp redeemed stock in form of prop and a note Son needed help ..Distrubutee must attach a statement to her income tax return for the year of the redemption reciting that she has not acquired any prohibited interest since the distribution and agreeing to notify the service of any such acquisition w/in 30 days after it occurs during the 10 year-look forward period and to extend the SOL for assessing and collecting a tax with respect to the distribution on year after the notice . §302(c)(2)(A)(ii).(a) Waiver of Family Attribution §302(c)(2) A redemption that completely terminates a SH actual interest in a corporation will be treated as an exchange even if the SH (called the distributee in §302(c) constructively owns stock of a family member under §318(a)(1) provided following requirements for waiver of family attribution in §302(c)(2) are met (1) All Interests are Terminated §302(c)(2)(A)(i) Distributee may have no interest in the corporation as a SH. Is this a continuing interest in the corporation so that it disqualifies a waiver of family attribution rules. (2) Ten-Year-Look Forward Rule The distributee may not acquire any of the forbidden interests (other than stock acquired by bequest or inheritance) during the 10 year period beg. (3). Father was only engaged for limited purpose and he did not have a financial interest in the corporation. The date of the distribution in redemption. but an acquisition of stock is prohibited. Hypo: What if you perform tax services. §. director or employee.. Did he retain control of the company Tax court held that F did not have a continuing interest in the corp.1302-4(e) Distributee who remains a creditor of the corporation after a redemption is not considered as acquiring a prohibited interest by acquiring corporate assets to enforce her rights as a creditor. officer. Independent K performs limited functions for the partnership. he thinks 9th circuit approach is not good. as an independent contractor retains a prohibited interest. father was kept as a consultant. Case: Lynch v.Procedural Requirement §302(c)(2)(A)(iii). 9th Circuit Ct held that a TP who performs post-redemption services for the corp. immediately after the distribution. Jensen says no. Employee vs.see above.

yr 2 redemption would have to be fixed and determined at the time of the initial transaction. – here she regains interest within 10 years – this is allowed. created by betty and billy. makes a gift of 20 shares to child and X corp.302-4(c)) G) son dies and leaves Alison shares. Example: Parent and child own 50 of the 100 o/s shares of X Corp. daughter. (4) Ten Year Look Back RuleEXCEPTION (1) Distributee must not have acquired any portion of the redeemed stock w/in the 10 year period preceding the distribution from a person who stock is attributable to the distrbutee under the family attribution rule in §318(a)(1) (2) At time of distribution.IRS may grant extensions for filing the agreement if TP shows “reasonable cause” for a late filing. who wishes to retire and shift control of X to child.302-4(a)(2). Page 235 Corp owned by J. – this is a prohibited interest (§1. Still own 120 shares A) is it an exchange? Son received interest prior to redemption this would not qualify.Acquisition or disposition by the distribute during the 10 year look back period was not principally motivated by a tax avoidance purpose. Parent. John owns 100. (gain by bequest or inheritence) B&B . But this is as valid business purpose. and the 10 year look back rule will not prevent the redemption form qualifying for waiver of family attribution under §302(c)Rev Rule 77-293. Here could argue that this was part of a single transaction. Would qualify as an exchange if waived the family attribution rules. daughter 50 son 25 A) before owns 100% after owns 100% redeems 50 shares. §1. Test . – substance over form. leaving child as the sole SH. and son. E) randall remains a director – this is a prohibited interest F) R forms a subsidiary and Alison becomes an employee of the sub. Parent retains no other interest in X Corp.A gift of stock is not principally motivated by tax avoidance merely because the donees is in a lower income tax bracket. and remaining 30 shares on year two. redeems parent’s other 30 shares. no person may own stock which is attributable to the distrbutee under the family attribution rules if that related family member acquired any stock in the corporation from the distribute within the 10-year-look-back period.302-4(d)) D) R redeems 20 of alisons shares in year one. See 77-293 . B) if didn’t file agreement not to notify IRS – then not eligble for exchange treatment C) what if shares contignent on R’s future profits ? this is some financial interest – regs say specifically that this is a prohibited interest (§1.§1. Here: Tax avoidance was not one of the principal purposes of the transfer to child. DOES NOT APPLY IF: §302(c)(2)(B).302-4(g).

a long term note – is more like equity – is more risky. Nancy is a sibling and there is no family attribution concerns between siblings.The note paid to parents for redemption lasts 20 year period. (b) J and M have specific legatees and B has residuary Here bc J and M have attribution through beneficial ownership. 1.so there is a problem – a complete redemption can be waived where family attribution rule applied. Whether there is a significant financial stake or 2.. – bella owns J and M shares and estate owns all shares. (2) Related Person Defined . J owns 50 sister owns 30 estate of father owns 20. would use test. And wants to consult for B&B – lynch says no. The trust can waive the attribution through family attribution. Before = actually own 20% const 80% After = actual non. they are residuary benes and thus cant pay off. The estate can only waive family attribution and not beneficial owner © J and M are residuary beneficiaries – here to solve the problem would typically pay J and M their interest but. (b) Waiver of Family Attribution by Entities §302(c)(2)(C). However. See waiver by entity below. Sams widow is beneificiary (a) cinelab redeems estates 20 shares . The lease? Redeemed SH can enter into an arms length lease with co. B) B creates a consulting firm.permits an entity to waive the family attribution rules. trust or corporation. Estate must agree to have no interest in co. estate. . Agreement to restrict dividends and such other – Code says – can continue as a creditor – is it unusual to put a restriction No creditors often do this. Did he retain control of the company 3. A waiver may be useful when a redemption terminates and entity’s actual ownership but the entity still owns stock that is attributed from one family member to another “related person” and is then reattributed to the entity. Tax ct. bc of 302©2© bella must also agree to all 3 provisions. Cinelab 100 shares outstanding. (d)20 shares owned by a trust providing income to bella and remainder to nancy. there is no Ind Contracter relationship permitted. Only applies to waive family attribution under §318(a)(1) DOES NOT WAIVE direct beneficiary or owner under §318(a)(3) (1) Entity defined §302(c)(2)(C)(ii)(I) partnership. Cts have allowed debt instruments to qualify.const 100% .

.. A’s shares are attributed to S under §318(a)(1) and are further attributable from S to Estate under §318(a)(3) S is a related person. X corp. See Role of § 302 (b) (1) After Davis Example: On the formation in Y1. §1. (3) Conditions for Entity Waiver An entity may waive family attribution if (1) entity and each related person meet the usual requirement for waiver under §302(c) and (2) each related person agrees to be jointly and severally liable for any tax deficiency that may result if an interest is acquired in the 10 year look forward period. Estate has terminated its actual ownership in X but continues to own 50 shares from A through beneficiary S. In Year 3. for a valid business purposes. and entity waiver rules would not allow Estate to terminate its interest under §302(b)(3). he would not be a related person. Mother and their two children. §302(c)(2)(C)(i). The sole beneficiary of Estate is A’s son. in exchange for 100 shares of nonvoting preferred stock. S. redeems Estate’s 50 shares. Davis: Redemption is not essentially equivalent to a dividend if it results in a “meaningful” reduction of the SH proportionate interest in the corporation. and a business purpose or lack of tax avoidance motive is irrelevant.302-2(b). Estate can waive family attribution and break the chain from A to S if Estate and S jointly agree not to acquire a prohibited interest for 10 ear and agree to notify IRS if an interest is so acquired S also must agree to be jointly and severally liable for any tax deficiency If S actually owned 50 shares of X. Example 2: Assume in Ex above that X corp.A related person is any person to who ownership of stock in the corporation is (at the time of the distribution) attributable under the family attribution rules if the stock is further attributable to the entity. S’s shares would be directly attributed to the Estate. §302(c)(2)(C)(ii)(II) Ex 1: A and Estate each own 50 of the 100 outstanding shares of X corp. In Year 5. (3) Redemption NOT essentially Equivalent to A dividend (a) The meaningful Reduction Standard If a redemption does not satisfy one of the specific §302 safe harbors. issues 25 shares of common stock each to Father. Father contributes 25k to X corp. X distributes 25k to Father in redemption of all his preferred stock.Dividend equivalence “depends upon the facts and circumstances of each case” §318 attribution rules fully apply. Assuming no 10 year look back rule problems. If S actually owned 50 shares. it still is treated as an exchange under §302(b)(1) if it is not “essentially equivalent to a dividend” US v.

together w/ a potential to participate in a control group with other SH. redeems ½ of the nonvoting P.A reduction of voting rights from 57% to 50% (with corresponding reductions in rights to earning and net assets on liquidation) has been ruled to be “meaningful” where the remaining shares are held by one unrelated SH.Evidence of family discord may negate the presumption of the family attribution rules for purposes of §302(b)(1).Under the attribution rules. Unless o/w indicated.S by a minority shareholder from 30% to 24.S If a corp. a reduction in voting power is a key factor. Rev rule 81-289.S of a SH who owns no other class of stock. IRS and other courts disagree. (3) Loss of Control in Concert with Others A reduction of common stock ownership from 27% to 22% is meaningful where the remaining shares are owned by three unrelated SH b/c the redeemed SH lost the power to control the corp. Make sure to consider majority by the reduced . Rev Rule 76-364 (4) Reduction of Ownership by Isolated Minority SH Rev Rule 75-512. is essentially equivalent to a dividend.Ex: IRS considers the three most significant SH rights to determine whether a reduction is meaningful: Rev Rule 81-289 (1) Voting (2) Participation in current earning and corporate growth (3) Sharing in net assets on liquidation Rev. (b) Meaningful Reductions. but Tax courts says family discord may be a relevant facts and circumstance test after family attribution rules have been applied Problem page 247 (1)Z corp has 100 shares of C/S o/s owned by A (28 shares) B (25 shares).302-2(a) (2) Significant Loss of Control Rev Rule 75-502. Father is considered to be a 100% SH before and after the redemption. C (23) and D(24). assume no relation. Determine whether the redemption is not essentially equivalent to a dividend? (a) Z redeems 7 shares from A – A yes there is a meaningful control change – before he could ask only one person to form a majority. Even a very minimal reduction of a SH interest is meaningful if the SH exercises no control. Rule 85-106.3% is meaningful. The redemption of the P.A reduction of C. the distribution ordinarily is not essential equal to a dividend §1. (5) Family Discord Haft. A pro-rata redemption of stock by a public company is not a meaningful reduction even if the SH has a small minority interest. in concert with one other SH.ex: minims reduction resulting from a tender offer by a publicly traded corp.If the redeemed SH has a voting interest. (1) Partial Redemption of Nonvoting P. Now he has to ask two to form a majority.S.

The Basis passes to the shares that he is deemed to own by construction. (4) Partial Liquidations Occurs when a corp. §302(b)(4). Here the basis transferes from the 5 shares redeemed to the 5 shares that remain. (other tests look to the effect of a redemption on the distribute SH) (a) NONCORPORATE SH’s qualify §302(b)(4).. IRS does not care about family disputes. For E its an exchange.this is a meaningful reduction (c) Z redeems 5 from A and A and B are mom and daughter A and B together still have a majority and not meaningful (d)Same as (c) except that A has not spoken to B since B married “o/s faith” .(b) X redeem 5 shares from A and A and D are mom and daughter.47% . Here bcd can control the corp by colluding with a – here it would not qualify as an exchange. it is still taxed as a dividend bc he was unable to waive the family attribution rules.. there are approaches. if there is a slight reduction in interest then can consider all facts and circumstances. What if all ten shares are redeemed (thus no shares left) . Other cases say. . has 100 shares of C/S and 100 shares of nonvoting preferred o/s stock. (2) Y corp.exchange treatment for distributions in redemption of stocked held by noncorporate SH if the transaction is a “partial liquidation under 302(e) of the distributing corporation §302(b)(4) looks on the nature of the assets distributed and the corp’s reason for making the distribution. What if 10 are redeemed which is properly classified as a dividend because §302(c)(2) waiver of family attribution is not available? A receives a dividend. (3) Indv. The Y common and P/s are owned by the following unrelated SH SHCommon SharesPreferred SharesA400B2055C2510D1515E020 a) Y redeems 5 preferred shares from E this is redemption not equivalent to a dividend – no meaning ful control change b) Y redeems all of its outstaning preferred stock. Bc it is a dividend and will be paying tax on it as ordinary income. Before comblinec control of 52% now 49. For the other sh’s – if sh can control corp with help of small number of other sh’s then IRS only focuses on power to control. 5 shares are redeemed in a transaction that is a dividend. significantly contracts its business and makes related distribution (of assets or their sale or insurance proceeds) to its SH in redemption of all or part of their stock. When distributions in redemption results from such a “corporate contraction” the transaction is more like a sale than a dividend. Owns 10 shares of CS with AB of 15k. The p/s is not convertible into Y C/S and is not §306 stock.only noncorporate SH qualify for partial liquidation treatment.. S Corps are treated as individuals for this purpose and qualify ..

§302(e)(3).§302(e)(5). Raw land held for investment or a securities portfolio is not an active trade or business §1. (b) Partial Liquidation Defined §302(e)(1) (1) Not essentially equivalent to a dividend ( definition not in the statutes) Determine at corporate level rather than a SH level Satisfy the (a) corporate contraction doctrine – or (b) “termination of Business Safe Harbor” (2) distribution is pursuant to a “plan” (a simple corporate resolution wil suffice) (3) Distribution occurs w/in the taxable year in which the plan is adopted or the succeeding taxable year Corporate Contraction Doctrine (amorphous and cannot be relied upon w/ assurance for planning) A distribution in partial liquidation is not essentially equivalent to a dividend if it result from a (permenant) contraction of the corporation’s business such as: (1) Involuntary Events After a fire damages a manufacturer’s factory. Ex: Corp acquires an active trade or business in a non-taxable acquisition/re-org. Comm’r and reg 1.346-1 Termination of Business Safe Harbor (1) Attributable to the termination of a “qualified trade or business” and (2) Corp continues to be engage in the conduct of another qualified trade or business §302(e)(2) (a) Qualified trade or Business§302(e)(3) Any trade or business conduct t/o the five year period ending on the date of the distribution and was not acquired (by the distributing corporation) in a taxable transaction during that five year period.346-1 (2) Change in Nature of Business A corporation distributes working capital that is no longer needed b/c of a change in the scale of its operations (3) reserve for Expansion A corporation no longer needs funds that had been accumulated for expansion/ Reg 1. distributes the insurance proceeds and contracts its business operations. estate or trust is treated as if held proportionally by its partners or beneficiaries.. Imler v. the distribution will satisfy (b) Distribution of Assets or Proceeds of Sale The terminated business must be operated directly by the distributing corporation Must be o assets of that business or the proceeds of sale of those assets . which applies to similar active trade or business under 355. co.355-3(b)(2)(iv).. and in this situation so long the business is done by someone for five years.Stock held by a partnership.

can qualify or exchange treatment under the safe harbor provision under e2 a and b met. Each SH is deemed to have surrendered shares w/ the value equal to the amount of the distribution. A also owns all of the stock of Beta Corp. Does not apply to the corporation bc they cant qualify for exchange treatment here – here it is a distribution under 301. Neither M nor P own any stock in Iris. company which is engaged in the beta processing business.. so AR is 40 and AB is 6. Each SH is deemed to have surrendered 50 shares of X stock with a basis of 6k (. no regard to whether the redemption is pro rata to the SH §302(e)(4) (f) No Surrender of Stock Required Actual surrender of shares is not required if it would be a “meaningless gesture” such as on a pro rata distribution. B and C each own 100 shares of X Corp. (c) All assets of books were destroyed by fire and A distributes ½ of the insurance proceeds equally to its 3 SH in redemption of an appropriate number of shares of stock and retains the remaining proceeds to carry on its book publishing business on a somewhat smaller scale . and an appropriate portion of the SH stock basis is allocated to the shares deemed surrendered. w/ a basis of 15k and a value of 100k. d. P (M’s wife) and I Corp. distributes 50k pro rata to each SH in transaction that qualifies as a partial liquidation but SH do not surrender any stock. types (c) Pro Rata Redemptions Under business safe harbor. A’s single class of c/s O/S are owned in equal shares by M. X corp. Does result matter if there is no actual redemption of shares .Sub stock or proceeds of sale of such stock NOT PARTIAL Rev Rule 79-184 May qualify as a tax-free corporate reorganization under 355 Merger Stock for stock Also c.40*15) in exchange for the 40k distribution.so gain is 34k LTCG Problem Page 253 A corp operates a book and cram division. and it directly owns a diversified portfolio of securities (a) A has operated B and C for more than five years and it distrubtes the assets of Books to its 3 equal SH in redemption of 50 shares from each SH. if so why does that matter? What if A acquired books 3 years ago in a tax free re-org? bc it was purchased within 5 year period with cash (someone recognized gain or loss) if it acquired in a tax free organization – will get exchange treatment under the safe harbor as long as it operated for 5 years prior. Rev Rule 90-13 Example: A. (b) A purchased Books three years ago for cash.. a separately incorp.

won’t qualify under the safe harbor.e. Will qualify under the safe harbor . except that A liquidates B and then distributes the assets of B’s business which has been operated more than 5 years. (d) Same as (a) except A distributes assets of Books to Michael in redemption of all stock can qualify as an exchange under the safe harbor. (not distributing all the assets i. (e) Same as (a) except A distributes the assets of Books to Iris for all of A’s stocks does not qualify as a partial liquidation bc it was a corp may qualify as a complete termination of interest. (h) Same as 9(g). the insurance) Might qualify under imler if it is a permanent reduction of the business. – and get exchange treatment (f) A distributes the securities portfolio to its 3 equal SH in redemption of 20 shares from each SH (g) A sells all of its Beta stock and distributes the proceed pro rata to SH in redemption of 20 shares from each not a partial liquidation – selling a subsidiary does not qualify under the safe harbor – beta is an investment and thus is not a qualified business and not ceasing to conduct a business.

In case of losses. the E&P AB of any loss property distributed and the principal amount of debt obligatons. .§267(a)(1).Accumulated E&P are reduced by the amount of money. stock. §312(a).disallows a deduction if the redeemed SH owns (directly/indirectly) more than 50% of the corp. (b). not the taxable gain. §301(d) Exchange FMV@ (d) Corp. SH §243 dividends received deduction Effect of Redemption on E& P handout-See/attach (2) Consequences to Distributing Corporation (a) Recognition of Gain or Loss §311(a). Does not matter if it is exchange or distribution to SH (b) Effect on E&P (1) Distribution of Appreciated Property Distributing corporation increases its current E&P by the gain recognized on distribution of appreciated property §312(b) If the basis for property for E&P purposes is different from its basis for taxable income purposes. the distributee SH computes gain or loss as if the redeemed stock had been sold to an o/s. (b). (b) 301 Distrbution Dividends to extent of distributing corp’s E&P and reduction of Basis and capital gain to the extent of the balance of the distbrution (c) Basis of Distributed Property §301 FMV on date of distribution. (2) Reemption Treated as §301 Distrbution If redemption is treated as §301 distribution. but it may not recognize loss on the distribution of property that has declined in value. Specific Tax Consequences of Redemptions (1) Consequences to SH (a) Exchange: If redemption is treated as an exchange.. distribution. the effect on E&P is the same as any ord.D.Distribution corporation recognizes gain on a distribution of appreciated property in redemption of stock. the increase is the E&P gain. the FMV of any appreciated property distributed.

done with reacquisition rule are not subject to disallowance under §162(k). Since the redeemed stock is 50% of the total number of shares (1k).. X may reduce E&P by 80k (160 *. has 1k shares of C.. X gives 100k in redemption of A’s 500 shares.S. O/S (its only class). reason is the E&P is 160k.5 = 75k (c) Stock Reacquisition Expenses A corp may not currently deduct any expenses paid in connection w/ the reacquisition (including redemption) of its own stock . §312(n)(7) (cant be reduced more than amount in dollars = percentage of the shares redeemed) E&P amount cannot exceed the distribution If Corp has only one class of stock o/s. Quinlivan . 200 AB) held as an investment (b) Same as (a) above. the E&P attributable to the redeemed stock are determined by multiplying Ex: X corp.. Beg of Year. etc. owned equally by A and B..tax consequences to X of the following alternative redemptions of A’s stock. assuming in each case that the redemption qualifies for exchange under §302(a)? (a) In redemption of A’s 100 shares. Redemptions and Related Transactions (1) Bootstrapping Zenz v. and they each have an AB of 100k in their X stock. if E&P was 240. Pro rate 100k for current year. Adj acuum E and P from beging of year to date of redemption. then can do the entire amount of the distribution. nonamortizable capital expenditure §162(k)(1) Disallowance deduction rule does not apply to the allocable costs of borrowing to finance a stock redemption Borrowing costs may be amortized over the term of indebtedness §162(k)(2)(ii) Rationale: borrowing is separate from redemption Other corporate payments such as payments to employees. ie greenmail They are nondeductible.5). except X’s AB in the land is 300k You would need to know the date of redemption. X distributes land(250k FMV. that may not exceed the ratable share of accumulate E&P attributable to the redeemed stock. Problem page 260 X corp has 200 shares of C.X has 100k of Accum. X has 160k of accumulated E&P and no current E&P.S o/s. E&P abd ut gas 50k of E&P in the current year I. A and B each acquired 100 shares of X upon their issuance at a price of 1k per share. Begin with 100k on 1/1 1/1 – 6/30 = 50k 150k *.(3) Redemption Treated as Exchange E&P are reduced in an amt.

this a substantially disproportionate under §302(b)(2) (2) Redemptions pursuant to Buy-Sell Agreements (a) Buy-Sell Agreement Closely-held corp. X issues 25 c/s to C and pursuant to the same plan redeems 25 shares of its stock from A and B. (b) Constructive-Dividend Problems arise when a continuing SH is personally and unconditionally obligated to purchase stock pursuant to a buy/sell agreement and that obligation is assumed by the corporation. B wishes to by X for 80k. include other restrictions on the transfer of shares and provisions to determine the value of any stock purchased pursuant to the agreement. So now 25 each out of 75 ps/ A and B’s interests are reduced from 50% to 33. Cross-purchase Departing SH or his estate sells the stock to the continuing SH Entity purchase Corp. Holsey. the redemption will qualify as a complete termination under §302(b)(3) whether it occurs before or after the sale. Ex 1: A owns 100 o/s shares of X.. A is considered to have completely terminated interest in X and exchange under §302(b)(3) Ex 2: A and B are unrelated and each own 50 of X’s 100 o/s shares C also unrelated wants to come in business. Sullivan A mere assignment to the corp of an option to purchase stock from another SH is not a constructive dividend. A sells remaining 80 for 80k to B. X first distributes 20k to A in redemption of 20 shares.5 and thus. SH use this to remove liquid assets from a corp and sell the remaining stock at a reduced price known as a bootstrap Rev Rule 75-447 A sale and redemption also may be combined to qualify the redemption as “substantially disproportionate” under §302(b)(2). use buy-sell stock purchase agreements to provide for a continuity of business. If the redemption and sale are part of an integrated plan. The value of X is 100k including 20k in cash a nd 80k operating assets X has 50k of E&_.If a redemption and sale are part of an integrated transaction to dispose of a SH entire interest in the corporation. redeems the departing SH stock Buy/sell can be mandatory or optional Typically. to satisfy economic and tax goals when a SH dies or retires and to resolve SH disputes.. Ex 1: .

A causes the corp to assume his obligation and redeem the stock from B. If B dies and X redeems all of B’s stock.. Rule.A and B. whose stock has been transferred Example A owns all stock of X and Y. Redemption is a constructive distributon to A Rev Rule 69-608 Ex 2: Same as (1) but agreement provides that upon the death of either SH. because A was not primarily obligated to buy the stock.. A ssigns his option to X corp. Redemption is not constructive to A b/c A had no unconditional obligation to buy the stock Rev Rule 69-608 Problem Page 283 Problems: (4) Charitable Contribution Followed by redemption A SH of a closely held corp. who are unrelated.. each who have a lot of E&P... . own all 100 shares of X A and B agree upon the death of either SH.. the redemption is not constructive toA. Rev Rule 69-608 Ex 3: Now. to redeem the stock from the charitable doness. the survivor will be unconditionally obligated to purchase decedent’s X stock from his state B dies. §304 applies when one or more controlling SH sell stock of one corp. Survivng SH is obligated to purchase any redeemed shares. At B’s retirement. If X chooses not to exercise the option. may indirectly w/d earnings but avoide dividend treatement by contributing stock to charity and causing the corp. Rev Rule 78-197. to another controlled corp (“brother-sister acquisition) or when any SH of a parent corp sells stock of the parent to a sub (parent-sub) §304 looks for dividend equivalency by applying §302 to determine if SH has sufficiently reduced his interest in the corp. Redemption Through Related Corporations Introduction Policy §304 prevents a SH from selling stock of one corp to another related corp in order to w/d (bail out) earnings while treating the transaction as a sale rather than a dividend. X corp. which redeems all of B’s stocks. agreement says either SH has an option to purchase stock of other b/c of certain events but is free to assign the options ot others.A contribution of stock followed by a redemption shall be treated as a dividend to the donor only if the charitable doness is legally bound or can be compelled by the corp to surrender the shares for redemption. has an option to purchase the decedent’s stock.

transferor increases his AB in the stock of the acquinring corp by his AB in the transferred stock. corps basis is the b transferred basis of the stock) If the constructive redemption is an exchange: (where the before and after analysis provides or exchange treatment) .’s E&P §304(b)(2) 2. and you need to determine amount and source of dividend by looking at (1) Acquiring corps E&P. in the corporation making the acquisition. the effect of the transaction is the same as a dividend b/c A has w/d funds from Y w/o reducing her 100% control of corp §304 Definitions: Property §304 applies only to acquisitions of stock in return for “property” “property. in return for property Issuing Corporation Corp whose stock has been transferred.. Control (1) Ownership of stock possession at least 50% of the total combined voting power of all classes of stock entitled to vote.money securities. then it is §301. distribution would be a dividend.If either corp were to redeem shares held by A. (treated as A transferring the stock to Acquiring co in a 351 trans. or¸ 50% of the total value of shares of all classes of stock §304(c)(1) §318 attribution applies.. 1. and Acquring corp will take the transferors AB in the transferred stock 3. If A sells or part of her X stock to Y. and then (2) Issuing corp. ex. A’s basis is the same as the basis in transferred asset. and other property but not stock. Getting stock back. Acquiring Corporation Corp that acquires stock form a SH of another related corp. §304(c)(3) Mode Analysis (1) Does §304 apply More than 50% of value (2) Does the constructive dividend qualify under §302 as a redemption determine if its a Calculate amount of stock before in corporation Calculate amount of stock in corp (remember to multiply %) (3) If does not come under §302.

look at E&P of acquiring corp. to the other in related transaction even if no SH has control §304(a)(1)(B) Tax Consequences: 1) §301 Distribution If under §301. respectively X has 70K E&P. (2) Brother-Sister Acquisition Constructive Redemption If one or more persons are in “control” of each of 2 corp nad sell stock of 1 corp to the other corp. A sells 30 shares of X corp with AB of 10k to Y for 100k Does this qualify under §304: (1) A owns at least 50% of all classes YES! So §304 applies (2) Before transfer A’s shares in issuing corp (X). so it will be 10k coming out of Y (Acquiring corp.then A taxed under 1001 – if a gain its AR – AB = taxable gain = probably capital gain (or loss) Acquiring corp takes the cost basis in the stock acquired. Control each of the 2 corp.2 or more unlreated SH who in the agg. then E&P of issuing corp.. (6) (4) Relationship of §304 to Other Code Sections (a) §351 . in retrun for property. property is treated for purpose of §302 and §303 as a distributuion in redemption of the stock of the acquiring corp.. §304(b)(2) 2) Exchange SH recognizes a gain or loss measured by the difference b/t the AR and the AB in the transferred stock SH basis in the stock remains unchanged and acquiring corp takes a §1012 cost basis in the issuing corp’s stock §1.304-2(a) E&P reduction I limited by §312(n)(7) to an amount not in excess of redeemd stock’s ratable shares of E&P.42.70+1585/200. and Y has 40k E&P. sell stock of one corp. §304(a)(1) §304(a)(1).) E&P.50% (3) After transfer A’s shares in issuing corp (X). Ex 1: Ex 1: A&B (unrelated) own 100 of the 200 shares of X corp and Y corp.. so comes under §301) (5) §301 dividend treatment..5 (4) No change under §302 (need to analyze each.

Out has no current and 5k of accumulated E&P . §304(b)(3)(B) Ex (1) A owns 80/100 o/s shares of X corp. Illustrates the need for §304 (a) Why did §304 apply to the sale by the TP of their AT&T common stock to Lents (b) Given that §304 applied.txct says that if there is any reduction in ownership then can consider TP argued that the PS was actually debt – this argument fails TP can only integrate two tax transactions where there was a fixed and firm intent to complete the second transaction. except that §304 will not apply to any debt incurred or assumed in connecton with the acquisition of the transferred stock. how do you test the redemption to determine if the TP have a dividend (c) Why were the TP unable to waive family attribution and qualify for “sale” treatment under §302(b)(3) – did not have complete termination of their interest. except A transfer 20 shares of X to Y for 15 shares and a liability incurred by A when he acquired X A recognizes now gain under §351 and §357. and §304 does not apply to Y’s assumption of liability. Problem Page 299 (1) The Niedermeyer case is a good example of tax planning blunder.saying there was family animosity . (2) . and Y corp Both have E&)P The remaining stock is owend by unrelated SH A sells 20 shares of X (AB-4k.P. 299 Bail corp.§351 will not apply to any property received in a §304(a) distribution. value 15k) to U for 15 shares (15k) and 5k cash Transfer qualifies under §351 for the stock but §304 applies for the cash Ex (2): Same as above. Claude owns 80 share of Bail stock (AB of 40k or 500 per share) nad 60 shares of Out stock (AB of 9k or 150/share) Remaining B&O shares are owned by 1 individual who is not related to Claud Bail hs no current or Accumulated E&P.§304(b)(3)(A).if they had donated the preferred shares before the transaction they could have waived the family attribtion rules and thus would not have cnstructively owned AT and T TP argued that it was a dividend not equivalent to .ct said should never consider family animosity . and Out corp each have 100 share of Common stock O/S. (d) How could they have avoided this unfortunate result .

This it’s a meaningful reduction. in which he has 3k AB. (see page 291-292) immediately after must control (ie 80%) . (c) Same as (a). Bails basis in 60 shares is 12k.therefore it is a constructive redemption is it a 301 or is it an exchange do a before or after analysis before – 60% before after – Actual 40 + constructive 16% (80% of 20%) = 56% ( does nt satisfy substantial (not less than 50%) not dividend equal and went from 60% to 56% thus its not an exchange 4k dividend results = Accumulated E & P is reduced from 5k to 1k Claudes basis is increased by 3k in bail. – exchange treatment. . However – t304 says the boot requires treatment as dividend.got boot . except that C receives 3k and 1 share of Bail (FMV of 1k) for his 20 of out shares this would qualify under 351 and 304 – in these circumstances 304 governs transfer of prop in addition of stock receive in exchange stock (d) same as (a) except that Clreceives one share and 3k in liability. 304b3b situation not governed by 304 if liability incurred to acquire the stock.tax the lesser of the realized gain (AR 4k – AB 3k = 1k) or the boot ( 3k) thus taxed on 1k its also capital gain. (b) C sells all out to B for 12k – 304 applies as above it’s a constructive redemption – is it exchange treatment do a before after analysis Before (A) 60% after (A) )0 and (C) is 48% Not a substantially disproportionate 80% of 60% = 48% > 46% and thus not disproportinate Not a complete termination Redemption not essentially a dividend – yes – he had control and now it’s a minority. to Bail for 4k – 304 governs because claude owns 50% of the control of each. (2) §304 still necessary Chapter 6: Stock Dividends and §306 Stock (1)Introduction (a) Types of Stock Distributions: Corp makes a stock distribution when it distributes its own stock to some or all of its SH Stock distributions include: .(a) Claude sells 20 of his out shares. 304 still governs. And bails basis is 3k in the transferred shares. Claudes is taxed under 1001 AR = 12k AB = 9k = gain of 3k =its cap gain and held for longer than one year its cap gain.tax consequences .

smaller and may be of another class of stock (ex.stock distributions are not includible in GI unless an exception in §305(b) applies Ex of non-taxable dividends are “common on common and preferred on common” where no other classes of stock are o/s (b) Allocation of Basis “new stock” is not taxable. If it does increase the interest or SH gets cash or property and other increase their proportionate interest. Common on common stk dividend was not taxable b/c not gross income under 16th Amendment Common on preferred stock dividend was taxable b/c the SH received an interest different from her former stock holdings. Macomber. §307(a) Ex 1 A owns 100 of X c/s worth 12k or 120/share 2 for 1 split gets another 100 CS shares Not taxable. the SH basis in the stock held prior to the distribution “old stock” is allocated b/t the old and new in proportion to the relative FMV of each on the date of the distribution. Strossberger v.preferred) (b)History of Taxation of Stock Distributions Eisner v. Koshland v. with basis of 12k (120/share) 2 for 1 split A gets 25 shares with 25k (100/share) Value of A’s common stock after distribution is 75k A allocated 12k basis in the common b’/t common and preferred based on FMV. 12k/200 so $60/share basis Ex 2 A owns 100 shares of X.increasing number of o/s shares of the same class Stock Dividend. commissioner – dividend of PS does not create ataxable event – see 305 §305 is new rule Policy of §305 Stock dividend is not taxable if it does not increase a SH proportionate ownership interest in the corporation. then taxable (2) Nontaxable Stock Distributions (a) General Rule §305. Hlevering Test Stock dividend is only table only if it increased a SH proportionate interest in the corporation.Stock dividends and Stock splits Stock dividend may differ from a stock split Stock Split. (75% common and 25% preferred) (c) Holding Period of New Stock . and A allocates his 12k basis b/t old and new shares.

the distribution is taxable to all SH regardless of wehter any SH exercises the election.305-3(e) Ex 2: X has 2 class of stock o/s. or (2) ccash or other property.Ex 2 .B SH increase their proportionate interest in earnings and assets of X while the Class A SH receive cash. Reg. Reg 1. even if all SH elect stock.305-1(b)(1) (a) Election of Stock or Property §305(b)(1) If distribution . §1223(5) ie you can tack.S with a value of 10/share held SH who elect to receive stock are treated as a §301 distribution of 10/share.305-3(b)(2). Common stock and pays a cash dividend on the preferred stock. those who increase their proportionate interest are taxed on the value of the increased interest. §305(b)(2) Cash and stock distributions can have a disproportionate effect even if they are not pursuant to a plan and are unrelated. while other increase their proportionate interest in the earnings or assets of the corp. 1.305-3(e). but common on common is not b/c does not increase the proportionate. §1. (4) Ex: X corp has 2 class of CS o/s. (d) Consequences to Distributing Corporation Distributing corp.Common and Preferred X declares dividend on the Common payable in a add.Holding period of the old stock. Reg 1. recognizes no gain or loss on nontaxable stock distribution (§311(a) (1)) and may not reduce E&P §312(d)(1)(B) ie no effect on e & p (3) Taxable Stock Distributions Stock distributions in §305(b) are treated as distributions to which §301 applies and thus are dividends to the extent of the distributing corp. Reg 1. at ANY sh election is payable either in (1) stock of the dis. X declares a cash dividend of 10/share or SH may elect to receive add’l C. SH who participate in stock reinvestment plans by acquiring stock in lieu of cash dividends are taxable under §305(b)(1) on the FMV of the stock received. the are presumed to be beyond the reach of §305(b) (2) unless they are made pursuant to an integrated pan. available E&P if it exceeds it reduces the basis of the stock once reduced to zero then it is capital gain Amount of the distribution is the FMV of the distributed stock. A and B and each class has equal right X pays a 10/share on A stock dividend and a dividend on class B stock payable in additional shares of B stock with 10/share Taxable.. Rev Rule 78375 Ex X only has common stock o/s. Corp.305-2(a) (b) Disproportionate Distributions If result is that some SH receive cash or other property.. If separated by more than 36 months. Cash dividend taxable.

305-4(b). growth to any significant extent and has limited rights and privileges. Distribution is taxable to the preferred but not the common. Issuance of junior preferred stock does not give the common SH more than they had before the distribution.S or doubling of conversion ratio is taxable. Reg 1.PS is any stock which does not participate in corp. taking into account factors such as the dividend rate and market conditions If right is exercised over many years. probably can establish that the distribution will not have a disproportionate effect. C. (1) common and non-convertible preferred X declares a dividend on both common and preferred. Both distributions are taxable. (d) Distributions on preferred stock All distributions on P.S proportionate has increased. Reg.Ex 3: Now. Ex 2: X has two class of stock o/s. (c) Distributions of Common and Preferred stock If a distribution has the result of some common SH receiving preferred stock. the corp. §305(b)(4) Reg. one common and one preferred Each share of preferred is convertible into 2 share of common. (e) Distributions of Convertible Preferred Stock §305(b)(5) A distribution of convertible P. and the extent of conversion cannot be predicted. Ex X corp.s.S dividend is shares of prereed. X pay a dividend of one share of common stock for each common share held and doubles the conversion ration of preferred.S is taxable unless the P establishes to the satisfaction of the service that it will not have the result of a disproportionate distribution. 1. has only 1 c/s o/s . 1. not taxable b/c no increase in proportionate interests of the common SH. §305(b)(3) Ex: X has Class A and Class B CS X declares a divdened on Class A stock payable in addl’t shares of Class and a dividend on Class B stock. If it was subordinate to all preferred stock. §1. dividend is taxable. in each case payable in additional shares of the common. all are taxable.305-5(a). Now C.. §305(b)(5) Disproportionate right to convert must be exercised w/in a short period and it is likely that some SH will convert and others will not.305-6(a)(2). Neither the C. payable in preferred stock. Ex 1: X has two class of stock o.305-3(e).S are taxable except for an increase in the conversion ratio of convertible preferred stock that is made solely to take account of a stock dividend or split.. and other receiving common stock.

the distribution is taxable. can show that it is impossible to predict the extent to which the preferred will be conveterd. at a fixed priced during a relatively short period of time.. Distributing corp. C) a pro rata distrubition on class a and cash on class b – this is taxable to all due to 305b2 . – Ex. REDEMPTION AS A CONSTRUCTIVE DIVIDEND In the case of a redemption – the commissioner has the authority to declare it a constructive cash dividend. A gets cash for 10 shares redeemed. A) Pro rata share of non convertible PS – this is not taxable B) class b have option to take cash in lieu of distribution. b/c it result in the receipt of case by some SH and an increase in the proportionate interest of others. Ex (1). Reg. the prefreed was over a short period of time. recognizes no gain or loss on a taxable stock distribution/ §311(a)(1) Corp may reduce its E&P by t he FMV of the distributed stock. What if b gets additional shares to compensate – that’s ok Problem Page 313 – see problems Hilll is organized into two classes of stock Frank owns 100 shares of Class A and Fay and Joyce each own 50 shares of class B. §301(d) Holding period of the stock commences as the date of the distribution.305-6(b). and on the facts. a owns 80 and b owns 20. (b) Nontaxable Rights Taxed if it has one of the effects described in §305(b). (h) Consequences to the Distribution Corp. (g) Basis and Holding Period Basis to a SH who receives a taxable stk dividend is the FMV of the distributed stock. distribution is not taxable..and thus a disproportionate distrubution – only under 301 and occur under a periodic redemption plan. it was likely that some SH would covert while others would sell their stock. B gets increased percentage of ownership . Reg 1. 1. – this is taxable 305b1 – this is true for those that elect to take cash and those that don’t and applies to all classes of stock. (2).. If corp.312-1(d) (4) Distributions of Stock Rights (a) Rights Defined Rights are options to purchase shares from an issuing corp.Declares a dividend payable in the new issue of preferred stock convertible into common for a period of 20 years. If however..

i) a gets 100 cs and b gets conv preffered over long term.6%/21. - if short term – some would convert and some would not convert – causing a disproportionate dist. this is not taxed under 301 and thus commissioner could not regard this a a constructive dividend. Before is a 50%/30%20% Yr 1 After its 47.4%/31.D) class b is nonconvertible PS and Hill distributes class b stock to class A .305b2 this is taxable E) same as d above hill distributes a class of PS that is Juniour to Class B before current E and P = 100 dividend ps = 20 CS = 80 --------------------------------non taxable – f) assume on one class common outstanding. Issue – 10% debentures –convertible into common stock at 1 Cs:: $1000 debenture. – this is non taxable – it’s a proportionate ratio h) 305b3 .305(d) thus this is a disproportionate distribution under 305b2 bc frank gets a greater interest in the corp on distrubtion – if the conversion ratio changed to reflect this and keep her % interest in the biz the same. Corp declares a one for one split on the CS and the preferred ratio is doubled.0% Is it a redemption – exchange treatment – 302b1 as a redemption not equivalent to the dividend . 2. a has 500sh b has 300sh c has 200sh z corp has one class of CS – will 305c3 if there is a redemption plan for a shares.taxable.there is no disproportionate dist. Class a get common and class b get preferred. hill makes annual interest payment and one month later distribute common on common stock dividend w/o adjusting the conversion ration of the debentures the treatment of the convertible debenture is considered stock . g) same as f but the debentures are convertible preferred stock.he had veto power before now he doesn’t. . – with long term --.

interest in the corp. a SH basis in the common was allocated to the preferred.Yr 2 – 44. the essence of a dividend Chamberlin v.0 This redemption is no longer meaningful. Net effect was that SH received cash w/o reducing their prop. it is not “common stock” for this purposes. SH would then sell preferred stock to an investor.S that is subject to the issuing corp. – 301 applies. such as complete terminations of a SH interest in the corp..3/22. reporting LTCG.corp would then repurchase the PS from the investor after a number of years.SH may not offset her stock basis against the AR on a disposition of §306 stock. right of first refusal at net book value is “common stock” Rev Rul. Common stock is not included b/c it participates in corporate growth and thus lacks bailout potential.. In computing the gain. would make a tax-free distribution of preferred stock to its common SH. – and does not satisfy the 8% test. And could treat it as a constructive stock dividend. §306(c)(1)(A) If stock has either a limited right to dividends or limited right to assets upon liquidations. §306 STOCK (1) Preferred Stock Bailout (a) Background Device used by SH before 1954 to w/d corporate earnings at LTCG rates. Rev Rule 79-163 Voting C. Profitable corp. that do not have bail out potential... D/A under §305. (b) Overview of §306 §306 stock stock with bailout potentional SH must recognize ord. CommissionerRejected IRS saying this was taxable like a dividend and held that it was a good transaction. redemption or other disposition of stock. 76-386 .4/33. (2) Definition of §306 Stock (a) In General Principal category of §306 stock is: Preferred stock distributed to a SH as a tax-free dividend under §305(a). income rather than capital gain on sale. Exceptions for dispositions.

whether no part of a tax-free stock distribution would have been a dividend if cash has been distributed instead of stock. in exchange for Y common and Preferred stock Y preferred stock will be §306 stock b/c a transfer of cash to A in lieu of the preferred stock would have been treated as a dividend under §304(a)(1) (3) Dispositions of §306 Stock .. under §358(a)) are each §306 stock.. X has no accumulated E&P On July 1.. Ex: X. with ample E&P A transfers her X common stock to a newly formed Y corp. date of death basis Death FMV so no 306 taint! Ex 1: Parent gives 100 shares of X corp to child of §306 Stock remains §306 stock in child’s hand.s. Preferred stock is not §306 stock b/c a distribution of cash in lieu of stock would have not been a dividend. makes a tax-free distribution of preferred stock with a value of 25k to its common SH. (e) Certain Stock Acquired in a §351 Exchange Preferred stock acquired in a §351 exchange is §306 stock if the receipt of money instead of the stock would have been treated as a dividend to any extent. X has current E&P of 10k but at end of year. Test. (c) Stock with Transferred or Substituted Basis §306 stock includes stock which has a transferred or exchanged basis determined by reference to the basis of §306 stock.(b) No E&P §306 does not include stock distributed by a corp w/ no current or accumulated E& P for the year of distribution. b/c §1014. to Y in exchange for 100 shares of Y corp.. all preferred stock would be §306 stock. §306(c)(3). If X had ended the year w/ S20 current E&P. preferred stock (§362(a) basis) and the Y corp. common stock that is tax-free under §351(a) X corp. corp. It would no longer be §306 stock Ex 2: A transfers 100 shares of §306 p. §306(c)(2) If even a small part of a cash distribution would have been a dividend. If parent were to die and bequeath the stock to child. then all the stock is §306 stock. §306(c)(1)(c) Ex include Stocks received as a gift Stock received in exchange for §306 stock in a tax-free §351 transaction §306 taint is removed for death. common stock (substituted basis determined by reference to the Y corp. Ex: A is the sole common SH of X corp. 1k E&P deficit.

and any excess is treated as a gain from the sale or excahgne fo the stokc. may not reduce its E&P. if any. X has no E&P. No loss may be recognized on a disposition of §306 stock. this is the amount that would have been a taxable dividend if cash. rather than stock had been distributed. at a time when X has 30k of E&P A continues to own 100% of common stock. §306(a)(1) (C) Reg 1.(a) Redemptions If §306 stock is redeemed.’s current or accumulated E&P at the time of the redemption. Reg 1. This the amount that would have been taxable if cash rather than stock has been distributed at time of distribution 2k is a reduction of A’s basis in the P. and thus corporate SH are not allowed a §243 dividends received deduction. (b) Sales and Other Dispositions On a sale or other disposition of §306 stock. of the AR is first treated as a reduction of basis and then if necessary as a capital gain under distribution rules of §301 Example: X makes a tax-free distribution of preferred stock with a value of 20k to its common SH A X has 5k of E&P at time of distribution A’s allocable basis in the P. If X had no E&P at the time of the redemption. 20k is treated as ordinary income. rather than stock has been distributed at the time of the distribution. of the the amount realized first reduces the basis of the §306 stock. makes a tax-free distribution of prefreed stock with a value of 20k to its sole common SH A X has 50k of E&P at the time of the distribution A’s allocatable basis in the preferred stock (§306) is 2k Two years later. Entire 20k AR on the redemption is a dividend. A’s basis in the preferred stock probably is added back to the basis of A’s common stock. X redeems A’s preferred stock for 20k. the AR is first treated as Ordinary income to the extent of the stock’s ratable share of the amount that would have been a dividend at the time of the distribution if cash.S and 2k is treated as a gain from sale of stock Ex 2 . and the corp.306-1(b) The balance. §306(a)(2) Balance... O. A sells the §306 stock for 24k Of this amount. entire 20k would be return of capital under §301©(2) A probably could reduce his basis in both the preferred and the common stock before recognizing any gain.I is not considered a dividend.S(§306) is 10k 2 years later. the AR by the redeemed SH is treated as a distribution of property as to which §301 applies and this is taxable as a dividend to the extent of the corp. but any unrecovered basis is allocated back to the stock w/ respect to which the §306 stock was distributed. §306(a)(1)(B). if any.306-1(b)(2) Ex 2 and 3 Ex 1 X corp.

A may add the remaining 1k basis in the preferred back to his basis in the X common stock.306-1(b)(2) Example 2. becomes §306 stock. preferred §306 stock. 20k is treated as ordinary income. (2) Complete Liquidations §306(a) does not apply to a redemption of §306 stock in a complete liquidations. and 1k is a reduction of A’s 2k basis in the preferred stock. A sells all of her common and preferred stock to an unrelated person. No loss will be allowed. §306(b) (3) Any stock received in a tax-free exchange. A’s sale of the preferred stock is not subject to §306(a) b/c she completely terminates her interest in the corporation. §306(b)(4) §306(b)(4) relief is not automatically available. §306(b)(1) (B) Example A owns 500 shares of X corp. She owns no X stock constructively. contributions to capital and tax-free exchanges of stock under §1036 are exempt. §306(c)(1)(C). 4) Transactions Not in Avoidance of Tax §306(a) does not apply if the TP satisfies the service that either: (a)distribution and the subsequent disposition or redemption of §306 stock or (b)in the case of a prior or simultaneous disposition (or redemption) of the underlying stock with respect to §306 stock was issued. Reg 1. common stock and 250 shares of X corp. except A sells the §306 stock for 21k. the disposition or redemption of the §306 stock was not made pursuant to a plan having federal tax avoidance as one of its principal purposes. §306(b)(1)(A)(iii) Redemption of §306 stock that result in complete termination of the SH interest under §302(b)(3) or qualify as partial liquidation under §302(b)(4) are also exempt. and 14k is treated as a gain from sale of the stock. Case: Fire Oved: . (c) Exempt Dispositions Four types of dispositions are exempted from the rule of §306(a) b/c they do not represent any opportunity for bail out. such as §351 transfers. §306(b)(1)(A)(ii) §318 attribution rules apply. A’s AR on sale of §306 is ordinary income the 2k is reduction of basis.. on dispositions of prefreed stock of wildely held corp. at time of distribution. Ex 3 Same as (1).Say X’s E&P was 8k. however. Of this amount. (1) Complete Terminations and Partial Liquidations Disposition of §306 stock in a transaction (other than a redemption) that terminates the SH entire stock interest in the corp is exempt if the SH does not transfer the stock to a §318 related person or entity. (3) Nonrecognition Transactions Dispositions that qualify for nonrecognition treatment.

The court in Fireoved held that the prior sale of a portion of the common did not exempt a corresponding portion of the preferred from § 306(a) treatment b/c the taxpayer had the same degree of control after the sale of the common stock as he did before. this disappears and flows back into the common. J received the other 1k: AR on sale is Ord Income. Corp. Both satisfied. its 1001 AR-AB 1000-500 = cap gain of 500. – 1. e) if J gives to grandson. Problem is she had a basis in the PS of 500. There is a step up in basis to FMV at the time of death. The rest (250) is capital gain.GS gets the transferred basis (still 306) sells stock to unrelated party. f) skip g) see firoved handout – CS . 306 is designed to prevent a bailout of E&P if there is no E&P there is no need to apply 306. Exceptions: 306b1 termination of sh interest not in redemption. d) same as b but there is no E and P at time of distribution. Thus the CS basis returns to 2000 (from 1500 after reallocation) c) same as B but V sells to carl for 1750 – the first 1k is treated as OI (as above). This is treated as a sale AR –AB = 1000-500 = Cap gain of 500.before and after analysis before 50% after 33 1/3 % . Must have less than 50% and voting power must be 80% of what it was before. Generally . Thus is a substantially disproportionate stock. The court asserted that the evil § 306 was enacted to address was the ability of a shareholder to realize upon the accumulated E & P of the corporation (through the sale of preferred stock to a third party) without diminishing his control. No tax consequences to arg. 306 does not apply in death bequeaths – the stock loses its 306 status. There was 2k in E and P thus all 2k would be a cash dist (dividend). Problem here veto power See – handout on 306 for step by step P.is this substantially disproportionate. all 1k is taxed as OI – 15% dividend rate. GS sold stock to unrelated party for 1000. had E and P of 2k and Y3 E and P of 3k a) in yr 1: distribution of PS is tax free (no gain or loss (305a)) and have to reallocate basis after distribution from CS to CS and PS AB of PS= FMV of New / FMV of OLD * old basis 1k/ 3k +1k = ¼ * 2k = 500 basis in pf and 1500 basis in common. she received 1k. This is not 306 stock then normal rules apply. the next 500 reduces basis in the PS to zero. . – no reduction of e and p b) V sells PS to Carl for 1k in year 3. 330 – Corp non convert non vote PS worth 1k to J and V each had basis of 2k prior to dist and avalue of 3k after. 306 does not apply in certain circumstances (see above) grandson does not have attribution interest—it’s a complete termination of interest.

Must argue that qualify under 306b4 see fireoved. liquidates for tax purposes when it ceases to be a going concern and its activities are merely for the purpose of winding up its affairs. (B) Complete Liquidation under §331 (1) Consequences to the SH Recognition of G/L . In fireoved – he maintained his same level of control (veto power) here probably did not retain the same level of control after the redemption. Went from veto to no veto.Corp. paying its debts and distribution any remaining balance to SH Corp sells to 3rd party assets to pay creditors and give cash to SH and to satisfy claims to creditors and SH. Chapter 7 Complete Liquidations (A) Complete Liquidation Defined Corp distributes all of its assets (or proceeds of their sale) subject to any liabilities.332-2(c). – should be able to get exchange treatment. §1.Redemption of 306 exception (and wont apply) – complete termination of interest or partial liquidation. to its SH in exchange for all their stock Corp then dissolves under state law. Does not occur here.

Remember it triggers 1001 = AR-AB = G/L ( cap gain or loss. . acquired property.Amounts distributed to a SH in a complete liquidation are treated as in a full payment in exchange for the SH stock. Can only disallow the loss that accrued before the corp..SH basis on §331 is FMV of the property on the date of distribution. in 3 situations (1) Distributions to Related Persons §336(d)(1)(B) No loss can be recognized to a §267 related person if the distribution is: Not pro rata or is Disqualified property Related person §267(b)(2) SH owns directly or indirectly through attribution >50% in value of corp. recognizes G or L (different from non liquidation dist) when it distributes property in a complete liquidation as if it had sold the property to the distrbutee for its FMV. (look at old exam) If property distributed. Capital Gain or Loss AR – AB in stock AR-amount of money and the FMV of all other property received from the liquidating corporation – liabilities assumed by the SH or encumbering property. Exception to Loss Channel stuffing provisions (2) Limits on Gain or Loss S336(d) Limits the recognition of loss by distributing corp.e. Disqualified Property: Any property acquired by the liquidating corp.not distributed to the SH in the same proportion as their stock ownership in the corp.. Non Pro-rata §336(d)(1)(A)(i).§331(a). and only to extent of built in loss. in a §351 transaction or as a contribution to capital during the 5-year period ending on the date of distribution.’s o/s stock. Corp has to reduce its basis for determining the loss by the pre-contribution built in loss i. (2) Basis of Distributed Property §334(a). sold or exchanged by corp... (C) Consequences to the Corporation under §336 (1) Recognition of Gain or Loss §336(a) Corp. §336(d)(1)(B) (2) Property Acquired for Tax Avoidance Purpose§336(d)(2) §336(d)(2) 2 years. G/L is determined seperatly on each asset.excess of the AB of the property when it was acquired over the FMV of the property at that time. w/o reduction for any liabilities to which the property is subject. was acquired in a §351 transaction or as a contribution to cap as part of plan where principal purpose was to recognize a loss in connection w/ liquation.

notwithstanding (a) the transferee’s aggregate AB of the property so transferred shall note exceed the FMV of such property immediately after the transaction. Thus cant recognize the 240k loss distributed to ivan recall . – is disqualified bc it is a contribution to capital within the 5 year property. step it down at the time of the transfer – result is the same. Aggregate AB must exceed FMV of transferred property Allocation §362(e)(2)(b) Allocated amongst the property in proportion to its built in losses. thus there is a gain of 300k c) gainacre gain is 300k loss acre loss of 400k = just net the gain and loss 336d1 and 2 don’t apply 1.thus you step down the basis from 800k to fmv at time the asset was transferred to corp.is an irrebutable presumption – unless there is a relationship to the business operations. no disqualified property distributed pro rata. 349 a) Corp will recognize a gain of 300k. And no distribution within 2 years ie net loss of 100k b) this is not a pro rata distribution thus cant recognize the loss of 400k.you squeeze out the built in loss of the property. property – thus cant recognize loss of DQ prop to related person – only recognize a loss of 60k by flo. With respect to lossacre you reduce it to 700k reduce the aggregate basis to the aggregate fmv.trying to reduce the aggregate basis fro 900k aggregate to 800k aggregate. corp Cant recognize loss to distribution to Ivan. Bc 336d2 applies . at time of contribution there was a step down from 700k to 400k then there is a distrubition to I and F – 336d2 applies. 300k gain of gain acre and a 300k loss of lossacre What happens if 362(e) (2) did apply at the time property transferred to the corp. Ex: 23AB and 20 FMV.. g) 362e2 applied to ivans contribution to x and 336d2 applied to lossacre bc there was a plan.so 3k difference reduce the basis by 3k in the property E) 362 did not apply . F) if 362 e2 applied – Ivan contributed gainacre and 362e2 applied . Isqualifies the protion of the los distributed to the related person. and a loss of 400k. Not related 2.336d2 applies here bc transfer is within 2 years of liquidation . d) not subject to d2.Exception on 362(e)(2) If transferee’s aggregate Adjusted Basis of such property so transferred would exceed the FMV of such property immediately after such transaction then. After 5 years. As to Flo bc 336d2 applies – corp . Is it a distribution to related person that is disqualified.P.

Redo of the last problem F) now assume that Ivan and Fow own 80/20 of X Ivan contributed Gainacre and Lossacre. Parent takes the distributed assets with a transferred basis under 334b1 Holding period also tacks on. §334(a) treated as a normal liquidation distributed to Minority SH Basis is FMV holding period begins on the date of distribution Effect on Recipient Taxable Income No g/l Distribution to 80%- 80% §332 No gain or loss Distribution to Minority §331 §331 No gain or loss Effect on Corp’s Taxable Income 80%-->§337(a) .At time of transfer 362e2 applies corp would take basis fmv (reduce adj basis of the poperites by 100k to 800k – allocate to the loss property) distribution properties are disqualified . Flo contributed 200k Lossacre is a 336d1 disqualified property 362e2 applied to ivans contributions to X but 336d2 does not apply to the liquidation distrbution of lossacre because there ws no plan for X to recognize loss LOOK TO EXPLANATIONS FOR AN ANSWER. Sub asset bases and other tax attributes transfer to the parent Consequence to SH basis in Distributed Property §334(b)80% Parent. Subsidiary Liquidation Viewed as a mere change in form – not a taxation event 80% total value of all stock – and 80% of the total voting power (BOTH) §332 and §337 generally provide that neither the parent SH nor the liquidating corp recognize gain or loss on the receipt of property in complete liquidation of an 80% or more subsidiary.transferred basis and a tacked holding period in a §332.since we are distributing lossace must eliminate the built in loss (here 300k) 700k to 400k.

(sold in connection with a liquidation). immediately after the acquisition.If §332 applies. No gain recognized on Land to P P wont recognize gain – uses a transferred basis. This is tax free to the SH of T (351) Reason is that they have not cashed out – continued their investment SH take the same basis in the new shares that they had in the original stock Holding period tacks on. of stock of another corporation if. S recognized gainon inventory of 900 b)S gets no loss recognized for distribution of equip to I . (B) STOCK FOR STOCK EXCHANGE . I takes a basis of 1k in equipment What could it do – sell the equipment and take the loss – if 336d2 applied however. I recognizes a gain in excess of its basis thus there is a gain of 800.b. (A) a statutory merger or consolidation. Minority§336 included §336(d)(3) Can recognize Gain but not loss to a minority SH in a §332 Liquidation a) S recognizes a gain on the distribution if inv. If the SH receive anything other than stock – it is deemed as boot. the acquiring .c.FREE REORGANIZATION Reorg occurs where corp acquires stock of another corp for its own stock Target P= Parent/Purchaser T merges into P P survives SH of T receive shares of P this is a tax free reorg 368. The gain recognized – is the lesser of the realized gain or the FMV of the boot The trick is to determine what a tax free reorganization is 368a1 acquisitive reorganizations are set forth in 368a1a. TAX. no gain or loss recognized to P P does not recognize a gain or loss and takes a transferred basis. reduce the basis of the equipment to 1000. Basis is the adj basis in the old T stock minus the FMV of the boot + the gain recognized. sub recognizes no gain or loss. in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation).the acquisition by one corporation. Takes a basis of 1000k.

Control is defined in 368c . – amount of consideration of stock must be stock 40% stock to boot ratio is ok. (C) STOCK FOR ASSETS . business purpose. Does there have to be historic continuity? No. (TYPE C) STOCK FOR ASSETS ACQUISITIONS acquiring corp must get substantially all the assets of the target .80% of voting power and 80% of all other stock CTs have added their own requirements to reorganizations SC held that a 99cash 1% stock – was not a valid transaction – this was not intended to be a reorganization – too much like a purchase of assets . continuity of proprietary enterprise (Boot can be 60%) 2. in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation). There must be a purpose. Now that is not the case. 100% of SH receive stock but pursuant to preexisting agreement that sale of new stock ocurred is this a reorg. (TYPE B) STOCK FOR STOCK ACQUISITIONS Must be voting Stock Corp acquiring must become the controlling sh (80%) Cant have two transactions that constitute a single transaction – and one transaction has some boot. – not a continuity of interest. So 10% stock is not a reorganization. just have to use the business assets 3. continuity of business enterprise IRS used to require that new biz conduct identical business as prior to reorg.corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition). Judicial Requirements for a tax free Reorg 1. it doesn’t make a difference if a sufficient number of old sh receive stock. but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other shall be disregarded. of substantially all of the properties of another corporation.the acquisition by one corporation.

Reverse triangular merger P drops down S and T acquires S S dissolves . You can have some boot in a C reorg – up to 20% can include boots – includes assumed liabilities) Target must dissolve. USE OF A DROP DOWN SUBSIDIARY 368a2d Can create a drop down subsidiary – if T ( P then P acquires all liablilites If use a B or C can use parents stock Forward triangular merger P drops down S and S acquires T T dissolves.what is substantially all? Gross assets – liabilities = net assets It is substantially all if 70% of gross assets AND 90% of net assets.

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