For 355 to Apply

1


For 355 to Apply
Four Critical Tests - Business Purpose -
Trade or Business - No Device -
Continuity of Interests
2




Tax Impact to Distributing Corp if 355 Apply

• General Rule No gain or loss to distributing
  corp on distribution of controlled corp stock or
  securities. 361(c) and 355(c). If other
  appreciated boot also distributed, must recognize
  gain on it.
• Exception 1 Stock of controlled corp acquired by
  distributing corp within five yrs of distribution
  considered boot. Must recognize gain on it.
  355(a)(3)(B)
• Exception 2 If after distribution 50 or more
  of interest in either distributing or controlled
  corp owned by persons who acquired by purchase
  within 5 year period, then stock distributed is
  disqualified stock in disqualifying
  distribution per 355(d). Distributing corp must
  recognize gain. Distributee shareholder not
  impacted. Purchase exists if no carry-over
  basis.
• Exception 3 Gain recognized as if taxable sale
  if pursuant to plan 50 or more of stock of
  distributing or controlled corp acquired by
  non-historic shareholders within 4 yr period
  starting 2 yrs before distribution. 355(e).
  Anti-Morris trust provision to prevent tax-free
  dumping of unwanted assets in connection with
  tax-free reorgs.
• 
  

3




Tax Impact to Distributing Corp if 355 Apply

• Trap Do not confuse three exceptions to
  threshold trade or business requirements of
  355(b)(2)(C) and 355(b)(2)(D)
• 355(b)(2)(C) Active business may not have been
  acquired within 5 yr period prior to redemption
  in transaction where gain or loss recognized.
• 355(b)(2)(D) Control (80 voting and 80 all
  classes) of corp conducting business not acquired
  by corporate distributee or distributing corp
  with 5 yr period in which gain or loss
  recognized.
• If either of these apply, active trade or
  business flunked and 355 benefits not available
  to any party.

4


Problem 560(a)
Basic Facts T Corp has sub S corp both active
business over 5 yrs. P Corp wants to buy T corp
business, but not S. T and S of equal value,
both with appreciated assets.
S Corp
100
S Corp Stock
B Corp
T Corp
Cash
100
T Corp Stock
Shareholders
P Corp
Cash
5


Problem 560

• Basic Facts T Corp has sub S corp both active
  business over 5 yrs. P Corp wants to buy T corp
  business, but not S. T and S of equal value,
  both with appreciated assets.
• T sells S stock to B Corp. T shareholders sell T
  stock to P.
• T recognizes gain on the sale of S stock.
• Ts shareholders recognize gain on sale of
  T stock to P.
• P has 338 election option.

6


Problem 560(b)
Basic Facts T Corp has sub S corp both active
business over 5 yrs. P Corp wants to buy T corp
business, but not S. T and S of equal value,
both with appreciated assets.
S Corp
100
2007 S Corp Stock
B Corp
T Corp
100
2005 T Corp Stock
9 Months S Corp Stock
Shareholders
P Corp
Cash
Cash
7


Problem 560(b)
Basic Facts T Corp has sub S corp both active
business over 5 yrs. P Corp wants to buy T corp
business, but not S. T and S of equal value,
both with appreciated assets. 2005, P buys
stock in T from shareholders no 338 election.
Two yrs later, T distributes S stock to P for
valid business purpose. Nine months later, P
sales S stock to B. T shareholders have
gain on sale of T stock. T recognizes
gain on distribution of S stock per 311(b) no
hope under 355 because bought in taxable
transaction within 5 yrs. 355(b)(2)(D).
P receives S stock as dividend, but has 100 243
deduction. But Ps basis in its T stock reduced
by untaxed dividend. Reg. 1.1502-14(a)(1)
32(b)(2). P takes FMV basis in S stock per
301(d) thus no gain on sale of S stock. S basis
in assets not change.
8


Problem 560

• Basic Facts T Corp has sub of S corp both
  active business over 5 yrs. P wants to buy T corp
  business, but not S. T and C of equal value,
  both with appreciated assets.
• Same as (b), but P individual. 355(b)(2)(D) not
  problem because P not corporate distributee.
  Distribution of S stock may qualify under 355 for
  P if can avoid device issue on resale. If not
  prearranged, have shot. Rev. Rule 74-5. Per
  355(d), T will recognize gain on distribution
  even if it otherwise qualifies under 355.
• Same as (b), but P acquired all T stock in
  tax-free B reorg. No 355(b)(2)(D) issue because
  no taxable exchange and basis carryover. 355 may
  apply. P recognized full gain on sale of S stock
  to B.

9


Problem 560(e)
Basic Facts T Corp has sub S corp both active
business over 5 yrs. P Corp wants to buy T corp
business, but not S. T and S of equal value,
both with appreciated assets.
S Corp
B Corp
100
50 T Stock
Cash
T Corp
S Stock
50 T Stock
100
50 T Stock
Shareholders
P Corp
Cash
10


Problem 560
Basic Facts T Corp has sub of S corp both
active business over 5 yrs. P wants to buy T corp
business, but not S. T and C of equal value,
both with appreciated assets. (e) 2005 P
purchases 50 of T stock and B purchases other
50 of T stock from T shareholders. In 2007, T
distributes all S stock to B in exchange for T
stock owned by B. 355(b)(2)(D) not violated
because P did not acquire control (80) within 5
yr. period. Thus, 355 possible, but 355(d) will
trigger gain recognition to T on distribution of
S stock.
11


Problem 568(a)
Basic Facts Basic Facts L Corp has hotel and
apparel business, of equal value and both over 5
yrs. D Corp wants to buy apparel business.
M Corp
Motel Assets
M Stock
Apparel Assets
D Corp
L Corp
D Stock
M Stock D Stock
Shareholders
12


Problem 568

• Basic Facts L Corp has hotel and apparel
  business, of equal value and both over 5 yrs. D
  Corp wants to buy apparel business.
• L transfers hotel business to sub M and
  distributes M stock to shareholders. Then sales
  apparel assets to D in exchange for D stock (less
  than 50) and distributes D stock to L
  shareholders.
• - Formation of M tax free under 351.
  Integrated transactions so device and no 355.
  Really just liquidation of L
• - No C reorg potential on apparel sale
  because not substantially all assets under
  integrated approach. So income recognition to L.
• - Distributions to L shareholders are
  liquidation per 331 under integrated approach.
  Shareholder have gain. L would also have gain on
  M stock and D stock under 336 (but B stock have
  high basis from gain recognition on sale).

13


Problem 568(b)
Basic Facts Basic Facts L Corp has hotel and
apparel business, of equal value and both over 5
yrs. D Corp wants to buy apparel business.
M Corp
Motel Assets
M Stock
Merger of L D
D Corp
L Corp
M Stock D Stock
D Stock
Shareholders
14


Problem 568

• Basic Facts L Corp has hotel and apparel
  business, of equal value and both over 5 yrs. D
  Corp wants to buy apparel business.
• Same as (a), but L merges with D after spin-off
  and L shareholders receive non-voting D stock.
• - Per Morris trust rationale, spin off
  qualifies per 355 and merger qualifies as valid
  A reorg.
• - Problem is 355(e) which will trigger
  gain to L on distribution of M stock. D acquired
  50 or more of distributing or control
  corporation pursuant to plan 4 yr period
  starting 2 yrs before distribution.

15


Problem 568(c)
Basic Facts Basic Facts L Corp has hotel and
apparel business, of equal value and both over 5
yrs. D Corp wants to buy apparel business.
Merger of C D
C Corp
Apparel Assets
C Stock
D Corp
L Corp
C Stock
D Stock
Shareholders
16


Problem 568

• Basic Facts L Corp has hotel and apparel
  business, of equal value and both over 5 yrs. D
  Corp wants to buy apparel business.
• L transfer apparel to new C corp, spins off C
  corp stock pro rate. C merged into D corp
  following spin off. L shareholders get D stock.
  
• - Old rule was that step-transaction would
  be applied to treat as asset sale by L followed
  by dividend liquidation. No more per Rev. Rule
  98-44.
• - Now, formation and spin-off of D qualify
  as D reorg and 355 apply. But if L shareholders
  do not own more than 50 of D post merger, 355(e)
  applies and L recognizes gain on spin off of C
  corporation.

17


Problem 568

• Basic Facts L Corp has hotel and apparel
  business, of equal value and both over 5 yrs. D
  Corp wants to buy apparel business.
• Same as (c) but L shareholders end with over 50
  of D stock. No 355(e) application and no gain
  for L. Highly unlikely that target end up with
  over 50.
• Same as (b) but merger of L into D one year after
  distribution. Question is plan per 355(e).
  Because within 2 yrs following spin off, burden
  on taxpayer to prove no plan to sell off. More
  facts needed. See Reg. 1.355-7(b) for factors
  and safe harbors.

18


Problem 568

• Basic Facts L Corp has hotel and apparel
  business, of equal value and both over 5 yrs. D
  Corp wants to buy apparel business.
• Same as (b) except business purpose of spin off
  unrelated to apparel acquisition and merger three
  years after spin off. No plan. Within safe
  harbor of reg. Thus, no 355(e) and no gain at L
  level on spin off.
• Is 355(e) necessary? Some think overkill, but
  planning to avoid plan requirement per Regs is
  possible.