For 355 to Apply

1


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

Active Trade or Business 355(b)

• Both distributing and controlled corps must be
  engaged in active trade or business after
  distribution that has a 5 year history.
• Passive business activity wont work. Corp
  itself must perform active and substantial
  management and operational functions.
• Vertical division of single integrated business
  permitted.
• Functional division is permitted if active, even
  though all income from related source.
• Geographical divisions not controlling. Regs.
  follow Lockwood case.
• Active business may not have been acquired within
  5 yr period prior to redemption in transaction
  where gain or loss recognized.
• Real estate no hope unless provide substantial
  services.
• 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.

3

Continuity of Interest Reg 1.355-2(c)

• After distribution, at least 50 of both
  distributing and controlled corps must be owned
  by historic shareholders of distributing corp.
• Heavily overlaps Device requirement.
• Historic shareholder is anyone who acquires
  distributing corp stock before plan to
  distribute. Some claim includes any person who
  bought stock at lest two years before
  distribution.
• Post-Distribution activity (sell off of
  distributed stock) relevant and may kill if part
  of the overall plan.

4

Device Requirement 355(a)(1)(B)

• 1. Safe zones (presumed innocent)
• - No EP in distributing corp and
  controlled corp.
• - Absent 355, distribution would qualify
  to cover death taxes and expenses per 303.
• - Absent 355, distribution would qualify
  as exchange under 302(b).
• 2. Device Factors Pro rata distribution to
  shareholders subsequent sell off of stock of
  either corp nature of assets in controlled corp
  (cash and investment assets).
• 3. Non-Device Factors - Strength of business
  purpose publicly traded or widely held stock
  availability of 243 dividends deduction available
  to corporate distributee shareholders of
  distributing corp.

5




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(c)(2)(A)
• 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.
• 
  

6
Problem 557
Basic Facts F sole shareholder of C Corp,
operator of department store of 15 yrs. Stock
basis 200k, FMV 2 mill. New branch store bought
3 yrs ago represents 500k of 2 mill value and
basis of 100k. C Corp transfers branch store
assets (500k) to new B Corp for 400k common stock
and 100k securities S Corp then distributes B
Corp stock and securities to F F then gifts B
Corp stock to children as part of estate plan.
400k EP. Is this valid 355 transaction? Is
estate planning valid business purpose? Probably
not split of authority. Trade or business
requirement satisfied? Yes, vertical division of
15 yr old business. Device? Planned gift may
kill. Continuity of interest? Planned gift may
kill. Tax consequences if valid -
Transfer of assets to B Corp in exchange for
stock and securities valid D reorg and S Corp
recognizes no gain or loss under 361(a). 361(a),
unlike 351, includes securities as nonrecognition
property. 361(a) trumps 351.
7
Problem 557
Tax consequences if valid - C Corp basis
in stock and securities substituted 100k asset
basis per 358(a)(1) 80k allocated to stock and
20k allocated to securities. - 25 of C
Corp EP allocated to B Corp (based on relative
FMV of assets). Reg.1.312 -10(a). - C
Corp has no gain or loss on distribution of stock
and securities to father. 362(c). C Corps EP
reduced by basis in securities (20k) to 280k.
This done pursuant to 312(a)(3) and (b) by
increasing 300k basis by 80k appreciation and
then reducing by 100k FMV distributed. - B
Corp no gain or loss on issuing stock. 1032.
Carryover 100k basis in assets. 362(b). Holding
period tacking under 1223(2). Picks up 100k of C
Corp EP. - Father Securities boot
taxed as dividend to extent of 100k FMV. Basis
in securities 100k. Fs 200k stock basis
allocated to C Stock and B Stock per FMV (1.5
mill v. 400k) 158k to S 42k to B. Full
tacking.
8
Problem 557
Tax consequences if valid - Gift by F to
son non-taxable. Son takes 42k carryover basis
per 1015 with tacking of holding period per
1223(2). Transaction fails under 355. - 351
on formation of B Corp. 100k securities are boot
so C Corp has 100k gain on formation of B Corp.
Basis in securities 100k. C Corp basis in B
stock is carry over 100k basis. No EP
allocation to B Corp because no reorg. - C
Corp distribution of B Corp stock to F triggers
300k gain on distribution (400k FMV over 100k
basis) per 311(b). - C Corp EP increased by
300k gain on B Corp stock distribution and then
decreased by 500k (FMV of distribution of stock
and securities distributed). - B Corp no
gain or loss on stock or securities issuance.
1032. Basis in assets is S Corp carryover basis
(100k) plus 100k recognized by C Corp 200k.
362.
9
Problem 557
Transaction fails under 355. - F has 500k
dividend under 301 on receipt of B Corp stock and
securities (FMV). C Corp has sufficient EP by
virtue of 100k gain on formation of B Corp and
300k gain under 311 on distribution of B stock.
F basis in stock is 400k, basis in securities is
100k, under 301(d). No tacking of holding
period. Basis in C Corp stock remains at 200k.
- Gift to child tax free and child takes
carryover basis of 400k in stock and gets tacked
holding period from F. 1223(2).