Corporate Taxation Outline

Table of Contents

FORMATION OF A CORPORATION 2
INTRODUCTION TO §351 2
CONTROL, PROPERTY AND STOCK 3
TREATMENT OF BOOT 4
ASSUMPTION OF LIABILITIES 6

CAPITAL STRUCTURE 7

NONLIQUIDATING DISTRIBUTIONS 8
DIVIDENDS 8
EARNINGS AND PROFITS 9
DISTRIBUTIONS OF CASH 9
DISTRIBUTIONS OF PROPERTY 10
CONSTRUCTIVE DISTRIBUTIONS 11

REDEMPTIONS 12
CONSTRUCTIVE OWNERSHIP OF STOCK 12
SUBSTANTIALLY DISPROPORTIONATE 13
COMPLETE TERMINATION 13
NOT ESSENTIALLY EQUIVALENT TO A DIVIDEND 14
TAX CONSEQUENCES TO THE CORPORATION 14

LIQUIDATIONS 15
COMPLETE LIQUIDATIONS 15
PARTIAL LIQUIDATIONS 16
LIQUIDATION OF SUBSIDIARY 16

TAXABLE ACQUISITIONS 17

ACQUISITIVE REORGANIZATIONS 19
A REORGANIZATION 19
B REORGANIZATION 20
C REORGANIZATION 20
FORWARD TRIANGULAR MERGER 20
REVERSE TRIANGULAR MERGER 21
TAX CONSEQUENCES 21

1
Formation of a Corporation
 Corporate transaction, always analyze
o Tax consequence to SHs, and
o tax consequence to corporate entity
 Basis is a measure of your after-tax investment
 Corporations have $0 basis in their own stocks
o No after-tax investment in stock  basis = $0

SH transfers a car worth $1k with a basis of $200 to the Corp in exchange for 100
shares of stock. What is SH’s tax consequence and what is corp’s tax consequence?
 Corp: realizes $1k gain, car w/ basis = $1k
o $1k gain = amount realized ($1k) – adjusted basis ($0)
 Corp has no after-tax investment in stocks  stock basis = $0
 SH: realizes $800 gain, stock w/ basis = $1k
o Not arm length’s transaction, cannot assume value received = value give
up
o Use book value – SH equity = assets – liabilities
Assets Liabilities
Car - $1k 0
$1k – SH Equity
$1k $1k

Introduction to §351
Analyzing a Nonrecognition Transaction
1. Calculate the realized gain or loss w/o nonrecognition provision apply
2. Determine whether this transaction qualify as §351
3. If not meet §351(a) requirements, does it meet §351(b)
4. If meets §351 requirements, work through the nonrecognition provision
 Presume money’s basis = face value
5. Check
 Is TP in the same position at the end of transaction as he is at the
beginning?

Shareholder
Sec. 351 Transfer to corporation controlled by transferor (tax deferral)
a) No gain or loss shall be recognized if property is transferred to a corporation
by
 one or more persons
 solely in exchange for stock in such corporation AND
 immediately after the exchange such person(s) are in control of the
corporation
o §368(c) “Control” – 80% of voting stock and 80% of each class of non-
voting stock

Sec. 358 Shareholder basis

(a)(1) Basis of stock received in a §351 exchange = basis of property transferred by
SH to the corporation

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Corporation
Sec. 1032 Exchange of stock for property
(a) No gain or loss shall be recognized on the receipt of money or other property in
exchange for its stock (including treasure stock).

Sec. 362 Basis to corporations

(a) Corporation’s basis in any property received in a §351 exchange is the same as
the transferor’s basis
(e)(2) Limitations on built-in losses
A. If property with a net built-in loss is transferred to a corporation, the
corporation’s aggregate adjusted basis of such property is limited to the
FMV of the transferred property
 If transferee’s aggregate adjusted basis of assets transferred >
aggregate FMV  transferee’s aggregate adjusted basis = FMV
B. Allocation of basis reduction. The aggregate reduction in basis is
allocated among the properties in proportion to their respective
built-in losses immediately before the transaction.
C. SH and the corporation may jointly elect to reduce SH’s basis in the stock.
Stock basis reduction = amount of asset reduction required under §362(e)(2)

E.g. Asset 1: FMV=$5k, basis=$10k; Asset 2: FMV=$15k, basis=$25k.

 Aggregate loss = $35k - $20k =$15k
 Asset 1 = $5k (built-in loss) / $15k =1/3; Asset 2 = $10k / $15k = 2/3
 Total basis reduction = $15k  Asset 1 basis = $5k; Asset 2 = $15k

C transfers 2 parcels of unimproved land (Parcel 1 and Parcel 2), each with a value
of $10k. C’s basis in Parcel 1 is $15k and C’s basis in Parcel 2 is $8k for 20 shares
of common stock. What result to C and X Corporation.
 C’s combined basis = $23k, combined FMV = $20k  §362(e)(2) would
limit X Corp’s basis in the properties to aggregate FMV
 There is only one property with built-in loss  $3k basis reduction is allocated
to that property  Corp’s basis in Parcel 1 = $15k - $3k = $12k; Parcel 2 =
$8k
o Corp still has a loss in Parcel 1, but that loss is offset by the inherent gain
in Parcel 2
 OR, C and Corp can make an election to reduce C’s stock basis by $3k and
give Corp full basis of $15k in Parcel 1
o Might be useful if Corp were going to immediately sell the property and use
the loss to offset other income

Control, Property and Stock

1. Transfer of “Property”
 Reg. §1.351-1(a)(1)(i) – services are not property
o Pure service provides is not considered a transferor of property
o If transfer both property and services, all that SH’s stock is counted
toward the 80% control requirement
 If property transferred is “relatively small value” in comparison to the
stock received for services, §351 does not apply
 The property transferred must be at least 10% of the value of stock
already owned / to be received for services

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 Not meet the 10% requirement, if property transferred is essential to
the incorporation of the business  qualify §351
2. “Solely” for Stock
 Has to be stock
o Ownership interest
 Voting rights
 Right to current earnings (dividends)
 Liquidation value
o Common stock – stock has all of these interests
o Preferred stock – has some preference with regard to economic value
 Give the owner the first rights to dividends out of corporation
 Get first liquidation value
 NOT corporate bond (debt)
3. Control Immediately After
 “Control” requirement - §368(c)
o 80% of total combined voting power, AND
o 80% of each class non-voting stock
 Immediately after

Intermountain Lumber Co. v. Commissioner

S’s sawmill burns down. S and W agree to rebuild. S transfers property to Corp in
exchange for 100% of stock. S sells 50% of stock to W.
 “Immediately after the exchange” means at the end of business deal
o Test “control” at the last step of business deal
 Really cares about – when does business deal begin? When does
business deal end?
 At the end of business deal, W owns 50% stock. Test control here
 Transferor of property is S  not qualify §351
o W did not transfer any property to Corp

Step Transaction Doctrine

 Test transaction after all the steps of the part of business transaction are done
 2 tests determine when does business deal end
o Binding Commitment Test
 The deal is all the party agree to
 Was there an enforceable contract to do step 2 / step 3?
 If yes, business deal ends after step 2 / step 3
o Interdependence Test
 Step 1 makes no economic sense w/o taking step 2 and step 3
 The last step has to occur otherwise the first step would be economic
senseless
 In general, gift is considered to be independent transaction
 Double Drop Down
o P Corp transfers assets to S1 in exchange for S1’s stocks. S1 then transfers
assets to S2 in exchange for S2’s stocks.
 IRS Ruling considers this qualify §351

E.g. Manager will pay $20k cash for her 150 shares ($1k/share) and the
incorporation document specify that she is receiving those shares in exchange for
her cash contribution rather than for future services.

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 Qualify §351
o Manage will receive stock for services worth $130k and stock for property
of $20k
o $20k is more than 10% of $130k, transaction qualifies §351

Treatment of Boot
Sec 351(b)
 Any gain realized by a transferor on an otherwise qualified §351(a) exchange
must be recognized only to the extent of the boot received.
o Gain recognized is the LESSER of gain realized or boot received
 SH can never recognize more gain than actually realized  boot does
not create gain
 No loss may be recognized under §351(b)

Rev. Rul. 68-55

 If transfer multiple assets, allocate boot to each asset in proportion to
the relative FMV of the transferred assets. Then recognize gain / loss to
each asset

SH’s Basis
 SH’s basis in stock = basis of asset transferred – boot received + gain
realized - §358(a)(1)
 Basis of boot property = FMV - §358(a)(2)
 If SH receives more than one class of stock, SH need to allocate his aggregate
exchanged basis among the various classes of stock received in proportion to
their relative FMV – Reg. §1.358-2(b)(2)

Corp’s Basis
 Corporation’s basis in asset = transferor’s basis + gain recognized -
§362(a)

E.g. B transfers land and inventory to X Corp and receives 15 shares of X common
stock ($15k value) and $15k cash.
FMV Basis Realized Boot Recognize
gain / loss Received d gain
Land 10k 13k (3k) $5k $0
Inventory 20k 7k 13k $10k $10k
Total $30k $20k $10k $10k
 Calculate ordinary tax consequences that would occur if the transaction was
taxable
 Does this transaction qualify for §351 treatment? – Yes
 Calculate SH’s gain recognized
o Must allocate boot received between the 2 assets transferred – Rev. Rul.
68-55
 Inventory will get 2/3 of the boot and land will get 1/3
o B will recognize $10k gain on the inventory, but no loss on the land

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 Determine SH’s basis in the shares received
o B’s stock basis = $20k - $15k + $10k = $15k
 Check – is this the right answer? Yes
o B starts this process with a $3k built-in loss and a $13k built-in gain
o On the transaction, he recognizes $10k of the built-in gain, but none of the
built-in loss
o The $10k built-in gain he recognized in the transaction is in fact his overall
gain  B should have no further tax consequences in the stock received
o B’s stock is worth $15k and its basis is $15k
 Corp
o Never recognize gain or loss on the issuance of stock for property - §1032
o Inventory basis = $17k, land basis = $13k
 Aggregate adjusted basis of assets is $30k, and the aggregate FMV is
$30k  §368(e)(2) not apply
 If Corp sold both assets, it would have a $3k gain on the inventory and
a $3k loss on the land, exactly offsetting.

Assumption of Liabilities
Sec. 357
(a) Assumption of a liability by a transferee corporation in a §351 exchange will
neither constitute boot nor prevent the exchange from qualifying under §351
Exception
(b) Tax Avoidance
 The assumption of a liability is treated as boot if TP’s “principal purpose” of
transferring the liability was the avoidance of federal income taxes or was
not a bona fide business purpose
o If an improper purpose exists, ALL the relieved liabilities are treated as
boot
(c) Liabilities in Excess of Basis
 (1) In general. If total liabilities assumed > total adjusted basis of
assets transferred, the excess shall be considered as gain
 (3) Certain liabilities excluded. If a TP transfers, in an exchange to
which §351 applies, a liability the payment of which EITHER would give
rise to a deduction, OR would be described in §736(a), then the amount
of such liability shall be excluded in determining the amount of
liabilities assumed.

Sec. 358(d)
 When liability is assumed by a corporation, for purposes of determining
the SH’s basis, the assumption of liability will be treated as money received

 §357(c) and §358(d) provide that deductible obligations are NOT

considered “liabilities” for these limited purposes.

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o E.g. accounts payable

Suppose SH borrowed $100k from bank, then transferred his land to the Corp
subject to $100k loan
 Under §357(a), no boot, no gain recognized
 How do you know the tax avoidance purpose?
o Timing
 If put debt on property shortly before transferring it to corp. 
probably tax avoidance
o What did SH do with the cash
 Spent on personal item as opposed to invest in the business

E.g. A organized X Corp. by transferring inventory and land. In return, A received 20

shares of X stock (FMV $20k) and X took the land subject to the debt of $30k.
FMV Basis Realized
gain / loss
Inventory 10k 20k (10k)
Land 40k 5k 35k
Total $50k $25k $25k
What is A’s basis and X Corp’s basis?
 A:
o Total debt assumed > total basis of transferred assets,  A must
recognize $5k in gain
o A’s stock basis = $25k - $30k + $5k = $0
 A started with total built-in gain of $25k. On the transaction, she was
forced to recognize $5k gain under §357(c), leaving $20k of her overall
gain deferred.
 A’s stock is worth $20k. Since A has a $0 basis, if she sells it, she will
have a gain of $20k.
 X Corp
o A recognized $5k gain overall, but is that gain allocated among the 2
assets?
 Allocate the boot gain in accordance with the relative built-in gains of the
assets transferred
o Land was the only asset with a gain  all of the gain should be
allocated to the land
 Inventory basis = $20k, land basis = $10k
o Although inventory has a built-in loss, aggregate basis of the assets
transferred < aggregate FMV  no §362(e) issue

Capital Structure
Debt and Equity
 Stock represents equity ownership
o If business is sold / liquidated, after paying debts, SHs are entitled to all
residual value of the business
 Debt: borrowing money and pay it back with interest

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o E.g. corporate bond – creditor

Advantage of Issuing Debt

 Avoidance of the “double tax”
o Dividends are taxable to SH and corporation
o Interest paid on debt is taxed to creditor, but deductible by corporation
 Repayment of principal on a debt is a tax-free return of capital to
creditor
 Provide a defense against subsequent imposition of the accumulated earnings
tax

Debt vs. Equity

 To prevent tax avoidance through the use of excessive debt, IRS may recast a
purported debt obligation as equity
 Factors considered:
o Form of the Obligation
 Debt instrument should bear usual indicia of debt – unconditional
promise to pay, specific term, and reasonable interest rate,
payable in all events
 Should avoid equity characteristics
o Debt/Equity Ratio
 High D/E ratio (thin capitalization) creates a risk that debt will be
reclassified as equity, because no rational creditor would lend money
to a corporation with such nominal equity
o Intent
 Use objective criteria: lender’s reasonable expectation of repayment,
evaluated in light of the financial condition of the company, and the
corporation’s ability to pay principal and interest
o Proportionality
 Debt held by SHs in the same proportion as their stock holdings may be
suspicious
 If debt is held in roughly the same proportion as stock, creditors have no
economic incentive to act like creditors by setting or enforcing the terms
o Subordination
 Debt subordinate to everyone else’s debt. If it is, it is common stock

Debt Form Risk

Unconditional promise to pay. Real question is would a bank want money?
 Debt – promise to pay. (Balloon would the creditor have loaned money under
payment, scheduled payment, these terms?
etc)
 Equity – no promise to pay. Proportionality. Q. Do the shareholders have the
debt structured so it is in the same proportion as
Sum Certain. (you borrow a set amount) their interest in corporation. (25% stock and 25%

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debt). Proportionality is bad.
Fixed interest rate. (including varying
rate based on an external factor/rate. It Subordination. (if subordinate to anyone else 
has nothing to do whether the business is equity). No creditor would agree to
successful) of return subordination at that level.

Reasonable term. (5, 10 years, Debt/equity ratio: How much debt $100k, $10k
Construction loan -5 yrs, mortgage 30 yrs) worth of stock --> 10:1) the higher the first
if the term is 100 years, that is not loan number, the worse it is. There is no defined good
that will be stock.) or bad ratio.

Convertibility. No equity features Hindsight: Did the corporation treat it as debt?

convertibility. Did they skip payments? If regular payment 
seems to be debt. (Professor Colombo thinks the
court should not look at this).

Nonliquidating Distributions
What is distribution?
 Economic transfer from a corporation to a SH because of that person’s status
as SH
o Why did this transfer occur?
 Not salary; not payment for services rendered; not interest
 Not all distributions are dividends for federal tax purposes

Dividends
 If have a distribution, go to §301(c) to determine tax treatment

Sec. 301(c)
1) Distributions that are dividends (§316) must be included in gross income
2) Distributions that are not dividends are first treated as a recovery of SH’s
basis in his stock
3) Any excess over basis is treated as gain from sale or exchange of the stock

Sec. 316 Dividend defined

(a) Dividend means any distribution of property made by a corporation to its SHs
out of
(1) accumulated earnings and profits, OR
(2) current earnings and profits
Every distribution is deemed to be made out of E&P to the extent they exist and is
deemed to be made from current E&P first.

Earnings and Profits

 How much of the corporation’s wealth, which if given to the SH, would make
the SH richer?
 It is all about SH’s economic position

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 2 ways to calculate E&P
1. All economic inflows – All economic outflows
2. Start with taxable income, then make certain adjustments
o Add back certain items excluded from taxable income
 Tax-exempt interest
o Add back certain items deductible in determining taxable income
 §243 dividends received deduction
o Subtract certain nondeductible items
 Federal income tax
 Capital loss in excess of capital gain
o Make certain timing adjustments
 Depreciation

Distributions of Cash
 Corporation can reduce its E&P by the amount of money distributed,
but only to the extent they exist
 A deficit in E&P may result from corporate operations / losing money
 A distribution NEVER cause a deficit in E&P

Accum. Current Single Distribution

E&P E&P
+ +  If distribution < E&P, all of distribution is dividend
 If distribution > E&P, use current E&P first, then
accum. E&P
- - None of the distribution is dividend
Closing E&P = accum. E&P + current E&P
- +  If distribution < current E&P, all of distribution is
dividend; closing E&P = rest current E&P + accum.
E&P
 If distribution > current E&P, use current E&P
against distribution; closing E&P = accum. E&P
+ - Temporarily prorate the deficit to the date of
distribution, subtract from accum. E&P  E&P to the
date of distribution (use this against distribution)
Closing E&P = remaining current E&P + leftover E&P (to
the date of distribution)

E.g. Suppose current E&P = ($5k), accumulated E&P = $10k, and distribution of $7k
on 7/1/2019
 Temporarily prorate current E&P: ($5k) x ½ = ($2500)
 E&P available 7/1: $10k - $2500 = $7500
 All of distribution is dividend
 Closing E&P = remaining current E&P + leftover E&P = ($2500) + $500 =
($2000)

Multiple Distribution

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Accum. Current Multiple Distribution
E&P E&P
+ +  Apportion current E&P to each distribution in
accordance with their relative amounts
 Do not apportion accum. E&P. Apply it on a first
come first serve basis until it is used up
 Closing E&P = remaining accum. E&P
- - None of the distribution is dividend
Closing E&P = accum. E&P + current E&P
- +  Apportion current E&P to each distribution
 Closing E&P = accum. E&P + remaining current E&P
+ -  Temporarily prorate deficit to the 1st
distribution. Subtract from accum. E&P  E&P
available at 1st distribution
 Calculate current E&P between 1st and 2nd
distribution. Subtract from remaining accum.
E&P  E&P available at 2nd distribution
 Closing E&P = remaining current E&P + remaining
accum. E&P

E.g. Suppose current E&P = (10k), accum. E&P $13,500, $5k distribution on 4/1 and
$15k distribution on 10/1.
 Temporarily prorate deficit to 1st distribution: ($10k) x ¼ = ($2500)
 E&P available on 4/1: ($2500) + $13500 = $11k
o Entire 1st distribution is dividend
o Use $5k against 1st distribution: $11k - $5k = $6k
 Between 1st and 2nd distribution, Corp has wrapped up ($5k) current E&P
 E&P available on 10/1: ($5k) + $6k = $1k
o $1k of 2nd distribution is dividend
o Apply §301(c) tier rules to the rest
 Closing E&P = ($2500)

E.g. Suppose current E&P = $15k, accum. E&P = $25k, SH’s stock basis = $9k, and
distribution of $40k on 4/1 and $20k on 10/1.
 Apportion current E&P to each distribution.
o 4/1 current E&P = $15k x 2/3 = $10k
 $40k / ($40k + $20k) = 2/3
o 10/1 current E&P = $5k
 Apply accum. E&P in the order the distributions are made
o 4/1: First $10k of distribution is a dividend out of current E&P. Next $25k of
distribution is a dividend out of accum. E&P, which is now exhausted.
Remaining $5k is a return of basis. SH’s stock basis = $4k
o 10/1: $5k of distribution is a dividend out of current E&P. $4k is a return of
remaining basis in the stock and remaining $11k is capital gain.
 Closing E&P = $0

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Distributions of Property
Appreciated Property
 If a corporation distributes an appreciated property, current E&P goes up
to the extent of gain
o Can assume that corporation sold the property and distributes cash to SH

Depreciated Property
 Corporation cannot recognize loss, current E&P cannot be adjusted for
the loss

Sec. 311 Taxability of Corporation on Distribution

a) No gain or loss shall be recognized to a corporation on the distribution of
property
 General Utilities v. Helvering: Distribution property by a corporation is not a
taxable event
b) If a corporation distributes appreciated property (FMV > adjusted basis),
gain shall be recognized to the distributing corporation

Sec. 312 Effect on Earnings and Profits

(a)(3) Following a distribution of a loss property, the distributing corporation
may reduce E&P by the adjusted basis of the distributed property
 Overrides normal adjustment of lowering E&P by amount of distribution
(b)(2) Appreciated Property. Distributing corporation may reduce E&P by the
FMV of the property
(c) Adjustments for Liabilities. Proper adjustment shall be made for the amount
of liability assumed by SH
 Closing E&P goes down by the NET amount of distribution

Sec. 301
(b) Amount Distributed
(1) Amount of distribution = money + FMV property
(2) Reduction of Liabilities. Amount of distribution shall be reduced by the
amount of liability SH assumed. But not below zero.
(d) Basis of property received in a distribution shall be the FMV of such
property.
Suppose Corp. has accum. E&P = $0, current E&P = $40k, and land with $100k
basis and $30k FMV. Corp. distributes land to SH.
 §301(b): distribution = FMV of land = $30k
o Current E&P = $40k
o Entire distribution is dividend
 §312(a): In calculating closing E&P, corp is entitled to reduce E&P by the
adjusted basis of property but not to create a deficit
o Closing E&P = $0
 §301(d): SH’s basis in the land = $30k

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the $25,000 of accumulated E&P, plus $9000 of current E&P created by the gain on the
distribution of the land, less $4000, which is the net amount of the distribution.

Constructive Distributions
 A payment from corporation to SH that is labeled something else other than
dividend
o If this is an arm’s length transaction, this would not happen
 2 scenarios
o Overpayment
 Corporation pays too much for something that it receives from SH
 Excessive compensation to SHs or their relatives
 Excessive rent for corporate use of SH property
o Free / Below market use of corporate property by SH
 Corporation is not getting FMV for something that it is giving to SH
 Use corporate jet to take a vacation in Utah
o The use value of the property is a constructive distribution (what is
the rental value?)

E.g. A is sole SH of both X corp. and Y corp. Y pays X $5m for a piece of land that
worth $3m.
 $2m constructive distribution from Y to A, followed by a capital contribution
from A to X (§351 transaction)
 Why did this happen?
o Because SH said to make this happen
o Excess value is the distribution to SH

Redemptions
 Corporation buys back its own shares from SH(s)
 Need to draw a line between redemption that resemble a sale and
redemptions that resemble a dividend
o Sale - transactions result in a meaningful reduction in the SH’s
proportionate interest
o Dividend – transactions that enable SHs to withdraw cash / property while
leaving their proportionate interest intact

Sec. 302 Distributions in Redemption of Stock

(d) If a corporation redeems its stock AND if §302(a) does not apply, such
redemption will be treated as a §301 distribution.
 Default rule: every redemption will be presumed as a §301
distribution
a) If a corporation redeems its stock AND if §302(b) applies, such redemption will
be treated as a §1001 property sale transaction.
b) Redemptions Treated as Sale Exchanges
1) Redemptions not equivalent to dividends – (davis – meaningful
reduction)
2) Substantially disproportionate redemption of stock – (ownership
test – equation)

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3) Complete termination of ownership – (waiver of family attribution
question)
 Whether there has been a sufficient reduction in SH’s ownership interest in
the corporation?
c) Must use §318(a) in determining the ownership of stock

Constructive Ownership of Stock

Sec. 318 Constructive Ownership of Stock
1) Family Attribution. An individual is considered as owning stock owned by his
spouse, children, grandchildren and parents.
2) Outbound Attribution. From entity to owner – proportional
 Partnership and Estate. Stock owned by a partnership / estate is
considered as owned by the partners / beneficiaries in proportion to their
ownership interests.
 Trust. Stock owned by a trust is considered as owned by the beneficiaries
in proportion to their actuarial interests in the trust.
 Corporation. Stock owned by a corporation is considered owned
proportionately by a SH only if SH owns at least 50% in value of that
corporation’s stock.
3) Inbound Attribution. From owner to entity
 Partnership and Estate. All stock owned by partners / beneficiaries is
considered as owned by the partnership / estate.
 Trust. All stock owned by a trust beneficiary is attributed to the trust.
 Corporation. All stock owned by a SH is attributed to the corporation only
if SH owns at least 50% in value of that corporation’s stock.
4) Option Attribution, A person holding an option to acquire stock is considered
as owning that stock.
5) Reattribution Rule. Stock constructively owned by a person by reason of
attribution rule shall be considered as actually owned by such person.
 No double family attribution
 No sidewise attribution – inbound attribution followed by outbound
attribution
 Option attribution takes precedence over family attribution where both
apply

Substantially Disproportionate – (2)

Sec. 302(b)(2)
1) 50% Ownership Test
 Immediately after the redemption, SH must own (actually and
constructively) less than 50% of the total combined voting power
2) I. 80% Test
 % of total voting stock owned by SH after redemption must less than 80%
of the % of total voting stock owned by SH pre-redemption
Voting shares owned after redemption
< 0.8 x
Total outstanding voting shares after redemption
Voting shares owned pre−redemption
Total outstand voting shares pre−redemption
3) II. 80% Test

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 SH’s common stock % after redemption must be less than 80% of SH’s
common stock % pre-redemption
 After the redemption, the total number of outstanding shares goes
down

Step Transaction Doctrine - Sec. 302(b)(2)(D)

 If two redemptions are part of a plan, then test SH A’s redemption after SH
C’s redemption is done.
o “Plan” does not require any kind of collusion or collective action by SHs
o Steps qualify as a “plan” if SH A does a redemption because A knows that C
is going to do a redemption – A’s redemption is motivated by the
knowledge of C’s redemption, there is a “plan”
 Need to ask what motivated A’s redemption?
o Was it the knowledge that C was doing a redemption? Was it something
else (e.g. a need for cash?)
o What did A know about C’s redemption when she was planning her own
redemption, and did that knowledge motivate her to do her own
redemption transaction

Complete Termination – (3)

Sec. 302(b)(3)
 If SH completely sever his relationship with the corporation, redemption is
treated as a sale

Waiver of Family Attribution

 Context: Closely held family corporation, SH wants a complete termination but
the remaining shares are held by close relatives.
 Sec. 302(c)(2) – family attribution waiver available if 3 requirements are met:
o No post-redemption interest in the corp (other than as a creditor)
 Literally no connection with the corp
 Cannot be an officer, director, or employee
 Ok to have informal, unpaid advice
o Cannot retain or acquire any interest for 10 years (other than by
inheritance)
o File closing agreement with IRS
 §302(c)(2) ONLY applies to family attribution

Not Essentially Equivalent to a Dividend – (1)

Davis per se rule
 If taking into account §318 attribution rule and there is no change in a SH’s
ownership interest, redemption does not qualify for sale treatment.

U.S. v. Davis
Davis and his family owns X corp. Davis, wife, and 2 children each owns 250 shares
of X corp. In 1945, Davis transfer $25k to X corp in exchange for 1000 preferred
stock. In 1963, X corp has > $25k in E&P and Davis had X corp redeemed all of his
preferred stock.
 §318(a) attribution rules apply to all of §302(b)

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 To qualify for preferred treatment under §302(b)(1), (meaning to
qualify as a sale instead of a distribution) a redemption must result in a
meaningful reduction of the SH’s proportionate interest in the corporation.
o Did the redemption change SH’s ownership interest?
 If no change, not meet §302(b)(1) test
o If there is an ownership interest change, how much change?
 Taking into account family attribution, Davis owns 100% before and after
redemption  not meet §302(b)(1) test  redemption treated as dividend

Meaningful Reduction Standard

 Redemption effect on the redeemed SH’s voting power, distribution rights and
liquidation rights
o If SH has a voting interest, the key factor is the reduction in the SH’s voting
power
 SH’s voting interest went from 57% to 50% and the remaining voting
stock owned by an unrelated SH  meaningful reduction
 If SH went from a position controlling the corp to a position not
controlling the corp  meaningful reduction
o For true minority SH (literally have no way to engage in management
decisions), any redemption reduces ownership interest will meet §302(b)(1)
test
 Focus upon the effect of the redemption upon SH’s control of corporate affairs
o A pro rata redemption never changes a SH’s interest in the corp  never
meet Davis test
o If SH only owns nonvoting preferred stock, any redemption would meet
Davis test
o For publicly-held company, even tiny changes in ownership will meet
§302(b)(1) test, because no single SH can exercise control over corporate
affairs

Tax Consequences to the Corporation

Sec. 311(b)
 A corporation distributing property in redemption of stock always recognizes
gain but may not recognized loss.
o Any gain recognized on a distribution of appreciated property increase
current E&P.

Effect on Earnings and Profits

 If redemption is treated as a distribution, §312(a)(3) and (b)(2) apply – reduce
A&P by basis (loss property) or FMV (gain), adjust for net of liabilities
 If redemption is treated as a sale, closing E&P is adjusted down by
percentage of outstanding stock redeemed, not to exceed price paid
by corporation – question on this!!

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Liquidations
Complete Liquidations
When does a corporation going to liquidation?
 Legal dissolution under state law is not required
 Liquidation – corporation has ceased doing business and is merely in the
process of winding up its affairs
o No time limit on liquidation (can take more than a year)
 Liquidation occurs when board of directors should adopt a liquidation
resolution and the resolution should state that the corporation is going out of
business and winding up its affairs
o If no resolution, has to factually establish when the decision was made that
the corporation is going out of business
 Once a corporation is in liquidation, any distribution to SH will be considered
as liquidating distribution
o This is a sales transaction  E&P account is irrelevant

Consequences to SHs
 Sec. 331(a) – SH is treated as sold his stock back to the corporation in
exchange for liquidating distribution
 Sec. 334(a) – SH’s basis in property distributed by a corporation in a complete
liquidation shall be the FMV of the property
 If a liquidation extends beyond a single taxable year, SH is entitled to use his
basis first. Once the basis is exhausted, the remainder becomes gain from
sale of stock.

E.g. A owns 100 shares of X Corp which he purchased several years ago for $10k. X
has $12k of accum. E&P. What is tax consequence to A if X distributes $10k in the
current year and $10k in year 2 in exchange for his stock?
 A has $10k basis. The first distribution A would get tax free – return of basis
 A would have a $10k gain from sale of stock in year 2

Consequences to Liquidating Corporation

 Sec. 336(a) - General rule: liquidation treated as a taxable sale of assets by
corporation, with recognition of gain / loss
 Sec. 336(d) Loss Limitation Rules
o Related party rule. No loss shall be recognized by a liquidating
corporation on the distribution of property to a related party
o if either
 the distribution is not pro rata among the SHs;
 OR
 Related party – SHs who own directly or through §267 attribution
rules more than 50% in value of the stock of the distributing
corporation
 Pro rata distribution – each SH gets their percentage interest in
each asset
o E.g. Suppose have 2 SHs. SH1 owns 60% and SH2 owns 40% of the
corporation. If Corp distributes land, SH1 has 60% and SH2 has 40%
interest in the land.
 the distribution is of disqualified property

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 Disqualified property – property acquired in a §351 transaction or
as a contribution to capital within the 5-year period ending on the
date of distribution
o Anti-stuffing rule
 Asset was acquired by a corporation in a §351 transaction during a 2-
year period prior to adoption of plan of liquidation  presumption
of evil plan (evading taxation)  corporation is prohibited from
recognizing built-in loss
 For purpose of calculating loss on either a sale of the asset to a 3d
party OR a liquidating distribution to any SH, corporation’s basis
in the asset is limited to the FMV at time of distribution  built-in
loss is eliminated
 SH can factually establish asset is transferred to the corporation for a
legitimate business purpose (extremely difficult)

Partial Liquidations
Sec. 302(b)(4)
 If a transaction qualifies as a partial liquidation, that transaction will be
treated as a sale transaction
o Partial liquidation – a distribution is pursuant to a plan, occurs within the
taxable year in which the plan is adopted or the succeeding taxable year,
and is “not essentially equivalent to a dividend” (determined at the
corporate level)
 Genuine contraction of the corporation’s business – whether corporation
has discontinued and liquidated a line of business
 Corporation operates multiple lines of business and decides to kill one
line of the business
 In a single line of business but contract that business by significant
amount

Safe Harbor Test – Sec. 302(e)(2) (do not need to worry about this)
 Treated as partial liquidation if the distribution consists of assets of a qualified
trade or business OR is attributable to the termination of such a trade of
business, AND immediately after the distribution the corporation continues to
conduct another qualified trade or business

Earnings and Profits

 A partial liquidation is treated as a redemption transaction which is a
sale. In the case of a redemption treated as a sale, the corporation’s E&P is
adjusted downward by the percentage of stock redeemed (not to
exceed the price paid)
o E.g. Assume X corp operates Business A and Business B. Each business is
worth $2M. X corp ends Business B, and either distributes the asset in kind
to SHs pro-rata or sells the assets and distributes the proceeds.
o IRS would treat this as X corp has redeemed half of SHs’ stock in a
transaction treated as sale  X corp would reduce E&P by 50% (or the
amount distributed, whichever is less) in calculating its ending E&P for
the year. If the transaction is a distribution of assets in kind, X corp would
have to recognize any gain on the assets under §311, which would in

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turn cause E&P account to increase. Closing E&P = augmented E&P reduce
by 50%

Liquidation of Subsidiary
Consequences to Parent
 Sec. 332 - a parent corporation recognizes no gain or loss on the
receipt of assets in liquidation if
o Control – Parent must own at least 80% of voting and value of the
subsidiary
 From the date of adoption of the plan till the parent receives the
distribution
 Sometimes a parent corporation intentionally violates 80% tests to avoid
§332 and recognize a loss
o Subsidiary must adopt of a plan of liquidation
 Corporate resolution is enough
o Timing
 Subsidiary distributes all of its assets within one taxable year of the plan
adoption, OR
 If specified in the plan, can take up to 3 taxable years
 Sec. 334(b) – parent takes the distributed assets with a transferred
basis – non-subsidiary takes basis of FMV
o If parent has basis in the stock, it is irrelevant – P’s stock basis in the
subsidiary disappears
 Sec. 381 – P inherits S’s tax history – S’s E&P account, net operating
loss

Consequences to Minority SHs

o Complete taxable transaction per §331

Consequences to Subsidiary
 Parent: Sec 337 – Subsidiary does not recognize gain or loss on
distributions of property to its parent in a §332 liquidation
 Minority SHs: Sec 336(d)(3) – No loss shall be recognized to a subsidiary on
a distribution of property to minority SHs in a §332 liquidation
o Minority SH takes the distributed assets with a basis of FMV
o Subsidiary will recognize gain but not loss

Earnings and Profits

 When the subsidiary liquidates, its taxable year ends. At that point, any Sub’s
current E&P is added to its accumulated E&P. The accumulated E&P is then
inherited by the parent (added to parent’s accumulated E&P). This does not
affect the parent’s current E&P for its own taxable year.

E.g.

P owns 90% of S’s stock and M owns 10% of S’s stock.

P’s basis in S stock is $30k.

S has the following assets:

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Asset Adjusted Basis FMV
Land $30k $8k
Equipment $2500 $1k
Inventory $100 $1k
S wishes to liquidate and distribute equipment to M and the other assets to P.
How might S improve this result?
 If P has a $30k basis in stock, a taxable liquidation would permit P to
recognize a loss of $21k ($30k basis - $9k value received) on that stock. But
in a §332 liquidation, P’s stock basis becomes irrelevant. While P would inherit
the land with a $30k basis, preserving the inherent loss in the land, P’s loss on
its stock is gone.
 To improve the result: S can have P sell 11% of its stock to an outsider prior to
liquidation  violate §332 ownership requirement  taxable liquidation to P
and M. Or, P could intentionally violate the timing rules of §332 (e.g. take
more than 3 years to accomplish the liquidation). Then if loss property is
distributed pro-rate, S gets to recognize its loss (neither §336(d)(1) or (d)(2)
would be applicable) and P will get to recognize its loss on S stock.

Taxable Acquisitions
 Tax values
o Tax system does not take into account the future value / present value of
the payment
o A deduction is worth the TP’s tax rate (tax rate x deduction). $1 deduction
worth 21 cents to corp if it has enough income to absorb deduction
 E.g. $100 taxable income  $21 tax. But if the corp also has a $100
deduction, taxable income goes to zero and wipes out $21 tax bill.
o Deductions and tax payments should also be valued according to time-
value principles
 E.g. a $1 deduction this year worth 21 cents. But a $1 deduction 30
years from now worth only 4 cents.
o If you pay $1 in tax today, you are out $1. But if you can delay your tax
payment for 30 years, $1 is only worth 17 cents.
o Moral: delay paying tax as long as possible. Accelerate deductions to
current year if possible.

Assume T (Target) is wholly owned by A, who has 0 stock basis. T has the
following assets:
Asset FMV Basis
Land $2M $1M
Equipment $3M $0
Goodwill $1M $0
P offers to buy T’s assets for $6M. Tax consequences: T has $5M gain, pays
tax of $1M (20%) and distributes remaining $5M to A in liquidation, who pays
tax of $1M leaving A with $4M in pocket. Would P pay $6M for T stock? – No
 When P buys assets, it gets a cost basis in the asset, and depending on
the assets, gets valuable tax benefits. For example, P will get $3M basis

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in the equipment, which under current law could be deducted in one
year. That’s an immediate tax benefit of $600k. Similarly, P can
amortize $1M of basis in goodwill over 15 years; PV of $140k (deduction
of $67k per year, worth 20% per year, discounted to PV over 15 years
at 6%). Note that land will get a basis of $2M, but land is not
depreciable, basis would be recovered only on sale, which may be
never. So, assume no tax benefit from basis in land.
 So, on an asset purchase, P’s real cost after taking into account tax
benefits is more like $5,260,000 ($6M purchase price, less $740k of tax
benefits). P would not pay more than $5,260,000 for T stock.
 Note, however, that $5.26M is $260k better for A than an asset sale. A
would owe 20% tax on the extra $260k, but that still leaves A with
$208k more in-pocket than asset sale.
 Why did this happen? The $260k represents the tax that T would
have to pay on an asset deal that P cannot immediately recover
via deductions / depreciations. T will pay a tax of $200k on the sale
of the land, but P will not get any benefit from the basis increase in the
land. Similarly, T must immediately pay $200k in tax on the $1M gain
from the sale of its goodwill, but P will recover only $140k of that via
the amortization deductions over 15 years (present value). So, T pays
an extra $260k in tax now, but P does not get any benefit from the cost
basis. By doing a stock deal, T postpones paying that tax. In other
words, the $260k extra comes from not pre-paying taxes to the federal
government.
If T has $5M net operating loss (can offset the tax gain), prefer asset deal.
Have extra $740k floating around.

Acquisitive Reorganizations
 One corporation acquires the assets or stock of another corporation

A Reorganization

 Statutory merger or consolidation

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 Accomplished under state law. Parties sign acquisition agreement and file
articles of merger, which specifies effective date. On the effective date, by
operation of state law, all of T’s assets and liabilities are transferred to P, and
T as a corporate entity disappears (T’s stock disappears). P pays T’s SHs for
acquisition.
 This is an asset transaction.
 Judicial requirements
o Continuity of proprietary interest
 Rev. Rul. 66-224: 40% of the total consideration (SHs received)
has to be stock of P
 Can be any kinds of stock
 This is an aggregate calculation (analyze SHs as a group)
 Step transaction issues
 Do NOT care about historical owners
 T’s SHs immediately selling P stock they get in a merger, even if that
sale was contemplated before completion of the merger – OK
o Exception: if T’s SHs sold their P stock for cash to P or a related
party, not part of the continuity percentage
o Continuity of business
 P must continue the historical business of T, OR use a substantial portion
of T’s assets in P’s business post-acquisition (for some undefining period
of time)
o Business purpose
 All of acquisitive reorganizations have a business purpose – to acquire T

Step Transaction Issues

Assume A sells her T stock to B immediately before the merger. P completes

transaction with B. OK? – Yes
 Do not care who the historical owners are. Only care about whoever owns the
stock on the effective date of the merger, did they get 40% of consideration of
P’s stock.

If A receives 100% consideration of P’s stock and A sells 70% P stock she got in
merger to B immediately after. OK? - Yes (even if that sale was contemplated before
completion of the merger)
 As long as T’s SHs sale P stock to 3d parties.
 If T’s SHs get money from P as part of an overall plan of acquisition, that is not
part of the continuity percentage.

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B Reorganization

 Tax deferred stock acquisition

 Requirements
o Can ONLY use P’s voting stock to pay for T stock
o Control (80%) test immediately after
 80% total voting power and 80% of each other class of stock
 P does not need to acquire 80% of T’s outstanding stock in the
reorganization
 Creeping acquisition: OK for P to buy T stock for cash in earlier transactions,
as long as such purchases were not part of an overall plan to gain control of T
o E.g. P goes out and buys 30% T stock on open market for cash. Later, P
uses its voting stock to buy the remaining 70% T stock  qualify as B
reorg, as long as the cash transaction is not part of the acquisition plan

C Reorganization

 Asset acquisition. Structure looks like a merger transaction.

 Requirements
o T transfer “substantially all” of its assets solely in exchange for P’s
voting stock
 Substantially all
 90% of FMV of the net assets and 70% of FMV of gross assets
 Solely
 If no boot other than liabilities, assumption of liabilities by P is not
treated as disqualifying boot
 Boot relaxation rule: permits P to use up to 20% boot. But if boot used,
transferred liabilities are considered as boot

Forward Triangular Merger

 P sets up a separate subsidiary, T merges into S, and P pays for the merger

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oIsolate T’s liabilities in a separate subsidiary of P. P never owns T’s assets
directly.
 Requirements - §368(a)(2)(D)
o S acquires substantially all of T’s assets
 90% of net assets and 70% of gross assets
o No stock of S is used in the transaction
o The transaction would have qualified as a A Reorg if T had merged directly
into P
 Continuity of interest
 40% of consideration has to P stock
 Continuity of business
 Business purpose

Reverse Triangular Merger

 Stock transaction
 P sets up a subsidiary and S merges into T. P pays A for T stock and T
becomes a subsidiary of P.
o Why do this transaction?
 T has an asset that is non-transferable under law / licensing agreement
 want T to stay intact
 Requirements - §368(a)(2)(E)
o Post-acquisition, T must hold substantially all the properties of S and T
o SHs of T must exchange 80% control for P voting stock (in a single
transaction)
 80% T stock must be acquired for P voting stock  only 20% boot
permitted

Tax Consequences
 SHs (A)
o Sec. 354(a) – No gain or loss shall be recognized if SHs exchange T’s stock /
securities for P’s stock or securities
 Securities: corporate bond / long-term debt
 T’s stock for P’s stock OR T’s securities for P’s securities  OK
 If SHs exchange T’s stock and bond for P’s stock and bond  §354(a)(2)
limitation
 E.g. SHs have $1M T’s stock and $1M T’s corporate bond in
exchange for $800k P’s stock and $1.2M P’s bond.
 Excess amount P’s bond SHs receive over T’s bond SHs give up is
treated as boot.
o Sec. 356 – If SHs receive boot (cash / excess bonds), must recognized gain
in the lesser amount of gain realized or boot received.
 Characterization of gain – Clark Analysis

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 How much stock of P T’s SHs would have gotten if it has been all stock
transaction? (pretend T’s SHs only receive P’s stock)
 Pretend P redeemed some of that stock in exchange for the actual
boot
 Apply §302. If meets one of §302(b) tests, the gain is a capital gain. If
not, the gain is a dividend to the extent of the SH’s ratable share of
the E&P of T immediately prior to the acquisition.
o E.g. T has $50k of E&P. A owned 10% of T. A’s ratable share of E&P
is $5k.
o Sec. 358 – Basis in P’s stock = transferred basis – boot received + gain
recognized
 Target (T)
o Sec. 361(a) – No gain or loss shall be recognized if T exchanges property
solely for P’s stock / securities
o Sec. 357 – assumption of liabilities of T by P is not considered boot in a
reorganization
o Sec. 361(d) – If T receives boot, no gain or loss shall be recognized as long
as T distributes the boot to T SHs as part of the reorganization.
 Acquiring Corporation (P)
o Sec. 1032 – P does not recognize gain or loss on the issuance of its stock /
securities for T’s assets / stock
o Sec. 362(b) – Basis in assets = transferred basis

E.g. Clark Analysis

Assume P has 10 shares of common stock and is worth $10M. P acquires T in an A
reorg for $5M: $4M of newly-issued P stock (4 shares) and $1M in cash.
 Assume SH gets all stock – it would be 5 shares, since each share is worth
$1M
 Assume P redeems enough stock to represent the value of the boot – SH got
$1M in boot, so P would have redeemed 1 share
 Apply §302. Before redemption, SH would have owned 5/15 P shares
(33.3%). After redemption, SH owns 4/14 shares (28.6%).
o Not a complete termination
o Not substantially disproportionate. <50% test is met, but 80% is not. 80%
of 33.3% is 26.6% and A’s ownership is more than that.
o Probably meets not essentially equivalent test. A is a minority SH of P, and
with 4 shares probably has not meaningful way to participate in control of
P. (We’d probably want to know more about who owns other shares of P –
but say the other 10 shares are owned by a single SH, B. If the shares were
owned equally by 2 SHs, B & C, then there is a possibility A could
participate in a “control group” with either B or C, and thus might not meet
the Davis test).
 If P is a publicly-held company with widely dispersed shares, the boot paid to
A will nearly always meet the Davis test, because A will be a true minority SH
with no management rights. Under Davis, any change in such a SH’s stock
percentage meets the “not essentially equivalent” test.

Nonrecognition Analysis (see problem on page 450)

1. Determine regular tax consequences to the parties
2. Determine whether the transaction qualifies for nonrecognition.

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3. Determine if there is any boot gain
(a) If there is boot, gain is recognized to the extent of the LESSER of the gain
realized or the amount of the boot
(i) Apply Clark analysis – characterize that gain as a dividend or gain from sale
of stock
(b) If no boot, no boot gain to consider
4. Determine SH’s basis in the stuff received from P
5. Final check

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