1. LLM Corporate Tax Instructor: Dwight Drake Sale of S Corp Stock - Generally all capital. - No requirement, as in partnerships, to treat part of gain as ordinary based on nature of assets in S Corporation. - Still have capital gains look through on 28% collectibles. - Buyer’s stock basis determined by cost. - If Buyer is C corporation, S election terminates with sale. If no 338 election, only corporation continues as C corp with old basis in assets and all built-in gain potential.

2. LLM Corporate Tax Instructor: Dwight Drake Problem 729-1 Can valuable C Corp improve tax position at sale by making S election? - BIG Tax under 1374 locks up built-in gain at corporate level for 10 years. - Appreciation post S election will avoid double tax hit. - If buyer wants stepped-up basis, asset sale will be preferred. 1374 hit usually less painful than 338, but impact on individual parties different.

3. LLM Corporate Tax Instructor: Dwight Drake Problem 729- 2 Purchasing corp is S corporation: (a) Issue is preservation of S election when target corp bought for cash and notes. Can maintain new sub as QSSS – qualified subchapter S subsidiary. Or can liquidate and claim tax-free benefits of 332-337 regime. (b) If S corp acquires in C reorg, must monitor continuing S corp eligibility requirements (100 limit, etc). Also, targets attributes carryover, including E&P, passive income trap of 1375, and 10 year BIG trap of 1374. Note: 1374 and 1375 will be covered next week.

4. LLM Corporate Tax Instructor: Dwight Drake 355 Spin-Off Old Corp New Corp Old Corp Stockholders Business Assets Stock Distribution Of New Corp Stock 355 Alternative: 301 Dividend rules

5. LLM Corporate Tax Instructor: Dwight Drake 355 Split-Off Old Corp New Corp Old Corp Stockholders Business Assets Stock New Corp Stock as Redemption Proceeds 355 Alternative: 302(b) redemption/dividend tests. Old Corp Stock

6. LLM Corporate Tax Instructor: Dwight Drake 355 Split-Up Old Corp (disappears) New Corp 1 Old Corp Stockholders Business Assets Stock New Corp 2 Business Assets StockLiquidation New Corp 1&2 Stock 355 Alternative: 336 Complete Liquidation

7. LLM Corporate Tax Instructor: Dwight Drake If 355 Applies To Division Formation of Corp as preparatory step: - Valid Type D Reorg. - No gain or loss to parent corp per 361(a). - Basis in stock received is basis of assets transferred. 358(a). - Tack holding period to stock received. 1223(2). - E&P of parent corp allocated to Sub based on relative FMV of assets. Shareholder impact: - No boot: No gain or loss on receipt of stock. Allocate stock in parent corp to stock of both parent and sub based on relative FMV. Tacking of holding period. - Boot: If received in spin-off, dividend per 301 to extent of distributing corp E&P. Beyond that return of capital.

8. LLM Corporate Tax Instructor: Dwight Drake If 355 Applies To Division Shareholder impact: -Boot: If received in spin-off, dividend per 301 to extent of distributing corp E&P. Beyond that return of capital. If received in redemption, then gain recognized to extent of boot. Test for ordinary gain with 302(b) before and after standards, assuming no stock of distributing corp with surrendered for stock, but only for the boot. If flunk 302(b) tests, then boot all ordinary income to extent of gain. - Boot basis is FMV and new holding period. Aggregate stock basis is old basis in stock of distributing stock, plus gain recognized, less boot received. 358. Then allocate basis among old stock and new stock.

9. LLM Corporate Tax Instructor: Dwight Drake For 355 to Apply Four Critical Tests: - Business Purpose - Trade or Business - No Device - Continuity of Interests

10. LLM Corporate Tax Instructor: Dwight Drake `` 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 won’t 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.

11. LLM Corporate Tax Instructor: Dwight Drake `` 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.

12. LLM Corporate Tax Instructor: Dwight Drake ```` Device Requirement – 355(a)(1)(B) 1. Safe zones (presumed innocent): - No E&P 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.

13. LLM Corporate Tax Instructor: Dwight Drake Problem 526-1 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business in Boston and San Jose for 10 yrs, with R&D in each location. (a)M and C dispute. Boston assets (both computer and R&D) contributed to P Corp and P Corp stock distributed to C in redemption of C stock in L Corp. 355 apply? Dispute resolution valid business purpose. Vertical division of single active business run for more than 5 yrs satisfies 355 “trade or business” requirement if actively conducted by both corps afterwards. (b)Same as (a) but Boston facility opened three years old through internal expansion. Under final Regs, new facility in same line of business is not a separate business. Reg. 1.355-3(b)(3)(ii). Hence. If primary business run for five years may still qualify as vertical division of a single more-than-five year business and qualify for 355 treatment. No requirement that separate facilities must have been operated as integrated operation. Reg. follows Lockwood Estate.

14. LLM Corporate Tax Instructor: Dwight Drake Problem 526-1 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business in Boston and San Jose for 10 yrs, with R&D in each location. (c)Same as (a) but Boston facility acquired three years ago for cash. Per final Regs, taxable acquisition in same line of business run for five years is just considered an expansion, not a new business. Reg. 1.355 – 3(b)(3). Consistent with Lockwood Estate. Hence, still just vertical division of single more-than-five yr old business and qualifies under 355. (d) To discuss in class.

15. LLM Corporate Tax Instructor: Dwight Drake Problem 526-1 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business in Boston and San Jose for 10 yrs, with R&D in each location. (e) Court divestiture order requires spin-off of R&D to new R Corp, which stock is distributed pro rata to L Corp shareholders. Business purpose requirement met by court order. Trade or business requirement met under Reg. if R&D operation specific group of activities carried on to earn profit even though source of profit is other related business. Thus R&D qualifies as trade or business even if L Corp only customer for research. Big issue here is “device”. Factor favoring device is pro rata distribution and R&D support of L Corp. Regs say major device factor if R Corp primarily services L Corp post spin-off but R Corp could be independently sold without adversely effecting either corp. Need more infor here. Strong business purpose will help mitigate “device” finding.

16. LLM Corporate Tax Instructor: Dwight Drake Problem 526- 1 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business in Boston and San Jose for 10 yrs, with R&D in each location. (f) Three years ago L purchased Floppy Disc. Inc. (“Floppy”) is taxable transaction and spun it off pro rata to shareholders to comply with regulatory decree. Not just expansion of old business – software different than hardware. Since no five year hold, no hope for tax free treatment. (g) Same as (f), but Floppy acquired three years ago in A Reorg where L Corp issued nonvoting preferred (80%) and short-tem note(20%). Issue is whether Floppy acquired in taxable exchange. Fact that there was some boot to selling shareholders (short term notes) not issue to test transaction. Test is whether acquiring L Corp took transferred basis in Boston assets, which it would per 362(b). Thus, not considered transaction in which gain or loss is recognized. Active business test met.

17. LLM Corporate Tax Instructor: Dwight Drake Problem 526-2 Basic Facts: DC Corp manufacturing business with 10 story building (“Building”). Has leased four stories for 15 yrs. Six years ago formed Sub Corp 1 which leases two buildings on long-term triple net leases. (a)DC contributes Building to Sub 2 and spins Sub 2 stock our pro rata. Sub 2 rents four floor of Building and handles repairs and maintenance. With 40% of Building leased to outsiders, tough issue of whether separate trade or business. No ruling possible here and risky position. (b)Same, but DC occupies only one of 10 floors. Here, on solid trade or business ground because 90% to outsiders. Reg. 1.355-3(c) Example (12). (c)Same as (b), but 90% to outsiders under triple net leases. If no substantial services rendered, trade or business position very weak. Probably loser. (d)Building contributed to Sub Corp 1, and Sub Corp 1 stock spun out pro rata. Triple net will kill trade or business requirement. Must show significant services. Reg. 1-355-3(b)(2)(iv)(B); Rev. Rule 79-394.

18. LLM Corporate Tax Instructor: Dwight Drake Problem 539 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business and R&D in one location for 10 years. Bought for cash 6 yrs ago F Corp, a software manufacturer. L Corp and F Corp of equal value. (a)To resolve shareholder dispute, L Corp distributes all F Stock to C in complete redemption of C L Corp stock. Business purpose and trade or business issues slam dunk. Issue here is “device”. But since non-pro rata and complete termination of C’s interest under 302(b)(3) absent 355, any device risk very low. Should fly under 355. (b)Same as (a), but M & C mother and son. With waiver of family attribution in 302(b)(3) redemption, device factor still low and 355 should work. Note, in assessing non pro rata under 355, Regs say ten-year look forward requirement for family attribution waiver is disregarded. Reg. 1.355- 2(d)(5)(iv).

19. LLM Corporate Tax Instructor: Dwight Drake Problem 539 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business and R&D in one location for 10 years. Bought for cash 6 yrs ago F Corp, a software manufacturer. L Corp and F Corp of equal value. (c)Same as (a), buy before redemption M sold all M stock in L Corp to unrelated N, who wanted hardware business but not software business. Transaction fail under 355 because no continuity of interest. Reg. 1.355-2© requires that at least 50% of the stock of both entities (distributing and controlled) must be owned by historic shareholders. Otherwise, just purchase with attempted tax-free bailout of unwanted assets. (d)To enable maintenance of different retirement plans for manufacturing and research employees, L transfers research assets to new corp and distributes new corp stock pro rata to M and C. New corp. still only services L Corp. Issue is business purpose for distribution. May have purpose for two entities (different retirement plans), but no purpose for distribution of stock to M & C. Flunk business purpose so never get to device.

20. LLM Corporate Tax Instructor: Dwight Drake Problem 539 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business and R&D in one location for 10 years. Bought for cash 6 yrs ago F Corp, a software manufacturer. L Corp and F Corp of equal value. (e) Same as (d), except purpose of spin off is to comply with regulatory decree. No doubt business purpose, but issue is device, which is based on all facts and circumstances per Regs. Strong device factors here are pro rata and functional division. Key fact issue: Could research entity be sold without adversely effecting L corps operation? If so, strong evidence of device. Strong device evidence requires strong business purpose. Decree here may be enough to do job, but no slam dunk. Facts and circumstances standard always leaves ambiguous under these fact scenarios.

21. LLM Corporate Tax Instructor: Dwight Drake Problem 539 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business and R&D in one location for 10 years. Bought for cash 6 yrs ago D Corp, a software manufacturer. L Corp and D Corp of equal value. (f) State law prohibits L Corp from owning and operating D Corp. L Corp starts negotiating sell to S Corp. L Corp than spins out D Corp stock pro rata and shareholders sell stock to S Corp two months out. Here, high risk of device. Subsequent sale of stock major factor of device and killer if pursuant to pre- negotiated plan. Reg. 1-355-2(d)(2)(iii). (g) Same as (f), but L Corp refuses S Corp offer and then spins out D Stock. Four months later, shareholders sell D stock to another party. Although sell not prearranged, still strong evidence of device because so close in time. What did shareholders intend at distribution? Facts here very tough. Parenthetical language of 355(a)(1)(B) (subsequent sale not presume device) is watered down (nearly rejected) by Regs. Also, may have continuity of interest problem if historic shareholders not own D stock long enough. This transaction is very high risk.

22. LLM Corporate Tax Instructor: Dwight Drake Problem 539 Basic Facts: L Corp common stock equally owned by M and C. Computer hardware business and R&D in one location for 10 years. Bought for cash 6 yrs ago D Corp, a software manufacturer. L Corp and D Corp of equal value. (h) Same as (g) but shareholder sale is to S Corp on same terms as L Corp board rejected when offered by S Corp. Issue: Was there prearrangement? Probably, based on facts. Plus, all the problems in (f). Little hope of 355 here.