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

2. Corporate & Partner 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 within 5 yr period in which gain or loss recognized.

3. Corporate & Partner 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 least two years before distribution. -Post-Distribution activity (sell off of distributed stock) relevant and may kill if part of the overall plan.

4. Corporate & Partner 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 to corporate distributee shareholders of distributing corp.

5. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````````` ```````````````````````````````````````````` ```````````````````````````````````````````` `````````` 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. Corporate & Partner Tax Instructor: Dwight Drake Problem 801- 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.

7. Corporate & Partner Tax Instructor: Dwight Drake Problem 799- 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.

8. Corporate & Partner Tax Instructor: Dwight Drake Problem 801- 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. (d) 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.

9. Corporate & Partner Tax Instructor: Dwight Drake Problem 801- 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) Same as (d) but purpose was to allow separate compensation and retirement plan for employees. Query whether valid business purpose. May not need separate R Corp for separate employment and retirement plans. Plus, spin- off may be unrelated to plans. If so, no valid business purpose.

10. Corporate & Partner Tax Instructor: Dwight Drake Problem 801- 2 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. (a)To resolve shareholder dispute, L Corp distributes all D Stock to C in complete redemption of C’s 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), 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.

11. Corporate & Partner Tax Instructor: Dwight Drake Problem 802- 2 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. (c)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). (d)Same as (c), 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.

12. Corporate & Partner Tax Instructor: Dwight Drake Problem 802- 2 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. (e) Same as (d) 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 (d). Little hope of 355 here.

13. Corporate & Partner Tax Instructor: Dwight Drake Problem 808 Basic Facts: F sole shareholder of S 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. S 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 E&P. Is this valid 355 transaction? – Is estate planning valid business purpose? Probably not; slit 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.

14. Corporate & Partner Tax Instructor: Dwight Drake Problem 808 Tax consequences if valid: - S 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 S Corp E&P allocated to B Corp (based on relative FMV of assets). Reg.1.312 -10(a). - S Corp has no gain or loss on distribution of stock and securities to father. 362(c). S Corp’s E&P 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 S Corp E&P. - Father: Securities boot – taxed as dividend to extent of 100k FMV. Basis in securities 100k. F’s 200k stock basis allocated to S Stock and B Stock per FMV (1.5 mill v. 400k) – 158k to S; 42k to B. Full tacking.

15. Corporate & Partner Tax Instructor: Dwight Drake Problem 808 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 S Corp has 100k gain on formation of B Corp. Basis in securities 100k. S Corp basis in B stock is carryover 100k basis. No E&P allocation to B Corp because no reorg. - S Corp distribution of B Corp stock to F triggers 300k gain on distribution (400k FMV over 100k basis) per 311(b). - S Corp E&P 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 S Corp – 200k. 362.

16. Corporate & Partner Tax Instructor: Dwight Drake Problem 808 Transaction fails under 355. - F has 500k dividend under 301 on receipt of B Corp stock and securities (FMV). S Corp has sufficient E&P 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 S 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).