I.

II.

III.
IV.

The Step Transaction Doctrine (apply all three tests on exam)

1. Binding Commitment Test: A binding contract or commitment to engage in step two (or three) that is
in existence at the time of step one almost certainly will result in a collapsing of the steps into a single
transaction
a. Focuses heavily on whether there was a contract set in place
b. Easy to beat
2. Mutual Interdependence Test: If step one and the subsequent step (or steps) are so interdependent that
the legal relationship created by the first step would have been pointless without completion of the
series, then there is only one step
a. Could you have stopped after step one and been happy?
3. Ultimate Result Test: Separate steps may be combined if they were prearranged components of a
single transaction in which the parties intended from the outset to reach a particular result.
a. Did you envision all the steps that took place and did they end up taking place how you imagined
they would?
4. Results: if it is all part of the same transaction you can re order the steps
Tax Doctrines
1. Business Purpose
2. Sham Transaction
3. Economic Substance: tax benefits are denied for transactions that actually occur but do not result in a
meaningful change in a taxpayers economic position apart from a reduction in federal income taxed.
Check the box
1. **could be questions harder for issue spotting than other business tax
Incorporations and other Section 351 Transactions
1. Find transferors of property (may be a group)
a. Property does not include (1) services, (2) indebtedness of the transferee corporation which is
not evidenced by a security, or (3) interest on indebtedness of the transferee corporation which
accrued on or after the beginning of the transferors holding period for the debt
b. Cash, intangibles, movable property, and realty are all considered property
2. Check for control by property transferors under 368(c)
a. Control: ownership of stock possessing at least 80% of the total combined voting power of all
classes of stock entitled to vote AND at least 80% of the total number of shares of all other classes
of stock of the corporation. 368(c).
i. Count the shares already owned by the transferors
b. Consider whether there is an accommodation transferor problem
i. Kamborian: Where a trust contributed a small amount of cash to give a transferor group 80%
control, court found that the trust was not truly part of the transferor group.
ii. The transfers must have an economic connection you cant make a single transaction out of
otherwise unrelated transfers cant be of relatively small value
iii. Rev. Proc. 77-37 (safe harbor): If the FMV of the property transferred is 10% of the FMV of
the stock/securities already owned, then it is not relatively small [persuasive guidance]
c. Make sure control exists immediately after the transaction;
i. Issue: how long does a party have to keep the controlling share before relinquishing control to
below 80%
ii. Consider application of the step-transaction doctrine to transfers of stock to non-transferors of
property
A. American Bantam Car Co: held that the step transaction did not apply (forcing 351
treatment against the taxpayers wishes b/c of depreciation deductions) where there were
5 days between exchanges and other evidence of non-step-transaction

3. Consider whether 357(c) applies to create gain (negative basis problem, basically on highly
encumbered properties)
4. Compute gain/loss realized by each transferor of property under 1001
a. Gain = FMV basis
5. Compute gain/loss recognized by each transferor of property (only if there is boot)
a. If the transaction falls within 351, realized gains are recognized to the extent of boot. No loss is
recognized. 351(b).
i. Boot = the amount of money received + FMV of such other property received (anything other
than stock)
A. Including nonqualified preferred stock: 351(g).
ii. Liabilities: In general, 357(a) allows non recognition of assumed liabilities (2 exceptions)
A. Consider whether liabilities constituted boot under 357(b) exception
1) If the primary purpose was to avoid the income tax OR the purpose was not a bona
fide business purpose, then the assumption (in the total amount of the liability
assumed pursuant to such exchange) shall be considered boot. 357(b).
a) If this applies, all the relieved liabilities, not just the abusive debts, are treated
as boot
b) Drybrough: if you prove a tax avoidance purpose, the fact that you have a
business purpose will not save you there are usually legit business purposes
(limited liability, etc) so must find tax avoidance
i. Tax avoidance e.g.: encumbering property for personal reasons shortly
before a 351 transfer or causing Newco to assume a transferors personal
debts
B. Are the liabilities in excess of basis? Exception to general rule of nonrecognition
1) The amount by which the total liabilities assumed exceeds the total basis of assets
transferred automatically is recognized as gain. 357(c).
2) Transferor remains liable to creditor not ok
a) Owen: a transferor may not avoid 357(c) gain be remaining personally liable
for debts encumbering property transferred to Newco in a 351 transaction,
either directly or as a guarantor.
3) Transfer by Note potentially ok
a) Lessinger: concluded that since the corporation took the note with a basis
equal to its face value, the taxpayer should not be required to recognize any
357(c) gain. This rationale is not supported by the statute
b) Peracchi: held that a promissory note had a basis equal to its face value in
Peracchis hands and the facts showed that the obligation to repay was not
illusory. It represented a real and substantial increase in the taxpayers
corporate investment.
c) Synthesis: a transferor can avoid recognizing 357(c) gain in most JXs.
4) Exception to exception: 357(c)(3) items if paid would be deductible
a) Coordinates the tax treatment of accounts payable and accounts receivable for
cash-method taxpayers because otherwise there would be 0 basis in
receivables (thus not increasing aggregate basis of property transferred)
b) Exception to 357(c)(3): Contingent liability tax shelters 358(h)
i. Black and Decker transaction: contingent liability shelters transferring
property to a controlled corporation in exchange for both stock and the
transfer corporations assumption of contingent liabilities. After taking
the position that no stock basis reduction was required with respect to

these assumed liabilities, the transferor would then sell the stock ad
deduct the capital loss against gains from other business activities.
Effectively, duplicating and accelerating a deduction for a contingent
losses see basis
ii. 358(h)(2): the basis-reduction requirement does not apply where:
1. The trade of business with which the liability is associated is
transferred to the corporation as part of the exchange; or
2. where substantially all of the assets with which the liability is
associated are transferred to the person assuming the liability as part
of the exchange
b. If the transaction does not fall within 351, realized gains and losses generally are recognized, under
general tax principles.
6. Corporation: No gain or loss on the issuance of stock, under 1032 and Reg 1.1032-1(a), regardless of
whether or not the transaction is governed by Section 351.
7. Bases of stock received by transferors and assets received by corporation:
a. If the transaction falls within 351, property transferors generally have exchanged bases in their
stock. 358; corporation takes transferred bases in the property. 362.
i. Absence of Boot:
A. Transferor: Substituted basis (same as that of the property exchanged). 358(a).
B. Corporation: carryover basis. 362(a).
ii. With Boot
A. Transferor: Substituted FMV of any other property (except money) received any
amount of money received + the amount which was treated as a dividend + the amount
of recognized gain
1) Basis of any non-money property received is its FMV
B. Corporation: carryover basis + gain recognized by the transferor. 362(a).
iii. Special basis rules apply if liabilities were transferred***
A. 357(c)(3): exception for accounts receivable or properties that would be capitalized
B. Basis Step Down Rule: for Black and Decker transactions
1) First apply the general 358 stock basis rules to a 351 transaction
2) If the transferors stock basis exceeds the FMV of the stock, the basis must be
reduced (but not below FMV) by the amount of any liability assumed by another
person as part of the exchange if a basis reduction under 358(d) is not otherwise
required with respect to the assumption e.g. because the liability is excluded
under 357(c)(3) or is a contingent liability.
3) Exceptions
a) 358(h)(2): the basis-reduction requirement does not apply where:
i. The trade of business with which the liability is associated is transferred
to the corporation as part of the exchange; or
ii. where substantially all of the assets with which the liability is associated
are transferred to the person assuming the liability as part of the
exchange
C. Where the basis of the nonrecognition property received by the shareholder-transferor in
the transaction would exceed its fair market value under the normal basis rules, the basis
must be reduced by the amount of liability assumed that was not otherwise reduced
under section 358(d)(1).
iv. If the corporations aggregate basis of property transferred to it exceeds the propertys aggregate
fair market value, 362(e)(2) requires a reduction in basis to fair market value. The reduction is at
the corporate level, absent a special election.

V.

VI.

b. If the transaction does not fall within 351, bases will be fair market value (cost) bases.
8. Holding Periods:
a. If the transaction falls within 351, property transferors receive tacked holding periods with respect
to capital and quasi-capital assets transferred. 1223(1). Assets transferred to the corporation receive
tacked holding periods. 1223(2)
b. If the transaction does not fall within 351, holding periods start anew.
9. Avoidance
a. Incentive: may want to avoid qualification to accelerate recognition of a loss or to recognize gain
on an asset and step-up its basis for depreciation in the hands of the corporation.
b. Techniques: give preferred stock rather than common
i. Treating as a sale will likely not work. Burr Oaks (taxpayer tries to sell land to corporation,
court reclassified the debt as stock and held that A recognizes no gain under 351). See debt v.
equity
Capital Structure of a Corporation
1. Tax Advantages of Debt
a. Interest deduction:
b. Repayment of principal: tax free return of capital to the lender.
2. Tax advances of equity
a. 351 non-recognition
b. Corporate shareholders receive dividends received deduction. 243.
3. Distinguishing Between Debt and Equity. 385.
a. Ask: Does the investment, analyzed in terms of economic reality, constitutes risk capital or a
strict debtor-creditor relationship viewing the transaction as if it were with an outside lender.
Scriptomatic.
b. Section 385(b) lists five factors.
i. Form i.e. whether the instrument pays a fixed rate of interest and is evidenced by a written
unconditional promise to pay a sum certain on demand or on a specific date in return for an
adequate consideration.
A. Debt: an instrument should have the formal indicia of a debt obligation e.g. an
unconditional promise to pay, specific terms, and a fixed rate of interest payable in all
events
B. Hybrid instruments: if it has voting rights or make interest payments contingent on
earnings, likely equity
ii. Subordination i.e. whether the debt under scrutiny is subordinated to or has preference over
any other indebtedness of the corporation
A. Subordination of shareholder debt to claims of outside lenders and trade creditors is
regarded as evidence of equity.
iii. The debt/equity ration of the corporation. 385 is silent to how the ration is computed or when it
is excessive but courts look at this
iv. Convertibility i.e. whether the interest is convertible into stock
v. Proportionality i.e. the relationship between the holdings of stock in the corporation and
holdings of the debt under scrutiny.
A. Thinly capitalized: a corporation with a high debt/equity ration. More likely to be
considered equity because the purported debt is really a risk in the venture because no
rational creditor would loan money to a thinly capitalized corporation
Dividends
1. Determine the amount of the distribution under 301(b)

VII.

a. Cash received by the shareholder + FMV (as of date of distribution) of any other property received
any liabilities assumed by the shareholder in connection with the distribution or liabilities to
which the property is subject to before and after the distribution
2. Determine how much of that amount is a dividend as defined by 316
a. First, look at the current E&P. if current E&P is insufficient, look at accumulated E&P
b. Calculating E&P:
3. Determine the specific tax treatment of these amounts as provided in 301(c)
a. Shareholder:
i. a dividend is includible in gross income. 61(a)(7); 301(c)(1).
ii. non-dividend distribution is first treated as a tax-free return of capital that reduced the
shareholders basis in the stock. 301(c)(c). Any amount in excess of basis is treated as a gain
from a sale or exchange of stock generally capital gain if the shareholder holds the stock as a
capital asset. 301(c)(3).
b. Corporate shareholders
4. Determine whether the dividend is qualified and thus entitled to be taxed at long-term capital gains
rates under 1(h)
a. Preferential tax rate: taxed at a maximum 15%. Qualified dividend income is included in a
taxpayers adjusted net capital gain. 1(h)(11)(A). (remains ordinary income for other purposes
i.e. can only offset by capital losses by $3k)
b. Defined: all dividends received during the taxable year from domestic corporations and foreign
corporation that meet certain criteria. 1(h)(11)(B).
c. Minimum holding period rule: an otherwise qualified dividend is not eligible for the reduced rate
if:
i. Shareholder does not hold the stock for more than 60 days during the 121-day period beginning
60 days before the ex-dividend date. 1(h)(11)(B)(iii); 246(c)(1).
Corporate Redemptions of Stock
1. Did a corporation buy back its own stock from a shareholder? (If no, section 302 does not apply)
2. If yes, compute the shareholders percentage interest before the redemption and after the redemption
a. Section 318 attribution rules apply (hard part)
i. Shareholders are treated as owning stock that is actually owned by individuals or entities that
are closely related to the shareholder
A. Family attribution: 318(a)(1) requires attribution of stock ownership to a taxpayer from
a spouse, from a parent, and from a grandchild (if you are a grandchild, and transfer to
grandparent, it doesn't count because that is really taking it away from you)
B. Entity to owner attribution: 318(a)(2) requires that stock owned by a partnership,
estate, trust, or another corporation be imputed from that entity to its beneficial owners,
its partners, beneficiaries, or shareholders, in proportion to their ownership in the entity.
1) Importantly, stock owned by a corporation is only attributed to a shareholder who
owns a 50% percent or greater interest in the corporation after the application of
the stock attribution rules. 318(a)(2)(C).
2) Once you own 50% then it is in proportion to how much you own the proportion
only starts at 50%
C. Owner to entity attribution: 318(a)(3) requires the stockholdings of the owners of
partnerships, estates, trusts, or corporation to be attributed in full to their entities.
1) The same 50% threshold applies
2) If the corporation is the one getting redeemed, As stock would be attributed to the
corporation (50% of greater stock holder)

3.
4.

5.

6.

D. Reattribution: under 318(a)(5), the constructive ownership interest that result from
attribution may themselves be reattributed to another.
E. Options: stock is attributed to any person who holds an option to acquire that stock.
318(a)(4).
1) Stock that the holder could acquire by the exercise of an option, warrant,
convertible debenture, or similar right is attributed to the holder.
2) Appears that when the right to exercise an option is subject to contingencies not
within the control of the option holder, the option generally will not support
attribution.
ii. Caution: highly mechanical rule
A. They only apply if the code says they apply, and
B. Stock is attributed to a shareholder only from the individuals or entities specified in
Section 318
C. There are other stock attribution rules that slightly differ
D. YOU CAN ONLY ATTRIBUTE IT ONE OTHER PERSON NOT TWICE
b. The number of shares outstanding after the redemption will be less than before the redemption
because the shares redeemed are no longer outstanding
Was this a redemption from a non-corporate shareholder in partial liquidation of the corporation?
If no, was this a complete termination of the shareholders interest in the corporation? 302(b)(3).
a. Attribution of family owned sales can make this seemingly impossible
i. Waiver of family attribution 302(c)(2)(A): if requirements met, family attribution (318(a)(1))
will not apply in determining whether there has been a complete termination of interest
A. Immediately after the redemption distribution, the shareholder in question (the
distributee) retains no interest in the corporation other than as a creditor. The
distributee cannot even remain an officer, director, or employee. 302(c)(2)(A)(i).
1) Lynch: black & white definition of interest taxpayer must completely sever all
non-creditor interest in the corporation (including independent contractors getting
paid small amounts) [look out for equity-like debt]
2) Hurst: creditor interests held to be a complete termination even though they had
a pretty large amount of control, key is that there is a formulistic look and found
that the it was still a creditors interest and that was the most important thing
B. The distributee does not acquire any such interest (other than by bequest or inheritance)
within ten years from the date of the distribution. If this provision is violated, the waiver
will be invalidated retroactively. 302(c)(2)(A)(ii). A special statue of limitation runs for
on year from the sate the shareholder notifies the IRS of the receipt of the stock.
C. The distributee files an agreement with the IRS to notify it of any prohibited acquisition
described and to maintain necessary records. 302(c)(2)(A)(iii).
b. Waiver of family attribution by entities
If no, was this a substantially disproportionate redemption? 302(b)(2)
a. After redemption, the shareholder must have less than 50% of the total voting power of all classes
of the corporations stock, including voting preferred.
i. Immediately after does NOT require a change, you just need less than 50%
b. Immediately after the redemption, the voting power the shareholder has must be less than 80% of
the voting power the shareholder had before the redemption (most importantly)
c. Immediately after the redemption, the common stock the shareholder has must be less than 80% of
the common stock the shareholder had before the redemption.
If no, was this not essentially equivalent to a dividend, a fact-sensitive test? 302(b)(1).
a. Last resort if the redemption does not qualify under other paragraphs of 302(b)

VIII.

b. Davis: to qualify for preferred treatment under 302(b)(1), a redemption must result in a
meaningful reduction of the shareholders proportionate interest in the corporation.
i. Doesn't matter that there is a legitimate business purpose
A. Only ask if it is a sale or something else
ii. Where a sole shareholder (actually or constructively) has part of his or her stock redeemed, that
will always be taxed as a section 301 distribution rather than an exchange.
iii. If a shareholder owns only nonvoting preferred stock of a corporation (even after application of
constructive ownership rules), and the stock is not section 306 stock, the redemption of a part of
that stock generally will qualify under section 302(b)(1), although it does not otherwise qualify
under section 302(b).
c. Rev. Rul. 75-502: 57 to 50 = meaningful b/c voting rights are not deadlocked
i. indicia of stock ownership that are important to determining a meaningful reduction
A. Not mechanical/not how much/ doesn't have to be significant matters what actually
changed and the circumstances the amount of drop doesn't matter if you still have
control
B. The right to vote
C. The right to participate in dividends
1) When you don't have control, even small amounts usually past muster
2) There is one case that found a really small amount wasn't enough.
D. The right to share in net assets on liquidation
d. Family Hostility
i. Creone: there is a possibility of a family hostility exception if is a reduction, taking account of
the attribution rules i.e. for a sole shareholder it is impossible
A. Need unrelated shareholders with the family attribution rules preventing exchange
treatment
e. Zenz: [always consider step-transaction doctrine in these cases]
7. If the answer to any of questions 3-6 is yes, then the redemption is taxed as an exchange. The
shareholder will have capital gain in the amount of the difference between the amount distributed and
the shareholders basis in those shares.
8. If the answer to all of questions 3-6 is no, then the transaction is taxed as a section 301 distribution.
Apply section 301 to determine the dividend amount (ordinary dividend to the extent of the redeeming
corporations E&P).
Apply 305 to Stock Dividends
1. Was there an actual or constructive stock distribution with respect to stock? (If no, section 305 does not
apply).
2. 305(a) excludes tax treatment
a. Primarily pro rata distribution of common stock to common stockholder. See Eisner.
b. Pro rata distributions of preferred stock to common stockholders, where common stock was the
only outstanding class of stock prior to the distribution.
c. Basis: basis in the old stock is generally allocated among the old stock and the stock newly
received, in proportion to the FMV. 307(a).
3. If yes, was the distribution with respect to preferred stock? If yes, it is taxable under section 301.
305(b)(4).
a. B/c a preferred stock holder is limited to their dividends and they get a preference on liquidation
amounts but their amounts are capped anything they get beyond that increase their interest.
b.
4. If no, was any shareholder offered a choice (option) to receive cash or other property instead (whether
exercises before or after the declaration thereof)? If yes, it is taxable under section 301. 305(b)(1).

IX.

a. Put rights (allowed to redeem after for prearranged price): taxed under 301, b/c after the
declaration thereof
i. Even if the right cant be exercised immediately
ii. Maybe not if it happens very far in the future
b. Company option to buy back not taxed under 301: Frontier Savings: technically not at the election
of the shareholder because the company could reject, even though they had never turned down a
redemption
c. Dividend reinvestment plans are taxed under 301: e.g. a shareholder could elect to have all of the
cash dividends otherwise payable to him automatically reinvested in shares of X common stock at
a price equal to 95% of the FMV of the stock on the dividend payment date. Rev. Rul. 78-375.
i. Basis: the reinvested shares carry a basis equal to the FMV of X common stock on the date of
the distribution
5. If no, did a shareholder of one class of stock receive cash or other property while a shareholder of
another class of stock received the stock, increasing that shareholders proportionate interest in the
corporation? If yes, the stock distribution is taxable under section 301. 305(b)(2).
a. E.g. class A gets cash, class B gets stock no election they just get what they get result is class
B holders get more powerful
b.
6. If no, did any common stockholder receive common stock while any other common stockholder
received preferred stock? If yes, the stock distribution is taxable under section 301. 305(b)(3).
a. The preferred stock is treated as property under 317, something about the rights of the
shareholders is changing
b. Preferred does not give an increased interest in dividends, they are getting a capped interest in
dividends
c. Preferred is just different than common in the rights and benefits of owning the different types of
stock
7. If no, is the distribution of convertible preferred stock? If yes, it is taxable under section 301, unless it
is established to the satisfaction of the IRS that the distribution will not have the result of some
shareholders obtaining cash or other property while other shareholder obtain stock. 305(b)(5).
a. 1.305-6(b), ex 2: looks at the incentives/arrangement of the convertible stock is it because of the
price or time period of the conversion that some will convert and other who will cash out
i. Look at the process and analyze the facts and circumstances
b. Keep in mind that common/preferred stock is not property under 317(a).
8. 305(c): if some shareholders redeem, and others don't, the ones that don't redeem can be taxed under
301 because there equity can go up, their proportionate interest went up
a. Catch all provision just in case
b. Not an automatic rule because if there is some redemption, everyone would be taxed who doesn't
redeem
c. A redemption is appropriate to the non-redeeming party when,
Non-subsidiary Liquidations
1. Are they related parties under 267? If no,
2. If yes,
3. Loss limitations:
a. 336(d)(1)(A)(i): such distribution is not pro rata
b. 336(d)(1)(A)(ii): such property is disqualified property
i.
4. If they are not related, the amount of loss that may be claimed on the disposition of the property may be
limited by 336(d)(2)

X.

XI.

XII.

XIII.

a. The limitation on loss applies only if a principal purpose of the acquisition of the property by the
corporation was to create a loss for the corporation in the subsequent liquidation. 336(d)(2)(B)(i)
(II).
i. Property acquired by the corporation during the two years preceding the adoption of the plan of
liquidation will be treated as acquired for the prohibited purpose except as provided by
regulation. 336(d)(2)(B)(ii).
b. 336(d)(2) special rule for certain property acquired in certain carryover basis transactions
i. Only loss economically accruing after the transfer of the property to the corporation may be
deducted; pre-contribution, or built-in, loss is disallowed by reducing the basis of the
contributed property by the amount of the built-in loss at the time of the contribution
ii. Basic safe harbor have to acquire more than 2 years before the plan for complete liquidation
Liquidation of a subsidiary
1. Is it a controlled subsidiary? 80% of .. (see 1504(a)(2)
2. Subsidiarys Basis: Under 334(b)(1) the bases of the subsidiarys assets carry over to the parent
corporation, preserving the unrealized appreciation that would otherwise have been taxable to the
subsidiary.
3. Parents Basis: the parents basis in the subsidiarys stock disappears along with that sotck and the
parents investment gain or los permanently escapes tax consequences.
4. Remember: taxation to individuals is handled by 331 or 336
Comparison of taxable and non-taxable complete liquidations
Type of liquidation
Liquidating corporations
Shareholders tax
Basis Rules
tax consequences
consequences
Taxable
Gain realized is
Gain or loss realized is
Shareholders take FMV
recognized; losses may or recognized. 331.
bases in assets. 334(a).
may not be recognized.
336.
Non-taxable
Gain or loss realized on
Gain or loss realized b
Parent takes transferred
distributions to
controlling corporation is bases in assets. 334(b).
controlling parent
not recognized. 332.
corporation is not
recognized. 337.
Taxable Corporate Acquisitions
1. Taxable Asset acquisitions
a. Sellers tax consequences
b. Buyers tax consequences
2. Taxable stock acquisitions
338 Elections [STOCK ACQUISITION]
1. 338: Allows an eligible corporation to make an election to obtain what is essentially a cost basis in the
assets of a purchased corporation. In return for what is generally a step-up basis, the purchased
corporation is treated as having sold the assets to itself, so that gain or loss is recognized
2. Is there a qualified stock purchase? [any transaction or series of transaction in which stock (meeting the
requirements of section 1504(a)(2)) of 1 corporation is acquired by another corporation by purchase
during the 12-month acquisition period. 338(d)(3).]
a. 1504(a)(2): 80% control - vote and value test
b. 12-month acquisition period: must be purchased. Generally refers to acquisitions that did not occur
in a nonrecognition or transferred basis context. 338(h)(3).
3. If qualified

XIV.

a. The purchasing corporation may make a 338 election no later than the 15th day of the ninth month
beginning after the month containing the date on which 80% control was obtained. 338(g)(1), (h)
(2).
4. Tax consequences to Target of a section 338 election
a. If elected: its new subsidiary (T) is treated as having sold at fair market value all of its assets in a
single transaction occurring at the close of the date on which the requisite 80% control was
acquired 338(a)(1). This deemed sale is subject to complete recognition on the final tax return of
the old target corporation.
b. Target still owns the assets, so it is treated as a new corporation that purchased all of the assets as
of the beginning of the following day
c. Disadvantages: results in immediate recognition of gains (and losses) by the subsidiary corporation
i. Company may want to defer any gain inherent in its assets.
d. Advantages: higher asset basis, which will provide tax savings over a period of time, as assets are
depreciated or sold.
i. When T has net operating loss carryovers that will offset the gain recognized on Ts deemed
asset sale, or where T is a subsidiary and the parties also jointly make a 338(h)(10) electino
5. Calculation and allocation of Targets new asset basis
a. Aggregate asset basis = the grossed-up basis of the purchasing corporations recently purchased
stock + the basis of the purchasing corporations non-recently purchased stock. 338(b)(1).
i. Recently purchased: purchased by the purchasing corporation during the 12-month acquisition
period.
ii. Non-recently purchased: all other stock in the target corporation held by the purchasing
corporation on the acquisition date.
iii. Grossed-up basis = cost of stock x (100% - % of non-recently purchased stock)/ % of recently
purchased stock)
6. 338(h)(10) Election
a. No gain or loss is recognized by the selling group, but rather, the subsidiary is considered to have
sold its assets and distributed the proceeds to its selling shareholders, in liquidation. The deemed
liquidation generally will be protected by 332.
b. If seller accepted the liability: the election essentially allows the selling group to substitute gain on
a deemed sale of the targets asset for the gain that would have been recognized on the sale of the
targets stock. Unlike a sale of stock, the deemed asset sale results in a step-up basis of the targets
assets. A basis step-up is valuable to the buyer, which should increase the purchase price. Thus, it
may be more advantageous for the selling group to pa tax on the inside gain in the subsidiarys
assets rather than to be taxed on outside gain (he gain selling shareholders would have on the
sale of the subsidiarys stock)
c. Selling group could achieve virtually the same result by liquidating the subsidiary tax-free an then
selling the targets assets. In that case, the acquiring company would obtain a cost basis in the
assets it acquires, under 1012.
General Checklist for Valid Reorganizations
1. ***Exam question: these are what the parties want to do, what is the best way to go about it?
2. The transaction must qualify as a reorganization under 368.
a. A type - (stock for assets) 368(a)(1)(A)
i. Statutory merger/Consolidation? A transaction effectuated under a (state/federal/foreign) merger
statute must have the result that:
A. Must comply with foreign, state or federal statutes
1) Problem: laws often require consent to the reorganization by majority shareholders
of all corporations involved.

B. One corporation acquires the assets of the target corporation by operation of the
corporate law merger statute and then T liquidates
C. The target corporation ceases to exist. Rev. Rule 2000-5/Reg, 1.368-2(b)(1)(ii).
1) Cannot do a disregarded entity merger where an LLC goes to the acquirer and the
target corporation still exists target can go into the disregarded entity
ii. Subsidiary used in a Type A
A. Reasons: allows P to protect its assets from creditors of T, approval by the acquiring
corporations majority shareholders is easier because only approval of the parent
corporations board is required.
b. C type voting stock for assets 368(a)(1)(C) effectively intentioned to accommodate
transactions that are in effect mergers but which fail to meet the statutory requirements of A
[~non-statutory merger de facto merger]
i. Was substantially all of the properties acquired? [Fact sensitive]
A. Rev. Proc. 77-37 Safe Harbor [90/70 test]: where there is a transfer of assets
representing at least 90% of the FMV of the net assets and at least 70% of the FMV of
the gross assets held by the corporation immediately prior to the transfer.
1) Gross: total value of assets irrespective of debt
2) Net: value LESS debt
3) E.g. FMV = 100k, debt = 20k; sold for 75k; net = 100-20=80; 75/80=.94 OK;
75/100-.75 OK
B. Residual Test defining substantially. Rev. Rule. 57-518
1) Nature of the properties retained by the transferor
a) Good: Looking for liquid or easily liquidated assets
b) Bad fact: keeping operating assets
2) The purpose of the retention
a) Good: paying off debt
b) Bad: keeping assets to restart business, giving money to shareholders
3) The amount retained
a) Good: enough to pay off debts
b) Bad: a lot
C. 368(a)(2)(G)
1) The target must distribute all its properties or liquidate
ii. Was it divisive, therefore not eligible for nonrecognition treatment? [Step transaction doctrine
applicable]
A. Rev. Rul. 57-518: residual test ????
1) Cash, notes and a small amount of inventory roughly the same amount of the
liabilities OK
B. Helvering v. Elkhorn [substantially all is a stricter test than all]: step transaction doctrine
to stop a spin off then sale
C. Rev. Rule 88-48: how you do it right distinguishing facts: they didn't keep the assets,
they sent them to the acquiring company
iii. Was it solely for voting stock? [Stricter test than the judicial doctrines used mostly in A
reorgs.]
A. Low-boot tolerance (subject to hard to meet exceptions)
B. Assumption of Debt Exception: Assumption of liabilities is not treated as boot, so long
as solely voting stock is used as consideration. 368(a)(1)(C).
1) Boot relaxation Rule [hard to meet] 368(a)(2)(B).
a) If there is any cash boot in the deal, then the boot (liabilities + cash)
transferred must be less than 20% of the value of the assets. 368(a)(2)(B)(iii).

b) Because most businesses have substantial liabilities, any boot will usually
disqualify a putative C
iv. Tax Consequences and Basis Rules
A. Target transfers all of its assets to the acquiring corporation in return for temporary
stockholdings in the acquire. The target then liquidates, distributing the stock and any
remaining assets to its shareholders, who thereby become shareholders of the acquirer.
B. Acquirer:
1) Basis: determined under 362(b). i.e. Transferred basis?
C. Target:
1) 354(a) applies to shelter realized gain or loss to target shareholders on this
exchange, except that section 356(a) applies to any target shareholder that received
boot.
2) Under 356(a), gain realized by a target shareholder is recognized to that
shareholder to the extent of the boot he received.
3) Basis: takes basis in the new shares that is the same as the old share basis, adjusted
upward for gain recognized and downward for liability relief and boot received.
358(a)(1).
c. B Type voting stock for stock 368(a)(1)(B) the acquiring corporation swaps its voting
stock with target shareholders for enough stock of the target corporation as to have control of it
after the transaction. Thus, after reorganization is complete, the target is at least an 80% subsidiary
of the acquiring corporation, and the former target shareholders are new shareholders of the
acquiring corporation. [deals directly with the stock holders]
i. Solely for Voting Stock Requirement: requires that the voting stock be the sole acquisitive
consideration used to acquire the target stock [very little flexibility].
A. The use of any non-voting stock as consideration for the target stock will spoil a B
reorganization
B. The use of a mix of acquiring and parent corporation stock, even if both types of stock
have voting rights will fail.
C. Zero Boot Tolerance Exceptions
1) Cash or other property may be used in lieu of issuing fractional shares (arises
because there the small companies stock is worth such a small amount of the big
companies stock]
a) Rev. Rul. 66-365: uses a step transaction type analysis to say its two separate
transaction [strange] a B then a sudo-redemption. [Administrative
exception]
b) Examine continuity of proprietary interest to make sure that not too much cash
is being paid out relatively.
2) Acquirer can assume the targets reorganization expenses (not the targets
shareholders)
3) Options or warrants are not held to violate the rule (happens when there is a poison
pill) the acquirer can give the target the same option/warrant rights. Reg. 1.3563(b).
4) Non-stock acquisitions: if the target is struggling financially, the acquirer can
acquire the bonds in the interim period before close to give the target operating
cash. Been held to be ok even though it looks like it would violate the step
transaction doctrine many times.
D. Definition of voting stock
ii. The Control + immediately after Requirement

A. Ownership of at least 80% of voting and 80% of all other stock. 368(c).
B. Pre-existing control does not violate the requirement (you could go from 81% to 82%)
1) Creeping B reorganizations allowed: where control is acquired in a series of
acquisitions
a) Step-transaction doctrine risk Heverly v. Commissioner: its enough to get a
full 80% amou, you are still at risk of the step transaction doctrine if you
acquire too close
iii. Tax Consequences and Basis Rules
A. Acquirer: acquires the stock of the target
1) Takes a transferred basis in the stock of the target corporation. 362(b).
B. Target: remains in existence as a subsidiary of the acquirer
1) 354 applies to shelter their realized gain from recognition. Each shareholder takes
as his basis in the acquirer the basis he ha in the stock of the target corporation
under 358.
d. Forward Triangle Mergers 368(a)(2)(D)
i. S must acquire substantially all of the properties of T. [see C requirement} [subject to
Elkhorn Coal line of cases and the 90/70 test, residual test, etc.]
ii. No stock of S may be used as consideration in the merger. Use of S debt securities is not
prohibited.
A. Limit on consideration
B. Because the stock in S is not a controlling interest, if you received stock in the sub that
is like getting cash because it is just economic interest, there is no proprietary interest
because the parent controls the sub.
iii. The transaction must have qualified as a A if T had merged directly into P. [the transaction
must satisfy the judicial continuity of interest requirement i.e. P must acquire T using at least
50% P stock]
A. Must be a statutory merger (pursuant to a statute)
B. The transaction is still subject to all the judicial doctrines
e. 67-448
i. relies on step transaction doctrine to get B treatment
ii. cant be a pre-existing sub
iii. does not have a substantially all requirement
iv. No boot allowed
f. Reverse Triangle Mergers 368(a)(2)(E)
i. After the merger, T must hold substantially all of its properties and the properties of S (other
than the stock of P distributed in the transaction and any boot used by S to acquire shares of
minority shareholders). If, as is likely, S is a transitory subsidiary, it will not have any properties
other than the consideration used to acquire T.
ii. In the merger transaction, P must acquire 80% control of T in exchange for P voting stock. The
remaining 20% of T may be acquired for cash or other boot.
A. Note that 80% of T must be acquired for P voting stock in a single merger transaction;
prior T stock held by P will not help T meet this requirement. Thus, the permissible
consideration in a reverse triangular merger is more restrictive that in a forward
triangular merger, and creeping acquisitions will not qualify.
3. There must be a plan of reorganization.
4. There must be a business purpose for the transaction. [are the rules being followed in form but not
substance?]
a. Applies to all reorganizations but mostly A reorganizations

5.

6.

7.
8.

b. Gregory: you shouldn't be able to do transactions just for tax avoidance, you should have a real
business purpose for the transaction
There must be continuity of business enterprise [facts + circumstances] [A is most relevant]
a. Has the parent corporation continued the target corporations historic business OR use a significant
portion of Ts historic business assets in a business? Reg. 1.368-1(d).
i. Know it if we see it type of factual test
ii. E.x. cannot sell assets for investment portfolio and then do a merger with an investment firm b/c
you just recently acquirer the assets
There must be continuity of proprietary interest. Le Tulle v. Scofield. [Doesnt want a disguised sale]
[most relevant to A reorganizations]. Reg.
a. Cash, short term bonds, etc. = not a retained interest
b. Are the 3 elements met?
i. Qualitative is there a proprietary interest?
A. Does some of the consideration received by one or more of the shareholders of an
acquired corporation consist of voting or nonvoting stock [preferred stock ok] of the
acquiring corporation? (or, in a triangular reorganization, of a corporation in control of
it)
1) Do you have an interest in the company profiting? Preferred stock holders do
because there has to be profits to get their dividends.
2) Debt holders just have an interest in the business being viable
a) Debt instruments cannot constitute a proprietary interest.
3) Debt v. equity analysis relevant
ii. Quantitative how large does the stake have to be?
A. Does some substantial part of the consideration paid by the acquiring corporation consist
of its stock or stock of a corporation in control of it?
B. Substantial Safe Harbor: ~40% stock would be sufficient [Reg. 1.368-1(e)(v) Ex. 1 /
dicta in Nelson], although it is understood that 50% stock is safer under Rev Proc 7737.
iii. Temporal aspect [cant funnel stock back to acquirer] [cite: Rev. Rul. 1.368-1(e)(i)]
A. Did target shareholders sell sell stock back to the acquirer or an affiliate of the seller?
1) If yes, then it fails the test and is a disguised sale unless the facts and
circumstances show that it is OK. I.e. a buy back program
B. Did target shareholders sell stock to an unrelated party, immediately or otherwise?
1) If yes, it is ok you can sell all day long as long as its to unrelated people and you
are taxed on that transaction
2) As long as you are not funnel shares to target, it is not a disguised sale
c. If no continuity of interest, there is a sale upon which gain or loss must be taxed
NOT be subject to the step transaction doctrine
Tax Consequences of Transactions Qualifying as reorganizations
a. Acquiring Corporation
i. Carryover basis in the acquired net assets equal to the targets historical tax basis, even when a
gain is recognized by the target shareholders on any boot received
ii. Assumes a carryover basis in the stock received from target shareholders equal to the target
shareholders basis, even when a gain is recognized by the target shareholders on any boot
received
iii. B reorg: P takes a basis in the stock equal to T SHs basis in the T stock
iv. No gain or loss on the exchange of the acquiroers own stock for stock of the target
b. Target Shareholders
i. If no boot, 354(a)(1) = carryover basis

ii. If boot, 356(a)(1) = boot is taxed, but only to the extent of the total realized gain on the
transaction. Loss is not recognized in either instance.
iii. Basis: takes basis in parent stock equal to T SHs basis in the T stock surrendered + gain
recognized boot received
c. Target Entity
i. Target does not recognize a taxable gain on the transfer of assets to the acquirer.
9. principal code sections applicable to reorganizations
10.
Party involved in the reorganization
Applicable code sections
Target shareholders
354, 356, 358 for basis
Target Corporation
357, 361, 358 for basis
Acquiring Corporation
1032, 362(b) for basis
Parent of Acquiring Corporation
1032,; Treas. Reg. 1.358-6 for basis
XV.

STUDY
1. How you treat things, i.e. property with built in losses, at each stage of the corporation