ASF>EN PUBLISHERS

Corporate TaxationFourth Edition

Cheryl D. BlockProfessor of LawWashington University Law School

^j_ Law & Business

AUSTIN BOSTON CHICAGO NEW YORK THE NETHERLANDS

Summary of Contents

Contents xiPreface v - - ' xxiiiAcknowledgments xxvii

PART I. SOME PRELIMINARY MATTERS

Chapter I Introduction 3

Chapter 2 Choice of Form and Entity Classification 19

Chapter 3 , The Corporate Capital Structure 43

PART II. CORPORATE FORMATION

Chapter 4 Incorporation and Other Contributions to Capital 65

PART III. CORPORATE MIDLIFE EVENTS

Chapter 5 Nonliquidating Distributions 141

Chapter 6 Redemption Distributions 181

Chapter 7 Stock Dividends 237

PART IV. CORPORATE LIQUIDATION ANDRELATED ISSUES

Chapter 8 General Liquidation Rules 277

Chapter 9 Liquidation of Subsidiaries 303

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Summary of Contents

PART V. CORPORATE ACQUISITIONS AND DIVISIONSAND OTHER CORPORATE RESTRUCTURING

Subpart A. Taxable Acquisitions

Chapter 10 Taxable Mergers and Acquisitions 323

Subpart B. Tax-Free Reorganizations

Chapter 11 Introduction to Basic Corporate ReorganizationPrinciples 377

Chapter 12 Acquisitive Reorganizations 433

Chapter 13 Corporate Divisions 499

Chapter 14 Recapitalization and Odier Corporate Restructuring 545

Table of Cases 569Table of Internal Revenue Code Sections 571Table of Treasury Regulations and Revenue Rulings 581Index 587

Contents

Preface , xxlii

Acknowledgments ^ . ..-• xxvii

PART I. SOME PRELIMINARY MATTERS

Chapter 1 Introduction 3The Corporate Income Tax — A Double Tax Regime 3Computation and Rate Structure for the Tax on Corporate and

Shareholder Income 6General Computation and Rates 6Difference in Tax Treatment for Capital Gains and Losses

Versus Ordinary Income: The Influence onSubchapter C 7

The Modern "Qualified Dividend" World 9Overview of Capital Asset Definition 11The Corporate Alternative Minimum Tax 13Penalty Taxes on Undistributed Corporate Income 14

a) The Accumulated Earnings Tax 14b) The Personal Holding Company Tax 15

Affiliated Corporations 16Nonrecognition in the Subchapter C World 17Incidence of the Corporate Tax 17

Chapter 2 Choice of Form and Entity Classification 19Introduction 19Choice of Business Form 20

The Options 20Nontax Factors 21Tax Factors 23

a) Double Taxation 23b) Tax Rate Issues 25

Subchapter S Corporations 26

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Eligibility and Election 26a) Eligible Corporations 26b) Election and Termination 28

Tax Treatment of S Corporations and Their Shareholders 29a) Background 29b) Basic Pass-Through Rules 30c) Distributions 31d) Loss Limitations 31

Classification of the Business Entity 32Initial Classification Issues 32Incorporated Entities 33Certain Unincorporated Entities: Per Se Corporations 34Associations Taxable as Corporations: Movement from the

"Corporate Resemblance" Test to an Elective Regime 35s Elective "Check-the-Box" Classification Regulations 36

Summary and Implications 37

Chapter 3 The Corporate Capital Structure 43Introduction 43Distinguishing Debt from Equity 45

Why Does It Matter? 45Why Should It Matter? 46The Relative Tax Advantages of Debt Versus Equity 47Absence of a Precise Standard 48Overview of Factors Used to Distinguish Debt from Equity 5 0

a) Observing the Formalities of a Debt Instrument 5 0b) The Debt-Equity Ratio or Thin Capitalization 51c) Subordination to Other Claims 52d) Contingency of Payment 5 2e) Right to Participate in Profits 52f) Voting and Other Rights of Control 53g) Identity Between Shareholders and Creditors 53h) Acquisition of Essential Assets 5 3i) Intent of the Parties 54

Bifurcation of Hybrid Securities 54Losses from Investments in the Corporate Enterprise 55

General Losses 55Section 1244 Stock Losses 5 6

Gains from Investment in the Corporate Enterprise 57Conclusion 58

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PART II. CORPORATE FORMATION

Chapter 4 Incorporation and Other Contributionsto Capital 65Introduction r 65Shareholder Nonrecognition: §351 Eligibility

Requirements andvUnderlying Policy 66Overview 6 6Exceptions to Nonrecognition Rules 68Why Permit Nonrecognition for Incorporation

Transactions? 69A Closer Look at the §351 Requirements 71

a) The Transfer Requirement 71b) The Property Requirement 71c) The Solely in Exchange for Stock Requirement 74d) Control Immediately After the Exchange Test 75

Disproportionate Contributions and Other Variations 79Operation of Shareholder Nonrecognition Rules 80

Overview of Basis Rules: Deferral of Gain or Loss 80Effect of Boot 82

a) Taxation of "Boot Gain": §351 (b)(l) 82b) Securities, Notes, or Other Evidence of

Indebtedness as Boot 84c) "Nonqualified Preferred Stock" Treated as Boot 85d) No Recognition of Loss: §351 (b) (2) 87

Tax Consequences to the Corporation 87Nonrecognition Rule: § 10 3 2 87The Corporate Basis Rules: §362 88

a) Basic Substituted Basis Rules: §362(a) 88b) Limitations on Built-in Losses: §362(e) 90

Contribution Versus Sale 93Additional Contributions to Capital 95

Shareholder Level Issues 95a) Nonrecognition 95b) Basis 97

Corporate Level Issues 97Effect of Liabilities: §357 and Related Matters 98

The General Rule: §357(a): Contributionswith Liabilities 98

The Tax Avoidance Purpose Exception: §357(b) 100Liabilities in Excess of Basis: §357(c) General Rule 102Comparison of §357 (b) and (c) 104

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Special Rules Applicable to Accounts Payable: §357(c)(3) 104a) Regular Accounts Payable and Receivable 104b) Exceptions to the Exception: §357(c)(3)(B) 105

Avoiding the §357(c) "Trap" 108What Constitutes Assumption of Liability? 113

a) Different Types of Liability 113b) Assumption of Recourse Liabilities 115c) Assumption of Nonrecourse Liabilities 117

Multiple Assets Securing the Same Liability 118a) Basic Multiple Asset Transfer 118b) Abusive Multiple Asset Transactions 120

The Corporation's Transfer of Its Own Stock — SpecialIssues Under §351 121

PART 111. CORPORATE MIDL1FE EVENTS

Chapter 5 Nonliquidating Distributions 141Introduction 141Tax Consequences to the Shareholders 142

Overview of §301 Distributions with Respect to Stock 142A Closer Look at the §301 Trilogy 143Why Limit Dividends to Amounts Paid Out of

Earnings and Profits? 144The Tax Stakes: Timing and Character of

Shareholder Income 146a) A Matter of Timing 146b) The Character Issue 148

In-Kind Distributions 150Definitions of Earnings and Profits 151

General Concepts 151Upward Adjustments 152Downward Adjustments 153Additional Timing Issues 153

Special Rules for Corporate Shareholders 154The Dividends-Received Deduction: §243 154Special Rules for Corporations Filing a Consolidated Return 155Congressional Response to Dividends-Received

Deduction Abuses 156Dividends-Received Deduction in a "Bootstrap Acquisition" 158

Tax Consequences to the Distributing Corporation 160In-Kind Distributions: §311 160

a) In General 160

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b) Why the Lack of Symmetry in §311 ? 162Adjustments to E&P: §312 ( 163No Deductions for Dividends Paid 164

Distributions Involving Liabilities 165Shareholder Tax Consequences 165Distributing Corporation Tax Consequences 166

Constructive Dividends 168

Chapter 6 Redemption Distributions 181Introduction 181Tax Consequences to Redeemed Shareholders 183

Overview 183The §302(b) Tests for Sale or Exchange Treatment 184

a) Complete Termination of Interest: §302(b) (3) 184b) Substantially Disproportionate Distribution:

§3O2(b)(2) 185c) Redemptions Not Equivalent to Dividends:

§302(b)(l) 187d) Partial Liquidations: §302(b)(4) 191

A Look at Attribution Rules: §318 193Overview 193Categories of Attribution 194

a) Family Attribution: § 318 (a) (1) 194b) Attribution from Entities: §318 (a) (2) 194c) Attribution to Entities: §318(a)(3) 196d) Options Treated as Stock: §318(a)(4) 197

Multiple Attribution 197Waiver of Family Attribution Rules: §302(c)(2) 200

a) Waiver by Individual Shareholders 200b) Waiver by an Entity 204

The Mystery of Disappearing Basis 205Special Issues for Corporate Shareholders 207Redemptions of Stock to Pay Death Taxes: §303 208Redemptions Related to Inter-Shareholder

Transfers and Bootstrap Acquisitions 209Inter-Shareholder Transfers 209

a) In General 209b) Redemptions Incident to Divorce 211

Other Bootstrap Acquisitions 214Redemptions by Related Corporations: §304 216

Overview 216Measuring Control for Purposes of §304 218

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Commonly Controlled or Brother-Sister Corporations:§304(a)(l) < 219

Acquisitions by Subsidiaries: §304(a)(2) 222Overlaps Between §304(a)(l) and (a)(2) 224

Tax Consequences to the Corporation 224

Chapter 7 Stock Dividends 237Introduction , 237Tax Consequences to the Shareholders 239

The Basic §305(a) Nonrecognition Rule 239Basis Rules: §307 240The Shareholder's Holding Period 241The §305 (b) Exceptions 241

a) In General 241b) Election to Take Other Property: §305(b)(l) 242c) Disproportionate Distributions: §305(b)(2) 243d) Distributions of Common and Preferred: §305(b)(3) 245e) Distributions on Preferred Stock: §305 (b) (4) 245f) Distributions of Convertible Preferred: §305(b) (5) 246

Deemed Stock Distributions: §305(c) 246Tax Consequences to the Corporation 249The Preferred Stock Bailout: §306 Stock 250

Background and History Prior to 2003 250Tainted Stock in the "Qualified Dividend Income" World 253Working Through the §306 Stock Rules 254

a) The Definition of §306 Stock 254b) Disposition of §306 Stock 256

Exceptions to the §306 Rules: §306(b) 261Charitable Bailout 264

PART IV. CORPORATE LIQUIDATION ANDRELATED ISSUES

Chapter 8 General Liquidation Rules 277

Introduction 277Tax Consequences to Individual Shareholders: §331 279

Overview 279Dividends Distinguished 280Liquidation in Installments 281

a) Series of Liquidation Payments 281b) Contingent Payments over Time 283

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c) Corporate Sale of Assets Followed by Distribution ofNotes to Shareholders 283

Distributions Involving Liabilities 284Tax Consequences to the Liquidating Corporation: §336 285

Overview 285The Old World of General Utilities 286Distributions Involving Liabilities 287Treatment of Losses , 287

a) General Loss Recognition 287b) Loss Limitations , 288

Chapter 9 Liquidation of Subsidiaries 303

Introduction 303Tax Consequences to the Parent Corporation: §332 304

Nonrecognition Rules 304Observations About "Outside" and "Inside" Basis 307

Tax Consequences to Minority Shareholders: §331 308Tax Consequences to the Liquidating Subsidiary: §337 308

Distributions to the Parent Corporation 308Distributions to Minority Shareholders 309Additional Anti-Abuse Provisions 310

PART V. CORPORATE ACQUISITIONS AND DIVISIONSAND OTHER CORPORATE RESTRUCTURING

Subpart A. Taxable Acquisitions

Chapter 10 Taxable Mergers and Acquisitions 323

Introduction 323Corporate Acquisitions in General 323Choice of Acquisition Structure 325

a) Taxable Acquisition Versus Tax-Free Reorganization 325b) Stock Versus Assets 327c) To Elect or Not to Elect Under §338 328

Taxable Asset Acquisitions 328The Transaction 328Tax Consequences to the Selling Corporation and Its

Shareholders 330a) Tax Consequences to the Target Corporation 330b) Tax Consequences to the Target Shareholders 332

Tax Consequences to the Purchasing Corporation 332

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Allocation of the Purchase Price 333a) Tax Stakes for Buyer and Seller 333b) Special Allocation Rules: §1060 334

Taxable Stock Acquisitions 336The Transaction 336Tax Consequences to the Selling Corporation and

Its Shareholders 336Tax Consequences to the Purchasing Corporation 337

Stock Acquisitions Treated as Asset Acquisitions: §338 338Section 338: Roots and Background 338Qualifying Stock Purchases (QSPs) 340Deemed Sale and Repurchase of Assets by Target 341Mechanics of the §338(a)(l) Deemed Sale ' 343Mechanics of the §338(a)(2) Deemed Repurchase 345Qualified Stock Purchase Without a §338 Election

Followed by Liquidation or Reorganization of Target 348Deciding Whether to Make the §338 Election 350

Special Problems Under §338: Affiliated Corporations andConsistency Rules 3 51

Target as Part of a Selling Affiliated Group 351The Special § 3 3 8 (h) (10) Election 353Additional Potential Triple Tax Issues: §336(e) 355Consistency Rules 356

a) Background 356b) Asset Consistency Rules: §338(e) 357c) Stock Consistency Rules: §338(f) 360

Creative Acquisition Strategies 362Eliminating One Layer of the Corporate Tax 362

Subpart B. Tax-Free Reorganizations

Chapter 11 Introduction to Basic CorporateReorganization Principles 377Introduction 377Categories of Reorganization 378

Acquisitive Reorganizations 378Divisive Reorganizations 379Internal Restructuring 380

Overview and History: Doctrine Underlying Tax-FreeReorganizations 380

Overview of Corporate Reorganization Tax Consequences 3 81Tax Consequences to Shareholders 3 81

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a) General Nonrecognition Rule: §354 381b) Shareholder Receipt of "Boot": §356 383

Tax Consequences to the Corporation in a Reorganization 388Reorganization Basis Rules 389

Judicial Glosses on the Statute 390In General 390Step-Transaction Approaches to Reorganization

Transactions ; 392Continuity of Proprietary Interest 393

a) Introduction 393b) Early Case Law 394c) Evolving Continuity of Shareholder Interest (COSI)

Rules 397d) Measuring Continuity of Shareholder Interest 400e) Post-Reorganization Shareholder Continuity 402f) Historic Shareholder Continuity 406

Ownership and Continuity of the Target's Business 412a) Introduction 412b) Continuity of the Business Enterprise 412c) Post-Reorganization Restructuring and Remote

Continuity 414The Business Purpose Test 419

Meaning of "Party to a Reorganization" and "Plan ofReorganization" 421

Overlaps Between Tax-Free Reorganizations and TaxableQualified Stock Purchases (QSPs) 422

Chapter 12 Acquisitive Reorganizations 433Introduction 433Acquisitive Stock Reorganizations: The Basic Type B

Reorganization 435Description of the Basic Type B Transaction 435Tax Consequences of the Basic Type B Reorganization 436Rigidity of the "Solely for Voting Stock" Requirement 439Target Corporation Liabilities in a Type B Transaction 440Type B Acquisitions over Time 441

a) Old and Cold Target Stock Acquired forConsideration Other than Stock 441

b) Creeping Acquisitions 442Acquisitive Asset Reorganizations: Basic Statutory Mergers and

Consolidations 443Description of the Basic Type A Reorganization 443Tax Consequences of the Basic Type A Reorganization 446

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Assumption of Liabilities in Type A Transactions 446Type A Acquisitions over Time 447

Acquisitive Asset Reorganizations: The Basic Type CReorganization 447

Description of the Basic Type C Reorganization 447a) The "Substantially All of the Properties" Requirement 447b) Disregarding the Assumption of Liabilities 449c) The Relaxed Solely for Voting Stock Requirement 450d) The Liquidation Requirement 452

Tax Consequences of the Basic Type C Reorganization 452Type C Acquisitions over Time 454

Triangular Reorganizations 455Introduction 455The "Drop-Down" Transaction 455Direct Triangular Reorganizations 458

a) The Type B Triangular Reorganization 459b) The Type A Triangular Reorganization 461c) The Type C Triangular Reorganization 469

Nondivisive Type D Reorganizations 470Acquisitive Reorganizations in Insolvency: The Type G

Reorganization 473Overlaps in the Acquisitive Reorganization Definitions 474Carryover of Tax Attributes Following Tax-Free Acquisitive

Reorganizations 477Proposals to Eliminate the Reorganization Definitions 479

Chapter 13 Corporate Divisions 499Introduction 499

Corporate Divisions in General 499Rationale for Nonrecognition Treatment Balanced Against

Potential for Taxpayer Abuse 501Some Introductory Terminology: Spin-Offs, Split-Offs, and

Split-Ups 504Overview of §355 Requirements 506A Closer Look at the §355 Requirements 507

Control "Immediately Before the Distribution" 507Distribution of Control 508Active Trade or Business Requirement 509

a) Post-Distribution Active Trade or BusinessRequirement 509

b) Pre-Distribution Active Trade or BusinessRequirement 511

c) Particular Applications of the "Active Trade orBusiness" Requirements 514

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Anti-Avoidance Rules for Essentially NondivisiveDistributions 516

a) Device for the Distribution of Earnings and Profits 516b) Disqualified Investment Corporations: §355 (g) 517

Nonstatutory Requirements 519a) Business Purpose 520b) Continuity of Proprietary Interest 524

Overlap of §368(a)(l)(D) and §355: DivisiveReorganizations k - 525

Tax Consequences to Shareholders and Other Distributees 526Basic Nonrecognition Rule: §355(a) 526Receipt of Boot 526Basis in the Stock or Securities Received 528

Tax Consequences to the Corporation 529Special Corporate Gain Recognition Rules: Preventing

Corporate Escape from General Utilities Repeal 530a) Disguised Sales: §355(d) 531b) The Anti-"Morris Trust" Rules: §355(e) 532

Chapter 14 Recapitalization and Other CorporateRestructuring 545Introduction 545Recapitalizations: The Type E Reorganization 547

A Stab at a Definition 547Equity Exchanges 548

a) Common for Common or Preferred for Preferred 548b) Common Stock for Preferred Stock 549c) Old Preferred for New Common 550d) Convertible Shares 550e) Dividend Arrearages and Other Potential §305 Issues 550

Debt and Equity Exchanges 552a) Debt for Equity Exchanges 552b) Equity for Debt Exchanges 553c) Debt for Debt Exchanges 555

Mere Change in Identity, Form, or Place: Type FReorganization 557

Application of General Reorganization Principles 559Business Purpose Test 559Continuity of Interest Tests 560

Table of Cases 569

Table of Internal Revenue Code Sections 571

Table of Treasury Regulations and Revenue Rulings 581Index 587

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