Question

Andy and Bertha each has owned 50% of the stock of Wallet Corporation for many years. Andy’s stock basis is $800 (FMV $1,000) and Bertha’s stock basis is $1,200 (FMV $1,000). Wallet is engaged in two lines of business (and has been so engaged for the last five years, unless the facts specify otherwise): the manufacture and sale of electronic equipment (Electro division) and the manufacture and sale of air conditioners (Airco division). The assets of each division have a FMV of $1,000 and an adjusted basis of $500, no liabilities exist, and Wallet has E&P of $1,000. Assume that 100% of the stock of a corporation is worth the net value of its assets, and ignore calculation of tax owed by Wallet. Except where otherwise indicated, assume that the transactions are motivated by good corporate business purposes and that no shareholder plans to dispose of any stock received. What are the tax consequences to the parties in each of the following transactions?

A) Wallet transfers all of the Electro assets to new Purse Corporation in exchange for all of Purse’s stock and transfers all of the Airco assets to new Messenger Corporation in exchange for all of Messenger’s stock. Immediately thereafter, Wallet liquidates and distributes the Purse and the Messenger stock ratably to Andy and Bertha.

B) Assume in a. that the business purpose was to protect Airco assets from Electro creditors?

C) What if Wallet distributed the Purse stock to Andy and the Messenger stock to Bertha? What if Purse sold its Electro business assets shortly after the distribution?

D) What if (in a.) the value of the Electro business was $1,800 and the value of the Airco business was $200 and Wallet had NOL carryovers of $100?

E) Wallet transfers the Electro assets to new Purse in exchange for all of Purse’s stock. Immediately thereafter, Wallet distributes the Purse stock to Andy in exchange for all of Andy’s stock?

F) Would your answer to e. above change if Andy had sold his stock to Curtis for cash just after the distribution of Purse to Andy? What if Andy had sold his stock to Curtis just before the distribution of Purse to Andy?

G) What if the sale to Curtis in f. occurred two and a half years before the distribution?

Answer 1

Answer

Tax consequences to stock holders of Wallet Corporation

A. Wallet sells its assets to new company and distributes shares of new company to its stock holders

In this case, Wallet transfers all of the Electro assets to new Purse Corporation in exchange for all of Purse’s stock and transfers all of the Airco assets to new Messenger Corporation in exchange for all of Messenger’s stock.

As per US Code 355 “Distribution of stock and securities of a controlled corporation’’, No gain or loss on a distribution is recognized if

1. The transaction was not used principally as a deceive for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both
2. as part of the distribution, the distributing corporation distributes (i) all of the stock and securities in the controlled corporation held by it immediately before the distribution, or (ii) an amount of stock in the controlled corporation constituting control within the meaning of section 368(c), and it is established to the satisfaction of the Secretary that the retention by the distributing corporation of stock (or stock and securities) in the controlled corporation was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax,

Since, distribution of stock of Purse corporation by Wallet to its stock holders is not used as a deceive for the distribution of profits, no gain or loss on a distribution is recognized.

Note: (but the mere fact that subsequent to the distribution stock or securities in one or more of such corporations are sold or exchanged by all or some of the distributes (other than pursuant to an arrangement negotiated or agreed upon prior to such distribution) shall not be construed to mean that the transaction was used principally as such a device),

B. What if business purpose was to protect Airco assets from Electro creditors

If the distribution has been made for the purpose of protecting Airco assets, in such case also no gain or loss on a distribution is recognized.

C. What if Purse sold its Electro business assets shortly after the distribution?

The mere fact that subsequent to the distribution stock or securities in one or more of such corporations are sold or exchanged by all or some of the distributes, shall not be construed to mean that the transaction was used principally as such a device. Therefore, no gain or loss on a distribution is recognized.

D) What if (in a.) the value of the Electro business was $1,800 and the value of the Airco business was $200 and Wallet had NOL carryovers of $100?

The position remains the same even of the Wallet has NOL carryovers of $100.