Demise of Morris Trust transactions yields new planning opportunities.

• Author: Guida, Thomas A.

Under new Sec. 355(e), Congress has eliminated one of the most complex, but successful, means to defer taxes on divisive reorganizations. By making taxable what had come to be known as "Morris Trust" transactions, Congress has come much closer to providing nonrecognition treatment for the very few transactions in which divisive reorganizations do not take place in the context of an acquisition. However, because of the way Sec. 355(e) is written, gain can still be minimized when a divisive transaction occurs.

Historical Background

Even though businesses split up all of the time, they have spawned some extraordinarily complex regulations. On many occasions, the owners of a company that operates more than one business decide to split their operations and have the business operate as two separate entities. This is often done to defuse internal business conflicts, allowing feuding owners to split and take with them the assets necessary to run their respective portions of the company.

Normally, the disposition of assets to another company is a recognition event for the disposing company. However, Sec. 355 allows the historical owners of a company to divide the company's assets (via a divisive reorganization) without recognizing gain when the owners intend to continue using the assets in the conduct of separate businesses. The nonrecognition of gain represents an understanding by Congress that a divisive reorganization is similar to its Sec. 368 cousins, in which owners merely shift ownership of (but do not dispose of) assets. In a typical Sec. 355 transaction, some of the assets and liabilities of a corporation (Distributing) are transferred to a newly formed subsidiary (Controlled) in exchange for stock in a transaction that qualifies under Sec. 351 or 368(a)(1)(D). All of the stock in Controlled is then distributed to one or more of Distributing's shareholders. This distribution of stock can also occur tax-free with a pre-existing subsidiary, as long as there is no disqualifying distribution (as defined by Sec. 355(d)(2)).

Sec. 355 will apply as long as at least 80% of the voting power and at least 80% of the total number of all other shares in Controlled are transferred upward. There are certain other requirements for nonrecognition, including an active business requirement, a business purpose requirement and a prohibition against devices that disguise the transaction as a distribution of earnings and profits to shareholders. Until now, the...