TRA '97 and Sec. 355.

• Author: Geracimos, John
• Position: IRC s. 355

The Taxpayer Relief Act of 1997 (TRA '97) made significant changes to Sec. 355. In spite of all the brouhaha about the repeal of Morris Trust transactions, not all of the changes were anti-taxpayer. The TRA '97 gives added flexibility for post-distribution transactions involving the stock of a newly formed controlled corporation.

If all of the requirements of Sec. 355 are satisfied, a distributing corporation (D) can distribute stock of a controlled corporation (C) to its shareholders without D or its shareholders recognizing gain or other income on the distribution and receipt, respectively, of the C corporation stock. For a distribution to qualify under Sec. 355, (1) D must control C before the distribution, (2) the distribution must not be a device for the distribution of earnings and profits of either corporation, (3) there must be a continuity of interest on the part of the D shareholders after the distribution and (4) there must be a valid business purpose for the distribution of the C stock.

C can be either a preexisting or newly created corporation. In relevant part, Secs. 351 and 368(a)(1)(D) permit D to contribute assets tax-free to a corporation whose stock it will distribute to D shareholders in a Sec. 355 distribution. Both Secs. 351 and 368(a)(1)(D) require D or its shareholders to control C immediately after the contribution of assets. Before the TRA '97, control was defined as 80% of a corporation's voting stock and 80% of the number of shares of all other classes of stock.

Also, before the TRA '97, a distribution of the stock of newly created or preexisting C, followed by a tax-free merger of D into another corporation, could qualify under Sec. 355, notwithstanding the post-distribution merger (this is a Morris Trust transaction; in fact, facilitating the merger could be a good business purpose for the distribution). Similarly, persons could contribute assets to C for additional C stock after the distribution of its shares. In cases involving newly formed controlled corporations...