Bankruptcy

Table of Contents
I. Introduction Error! Bookmark not defined. A. Introduction to Patents and the Patent System Error! Bookmark not defined. 1. Patents (utility patents) Error! Bookmark not defined. 2. purpose of patents Error! Bookmark not defined. 3. patent institutions Error! Bookmark not defined. 4. Patent architecture Error! Bookmark not defined. B. Claim Drafting Error! Bookmark not defined.
II. Patentability Error! Bookmark not defined. A. Patentable Subject Matter Error! Bookmark not defined. 1. Products of Nature Error! Bookmark not defined. 2. Purified or isolated products of nature Error! Bookmark not defined. 3. Intangible Methods and Processes Error! Bookmark not defined. B. Utility Error! Bookmark not defined. C. Disclosure/Enablement Error! Bookmark not defined. 1. Claim scope Error! Bookmark not defined. 2. Experimentation Error! Bookmark not defined. 3. Other enablement issues Error! Bookmark not defined. D. Written Description Error! Bookmark not defined. E. Novelty (a, e, g): another person before invention Error! Bookmark not defined. 1. Introduction Error! Bookmark not defined. 2. Public Knowledge Error! Bookmark not defined. 3. Prior Invention under 35 USC 102(g) Error! Bookmark not defined. F. Loss of Right under 102 (first inventor bars herself) Error! Bookmark not defined. 1. 102(b) Statutory Bar Error! Bookmark not defined. 2. Statutory Bars and Trade Secrets Error! Bookmark not defined. 3. Third-party rules Error! Bookmark not defined. 4. America Invents Act Error! Bookmark not defined. G. Nonobviousness Error! Bookmark not defined.
III. Infringement Error! Bookmark not defined. A. Literal Infringement (Claim construction) Error! Bookmark not defined. B. Infringement by Equivalents (Second step, finding each element) Error! Bookmark not defined. C. Indirect infringement Error! Bookmark not defined.
IV. Remedies Error! Bookmark not defined. A. Injunctive Remedies Error! Bookmark not defined. B. Monetary Damages Error! Bookmark not defined. C. Willful infringement and inequitable conduct Error! Bookmark not defined.

Formations and contributions

Common Law of Corporate Tax

1. Sham transaction doctrine. Two parts: 1) taxpayer was motivated by no business purpose other than obtaining tax benefits and 2) the transaction has no economic substance because no reasonable possibility of a profit exists. Rice’s Toyota v. Commish 4th 1985

2. Economic Substance Doctrine

3. Substance Over Form

4. Business Purpose

5. Step Transaction Doctrine

Formation of a Corporation

A0. Tax consequences to corporation

-1032(a): corporations don’t recognize gain or loss on receipt of money or other property in exchange for stock including treasury stock
-[under 1012, investor takes a cost basis]
-issuing stock as compensation for services is equivalent to issuing stock for money or property 1032-1(a).

1.1032-1(d): basis of property exchanged for stock determined under 1012, where basis of property is cost

issuing debt is not income under 61

issuing debt for property, property takes basis equal to issue price of debt

taking stock in exchange for services for a shareholder does not count as OI until significant restrictions on obtaining the stock are cleared. 83. Shareholder can make an 83(b) election to immediately pay tax.

A. Introduction to 351

351(a): no gain or loss is recognized by a shareholder if property transferred to a corporation solely in exchange for stock in such corporation if the transferors of property are in control of the corporation immediately after the exchange 1. one or more persons must transfer property to corp
2. the transfer must be solely in exchange for stock of corp
3. the transferors as a group must be in control of the corp immediately after exchange control defined by 368(c) as 80% of voting power and 80% of shares

Shareholder’s perspective
358(a)(1): Shareholder basis under 351. Basis of stock in a 351 exchange = basis of property transferred to the corp
1223(1): holding period of a 351: holding period of the transferred property carries over if the transferred property was a capital asset or a 1231 asset; otherwise holding period begins on date of exchange

Corporation’s perspective
362(a): corporation uses transferred basis for assets
1223(2): if transferred property has a basis, then holding period also carries over

Result of a 351 transfer: tax liability doubles since both corporation and shareholder will realize gain

Limitations on Transfer of Built-in Losses
If property has a net built in loss then adjusted basis is limited to fmv of transferred property. Applied on a transferor-by-transferor basis
If multiple properties with built-in loss transferred then reduction in basis is allocated among the properties in proportion to their respective built-in losses immediately before transaction. 362(e)(2)
If nontaxpayer transfers property to a taxpayer, then adjusted basis of property cannot exceed fmv. 362(e)(1)
Or, shareholder and corporation may elect to reduce shareholder’s basis in stock it receives to fmv and keep the loss in the property. 362(e)(2)(C). [often better to have basis in property over stock]
Multiple properties, follow 362(e)(2)(B), allocate loss in proportion to their respective built-in losses

B. Requirements for Nonrecognition of Gain or Loss Under 351

1. Control as defined by 368(c) and 351:

368(c): need 80% of voting power + 80% of each class of nonvoting for control

351:
“One or more persons” must act according to an integrated plan to count under 351
-components of plan need not be simultaneously executed, 351 considers whether rights of parties are previously defined and the agreement proceeds with an expedition consistent with orderly procedure. “Freedom of action” Reg 1.351-1(a)(1)
-Intermountain Lumber v. Commish Tax 1976 (if transferee has irrevocably relinquished the legal right to decide whether to keep shares then ownership under 351 is missing; finds for taxpayer that no 351 transaction occurred because transferees intended to relinquish stock, never doubted that the sale would be executed, and the sale was a key element of the incorporation transaction) (Freedom of action test is inconsistent with the word “ownership” in 368(c)) (substance vs. form, because otherwise a 351 transaction is meaningless if a transferor can presell stock but delay delivery and still qualify for 351) (Wilson and Shook could have made the transaction a true 351 if Wilson became a transferor by exchanging cash for stock in S&W)
-control present if subsequent transfer events, which relieve transferee of control, are nontaxable events. Rev Ruling 2003-51 (

2. Transfers of Property and Services

Property: cash, capital assets, inventory, accts receivable, patents, sometimes intangible assets such as industrial knowledge and nonexclusive licenses

Stock issued for services is not issued for property. 351(d)(1)
Stock issued for both property and services is counted towards 80% control. Reg 1.351-1(a)(1)(ii). Stops “accommodation transferors” by applying the following rule:
-stock will not be treated as issued for property if the primary purpose of transfer is to qualify for nonrecognition and if stock issued is of relatively small value in comparison to value of stock already owned or to be received for services. Reg 1.351-1(a)(1)(ii). Property is not of relatively small value if the fmv = 10% of stock already owned or to be received for services. Rev Procedure 77-37

From shareholder’s perspective:
If shareholder transfers property + services for stock, the services will be taxed as OI to the shareholder. The corporation can deduct the value of stock exchanged for those services as a business expense.

3. Solely for stock

Not stock rights or warrants. Reg 1.351-1(a)(1)

debt securities and nonsecurity debt are boot

Nonqualified preferred stock is boot. 351(g). Attributes on nonqualified preferred on p.69

2003-51: subsequent non-recognition transaction executed pursuant to a binding agreement doesn’t destroy 351 control (as Intermountain Lumber would suggest) if the same events could’ve been achieved tax-free.

70-140: Step 2 came before Step 1. ?Otherwise taxpayer could sell assets to publically traded corporations in tax free exchange for liquid stock

84-111: IM Lumber doesn’t apply if subsequent transfer event is nontaxable

S1 owns X
S2 wants to own 60% of X
S1 transfers 4.4 dollars in exchange for shares and S2 exchanges assets for 60%

Or S1 and S2 form a new corp, Y, which buys stock in X in exchange for Assets

Look at Boot

4. Services under 351(d)

Patent is property
What about knowledge?
What about a guarantee?

5. Transfer to a company under 351(e)

Tp1
Tp2
Tp3
Tp4
*All have concentrated positions in a company; they want to diversify, but can’t because they would recognize gain on their positions

Plan: All Tps contribute concentrated positions into company in exchange for company stock. 351(e) outlaws this exchange.

B. Boot

1. Shareholder contributes Assets to corporation

Shareholder’s perspective
351(b): recognize lesser of boot or gain, see 358
358(a)(1): Basis in stock = basis of old stock – fmv of other property + gain recognized on other property
358(a)(2): Basis in boot = fmv
351(b)(2): no loss can be recognized

Corp’s perspective:
362: Basis = basis on transferred property + gain recognized by shareholder
362(e)(2): Basis for corporation = fmv to preserve a single loss, unless you make an election otherwise

2. Shareholder contributes liabilities to corporation

Crane: basis includes money borrowed to purchase, even if loan is nonrecourse; amount realized includes assumption of liabilities

357(a): assumption of liability is not boot for purposes of computing gain
358(d): basis to shareholder = old basis – liability assumed
362: Corporation takes taxpayer’s original, carryover basis (add up basis of all the assets)
*any unrealized gain is doubled

Exceptions to 357
357(c)(1): in case of negative basis, make basis zero then count negative portion as gain
-exception: taxpayer does not recognize gain if that liability would be deductible by taxpayer because any potential income would be offset by a deduction upon payment. 357(c)(3): defines liabilities to exclude any obligation that would give rise to a deduction if paid by transferor (if liabilities exceed basis) [doesn’t count for anything to taxpayer or to corporation]
-deductibile liability: tort liability, account payable,
357(b): assumption of liability is boot if taxpayer’s principal purpose was avoidance of federal income tax or no business purpose for transaction. Otherwise taxpayer could borrow against property then contribute to corporation; same thing as corporation paying taxpayer cash directly

Avoiding 357 gain

1. contribute cash equal to excess of liabilities over adjusted basis. No 357(c) gain.
2. remain personally liable on assumed debts?
3. transfer note to corporation for excess?
Peracchi 9th 1998 (contributes encumbered assets to corporation plus promissory note, IRS argues that a taxpayer cannot manufacture basis). 1) Economic exposure so that basis = cost under 1012. 2) substance = basis a) has substance because could replicate transaction by borrowing from bank, transferring cash to corporation, then directing corporation to invest in bank; 3) no mischief likely because taxpayer exposed to genuine risk a) Taxpayer is creditworthy b) Corporation could borrow against the note to raise cash 4) If note had a zero basis weird tax consequences

P
|
S

Trade Pstock to S for Sstock. When Pstock falls, sell it. When Pstock climbs, P sells it.

Make sure to understand the following
1032
351(a)
368(c)
358(a)
362(a) & (e)
Intermountain Lumber/2003-51 [substance over form]
351(b): boot, recognize lesser of gain or boot
358(a)(1) & (2): basis
362(a) & (e): carryover + gain recognized
357(a): assumption of liability is not boot, despite Crane and Tufts
357(c): if basis is reduced to zero, but there are more liabilities then gain is realized
357(b): if principal purpose is avoidance of income tax, then cannot exploit liability boot rule
357(c)(3): deductible liabilities don’t count for the purposes of 357

Hempt Brothers
Contribute accts receivables to newly formed corporation; corporation collects receivables
Lucas doctrine: income belongs to the person who earns it; therefore, Mr. Earl cannot assign income to his wife
PG Lake: if something is a substitute for ordinary outcome, then sale of that right is also ordinary income (but this case has nothing to do with the assignment of income, only classification of income as ordinary or capital)
Holding: 351 trumps Lucas v. Earl doctrine. Assignment of income doctrine does not apply. Therefore, corporation takes substituted basis in accts recievable from transferor, which is zero.
Reasoning: receivables count as property because they can be identified, valued, and transferred.
Issue becomes what are limitations on ability to reassign income by funneling it through a 351 transaction? Two limitations:
1. 1.482-1(f)(1)(iii): if income and deductions that are linkedtogether are separated in a nonrecognition transaction, then the IRS can reallocate income between the two entities
2. Brown (lawyer contributes receivables to corporation, transfers half of stock to wife). Held: impermissible tax transaction because it’s too transparent an attempt to allocate income to avoid taxes

95-74
Liabilities that have 1) not yet given rise to capital expenditures with respect to property of transferor and 2) have not yet increased transferor’s basis are excluded under 357(c)(1) and 358(d)

?????
Normal rule: liability assumped in a purchase, where the liability is nondeductible because the existence of the liability is reflected in the corporation’s purchase price, then basis in corporation goes up with payment of liability???
95-74 rule: question whether normal, Holdcroft rule applies to known by highly contingent liabilities
???
Consider fact pattern where Multiple shareholders participate in a 351
Also consider fact pattern where shareholder contributes property s.t. liability in a 351 for 99% boot

Black and Decker
Generated capital gain; owed 560mil in employee medical liabilities, but liabilities were contingent because company could contest validity of medical procedures. Puts $561 cash and $560 million liability into a subsidiary. Takes $1 million in stock with $561 basis. Sells stock, then consolidates with subsidiary and claims deduction when subsidiary pays medical liabilities. IRS argues: curtail 95-74 to sale of a whole business, not transfer of unrelated assets and liabilities
-Result = 358(h)

Collateral Issues

1. contributions to capital
(shareholder transfers property for no consideration)
Contributoing shareholder does not recognize gain or loss on contribution of property. Instead, shareholder may increase basis in stock by amount of cash and adjusted basis of contributed property. Reg 1.118-1 -Commish v. Fink: (taxpayers surrendered stock to corporation to improve its credit rating without consideration; held: no deductible loss when surrender w/out consideration and still retain voting control of corporation)

Corp’s perspective
Contributions to capital are excluded from gross income of transferee corporation
Corpropation takes same basis as transferor’s basis. 362(a)(2)

2. Intentional avoidance of 351
1. break control of exchange with a prearranged disposition of more than 20% of stock
2. Taxable sale
Depends on whether IRS reclassifies notes into stock. In Bradshaw v. US permitted taxpayer to transfer 250k land of corporation with 8500 capital. In Burr Oaks, court ruled that two-year notes with face of 330k were actually preferred stock because the corporation was thinly capitalized with 4500 capital

Organizational and startupexpenses

Organizational: may deduct 5000 of incorporation expenses in the year of incorporation, except deduction is reduced by amount by which total organizational expenditures exceed 50k. 248(a)(1)
Otherwise, amoritized over 180 months bengining in first month of business. 248(a)(2). Similar rule for start-up expenditures, incurred after formation but before beginning business operations. 195(b)

Features of organizational expenditures (p.112)
Features of start-up expenditures (p.112)

Some items are expenses of shareholders and cannot be deducted by corporation, such as appraisal fees (expenses connected w/acquisition of stock). They must be capitalized and added to shareholder’s basis in the stock.

MIPS

Corp forms partnership with outside investors (they are the LPs); both but in cash, but LPs put in vast majority. Partnership then lends money to corporation.
Tax treatment: partnership has interest income, income flows through to investors. Corporation deducts interest on borrowing. Result: securitized debt.
Accounting purposes: debt is eliminated because Corp is a general partner
94-47 attacks MIPS, but has little power

Reverse MIPS
Declared illegal under 94-48
Investors lend money to partnership, partnership buys stock in corporation. Investment Bank acts as general partner in partnership. Corporation is a LP. Under accounting, only equity shows up, not the debt b/c corporation is a LP. Each partner gets a share of dividend income and interest deductions. For accounting purposes, this is equity. For tax purposes, this is debt (to the corporation).
Core concern is that only recourse for investors if partnership defaults is equity in corporation. At the end of the day, investors lose creditors’ rights.
Reasoning of 94-48: 1) sham transaction (but easy to avoid); 2) in substance no creditors rights; 3) should not be able to deduct interest if loan is used to purchase a tax-exempt asset

Deductible principle notes
Futures price = current price + interest
Corporation buys $100 in stock, agrees to a 1 year forward sell for $110. Equivalent to lending money. Under 1032, that interest income is tax-exempt.
Corporation then borrows money from bank and agrees to pay back $110 in one year. Gets $10 in interest deductions.
Produces $10 deduction, with no offsetting gain and with no real cash flows.
Flaw is that this eliminates earnings. Turns out that companies refrain

163(l)
If the investor is ultimately getting equity, corporation cannot take an interest deduction

Feline prides appear to have a 163 problem because note must be exchange for stock.
Feline pride: issue forward option and note together. Get around 163(l) by remarketing. IRS held that a Feline Pride combination gets a deduction, if properly structured to subvert 163(l).

Nonliquidating distributions

Read TSM liquidating carefully. Court misrepresents facts. Follow the money.

Background on nonliquidating distributions:

Corporation sends property to shareholders in exchange for nothing. Distribution v. redemption v. dividend; only certain distributions and only certain redemptions are dividends.
Basic treatment is 301(c): cuts distributions into 3 pieces
(1) dividend portion is included in gross income [always net capital gain under 1(h)(11)]
316: dividend is a distribution out of earnings and profits. Comes first out of current earnings and profits then accumulated earnings and profits.
312: informs how to make adjustments to earnings and profits. Implies that earnings and profits are proxy for accounting measure of income, corporation’s true income
(2) next portion reduces basis of stock
(3) next portion treated as gain from sale of property [if held stock for long term, then treated as long term gain, falls into the netting system which is as follows:]

| Gain | Loss | Short | Net 1 | Net 1 | Long | Net 2 | Net 2 |

Net 2 against Net 1; this gets LTCG. Result: only want to apply short term losses against short term gains

Example:

Corporation: E+P = 8; distributes 15 to shareholder

Shareholder: Has 5 basis

(summarized in slide 33)

316: E + P explored: year 1: made 100 year 2: lost 110 year 3: made 20 current E+P = 20; accumulated E + P = -10

312:
Reduce E + P by distributions; includes tax exempt include; applies straight-line depreciation; lots of accounting rules

Distrubutions of property:

Nonliquidating Distributions

A. Cash Dividends

B. Distributions of Property

Corporation’s perspective
Basis: 70; Value: 100
Old rule was general utilities: this case held that corporation did not have a realization event when it distributed property to shareholders. Corporation could not claim gain or loss. GU Rule. Rips hole in tax base. Instead of Corporation selling asset to buyer then distributing profit to shareholder, corporation distrubtes property to shareholder who then sells to buyer. Shareholder pays dividend tax then takes a fmv basis in property.
Replaced with 311.
311(a): no gain or loss on nonliquidating distribution to corp
311(b): corporation must recognize gain on nonliquidating distribution (trap for uninformed) as if property was sold to distribute
311 is applied on a property-by-property basis.
311(b)(3) prohibits stuffing properties into a new entity to circumvent property-by-property basis rule.

Effects on E+P:
-gain recognized increases E+P. 312(b) immediately
-corporation may reduce E+P by adjusted basis of property. 312(a)(3).
-On a distribution of appreciated property (other than corporation’s own debt obligations), E + P reduced by fmv of property instead of adjusted basis. 312(b)(2). But while it recognizes the gain immediately, it must wait to reduce its E + P until end of tax year. 316(a)(2).

Cannot claim a loss on a sale to a related party. 267(b). Related party is one who owns 50% of corporation.

Shareholder’s perspective:
-Amount of distribution = fmv. 301(b)
-Basis = fmv. 301(d).

C. Constructive Distributions

Kinds: 1) excessive compensation to shareholders or relatives; 2) expenses paid for personal benefit of shareholders; 3) excessive rent for corporate use of shareholder property; 4) interest on shareholder debt that in substance represents equity

Nichols North Buse
Power to dispose of income is equivalent to ownership of it and the exercise of that power to procure payment of income to another is the enjoyment and hence the realization of the income by he who exercises it

Rev Ruling 69-630
Under 482???, corporation cannot sell property for below fmv. If 482 applies, IRS may recast transaction. Under a recast, IRS must explain how its result happened. For example, the IRS may recast transaction as a constructive dividend, then a contribution of property to transferee corporation in addition to the actual transfer of property.

D. Misallocation of Dividends

DRD
243. Ownership measured by vote or value.
Dividends received by corporate shareholders
0-19.9: deduct 70% of dividends received
20-79.9 deduct 80% of divdends received
80-100: Deduct 100% if payor and recipient corporations are members of an affiliated group.

Abuse of DRD (aka dividend stripping)
Possible because E+P is a corporate level account. Dividends can be paid out to shareholders who did not hold stock when it accumulated E+P.
246(c). Must hold stock for 46 days to qualify for DRD. Regulations expand on “hold”, general rule is that corporation must be exposed to risk.
Extraordinary dividend (exceeds 10% of basis in stock). 1059. Corporation receiving extraordinary dividend must reduce its basis in stock by the amount of nontaxed portion of the dividend if corporation has held stock for 2 years or less before dividend announcement date. If basis is reduced to zero, then excess is treated as gain 1059(a)(2). -1059(e) per se extraordinary dividends

Applies to corporations
1(h)(11): convert short term capital gain to long term capital gain; imposes a 60 day holding period

264A
Corporation borrows at 12%, earns 10% dividend on stock, net tax benefit even though economic loss.
246A prohibits DRD to extent stock is debt-financed.

E. Bootstrap Acquisitions

TSN
Courts will choose substance over form.
Pre-sale dividend to TSN, buyer takes $20 basis of FMV
Buyer recapitalizes subsidiary with $80
TSN likely wins because
1. Assets that come out of subsidiary are different than assets that went in post-sale, so dividend recast doesn’t work
2. Business purpose test met

Waterman steamship doctrine
Subsidiary dividends WSS $80 note. WSS sells subsidiary for $20 to buyer against a $20 basis. Buyer lends $80 to subsidiary so that it can satisfy note.

Recast by court as $100 sale with $20 basis; $80 dividend to WSS; $80 Div to Buyer. $80 Built in Loss for Buyer per a $100 basis. (Bizzare recast to event as two taxes and an offsetting loss)

Coffey (notes in book)

Basic

Gilmore

Litton
(1) dividend and sale were substantially spaced in time
(2) at time dividend was declared no formal action had been commenced to start sale [in order for step transaction doctrine to apply either: a) binding contract test, where can only recast step 1 and step 2 if you were required to do step 2 at the time of step 1; b) mutually interedependent, where would only want to execute step 1 if would execute step 2; c) end-result test] (by introducing contingency of finding a buyer and closing the deal, court cannot apply step transaction doctrine)
(3) true business purpose (anything besides federal tax sheltering counts; sheltering state income tax is a true business purpose)

Basic

I. Redemptions

A. Statutory Overview

302:
302(a): if you meet a 302(b) test then the transfer is a sale or exchange
302(b): (2) reduction of ownership interest in business w/substantially disproportionate redemption [mechanical test for computing how much]; (3) terminating interest is always sale or exchange [intended for sales within a family]; (4) do not learn; (1) not a dividend
302(d): if 302(a) doesn’t apply, then 301 applies.

Attribution under 318(a)
(1) family: spouse, children, grandchildren, parents
(2) upstream: stock owned by partnership is treated as being owned by partners in proportion to their interest in partnership (same with trust beneficiaries) (same with corporation if person owns more than 50% of corporation, then take a proportionate share)
(3) downstream: partnership owns all the stock that its partners own without proportionality; same for trust unless beneficial interest is remote and contingent; same for corporation if you own 50% or more of corporation
(4) options: option to buy stock is counted as stock ownership

318(a)(5) attribution rules chain attribution: keep on applying attribution to maximize number of shares but not for families: no chain attribution for families which would otherwise result in sibling attribution no sidewise attribution: can’t attribute downstream then upstream (but can do up then down) chain attribution of options works through family

302(b)(2) mechanical rule for sale or exchange
302(b)(2): must satisfy the following 1. Voting interest after exchange must be less than 80% of what it was before exchange [substantially disproportionate] 2. And less than 50% of the total vote 3. Must satisfy #1 on common stock by value if more than one type of common stock [watch denominator]. Only applies to issued and outstanding stock (options may count towards total; IRS takes position in Rev R 68-601 that options only count for person doing the redeeming). T-reg: 302-3
Piggyback rule for nonvoting preferred: if redemption meets 302(b)(2) then can piggyback redemption of nonvoting preferred onto transaction.

Rev Ruling 85-14 Facts: A starts at 72%, B announces intention to leave and return stock, A redeems to 49.9%, after B leaves A floats to 61%. Reasoning: relies on 302(b)(2)(d): fails substantially disproportionate element #1 if the aggregate of a series of redemptions is not substantially disproportionate in aggregate; statutory version of step-transaction doctrine; (ruling and regulations direct this redemption also fails the 50% test, but Weisbach says that ruling’s analysis makes it clear that it should not apply to 50% test.

302(b)(3): complete termination

302(c)(2) waiver – when does waiver need to be executed???

Lynch
Father’s stock in corporation is redeemed. Enters into consulting agreement with corporation to provide services. Held: providing consulting services to corporation is a prohibited interest.

302(b)(1) – Not essentially equivalent to a dividend

Common law

Davis
Taxpayer + Bradley own a corporation. Corporation needs to issue more equity to get a loan. Bradley contributes $25k to corporation for preferred stock. Corporation redeems preferred stock for $25k. Lower court holds for taxpayer that redemption was a sale or exchange because there was a good business purpose for transaction. Supreme court holds against taxpayer: 1) attribution rules apply; 2) redemption of sole shareholder is always a dividend, never a sale or exchange; 3) business purpose is irrelevant; 4) test for whether something is not essentially equivalent to a dividend: meaningful reduction in ownership

75-502
Estate has 250 shares, beneficiary has 750 shares, unrelated shareholder has 750 shares. Estate is redeemed. 302(b)(1)? Applies Himmel factors: 1) voting control; 2) rt to earnings; 3) rt to assets upon liquidation. Estate wins under Himmel, because lost voting control of entire company. Clear that 302(b)(1) compares shareholder against remaining shareholders

75-512
Son’s ownership goes from 300/1000 to 225/925 as trust redeems stock. Grandfather owns 625/1000 shares. Qualifies as a meaningful reduction because trust was a minority interest that took no part in management of corporation. Hard to know how much needs to be redeemed to qualify as a meaningful reduction under Himmel factors. Redemption of small minority shareholders, remote from management should count under 302(b)(1). If not remote from management, then trickier case.

85-106
A: 19, B: 19, C: 18, Small shareholders: 44.
Nonvoting stock held in same proportions.
C’s nonvoting stock held in trust
6/9 of trust’s nonvoting shares redeemed.
Not meaningful reduction for C because no change in Himmel factors. Ability to make choices for corporation stays the same.

76-385
Any redemption from a public company is meaningful for a small shareholder.

78-401
Loss of supermajority voting power is not important unless extraordinary corporate action is imminent.

80-26
Family discord does not defeat attribution, although may help 302(b)(1) argument.

77-426
Redemption of shareholder owning only nonvoting stock is meaningful.

Monday: do consequences to distributing + planning techniques

Planning techniques

Zenz

Z sells stock to Buyer
Corp then redeems Z’s remaining stocks

Bootstrap Acquisitions

Buyer wants to purchase target using $70 of its own cash and $30 of target’s cash; target has fmv of $100, high large e&p

Types of recasts:
1. Pre-sale dividend to seller (TSN, Litton)
-$30 div to seller
-$50 gain to seller
-buyer takes a $70 basis
2. Post-sale redemption of seller (Zenz)
-$80 gain
-buyer takes a $70 basis
3. Post-sale dividend to buyer (Waterman SS, 69-608)
-$80 gain to seller
-buyer takes a $100 basis
-buyer takes a $30 dividend
-buyer has a $30 built-in-loss

How to tell which kind taxpayer qualifies for
1. TSN and Litton look at business purpose [nontax reasons for configuring transaction]
2. IRS interpretation in 75-447 (IRS will assess before and assess after the transaction is complete, intermediate steps don’t matter) [get around 75-447 by waiting enough time in between steps to make the steps separate transactions; introduce real intervening contingencies] [also strange that 75-447 allows a dilution event by a 3p to play into redemption] [or 75-447 says that as long as form is reasonable, then it’s permissible. Zenz was smart enough to structure transaction as a redemption.]

???69-608: If and only if A has an unconditional obligation and corporation performs it for him, then A is deemed to have received a constructive distribution

Situation 1: ????
A and B are unrelated; they have a joint venture; If B leaves company, A must buy B out. In Situation 1, the company, X, buys out B instead.
Held: constructive distribution to A, then A buys out B’s stock (WSS recast): double tax + enhanced basis
-result: recast distribution that relieves A of obligation to purchase B’s stock; if and only if buyer has an unconditional obligation to purchase stock
-this holding only works with two shareholders; with more than two shareholders the ownership proportions don’t work out
-should’ve been recast as A purchasing B’s stock, then a redemption of A
-theory in ruling is that to undertake a fmv transaction, would have to pay a person value of fmv transaction, which is wrong.
-get around ruling by assigning A’s obligation to purchase B’s shares to X for nominal amount.
-ruling is wrong because unconditional doesn’t correspond to value; could be unconditional for value or unconditional for negative value

???Situation 3:

A and B are both beneficiaries of trust
Trust owns X
If buyer is already beneficial owner, then cannot have distribution to seller

Many articles on this topic

Shelters

Background
T-reg 1.302-2(c): after a redemption is recast as a dividend, TP’s basis in remaining stock is adjusted. (if H is completely redeemed, W gets H’s basis; if H is incompletely redeemed then H’s old basis is distributed amongst remaining shares) (Anytime basis shifts across entities, there is a tax shelter opportunity because a tax-exempt entity can give basis to taxable entity)

1059(e)(1)(A)(ii): per se extraordinary dividends; any redemption that is not pro-rata among shareholders is per-se extraordinary

Seagram Transaction

Seagram downs 24.2% of DuPont; rest owned by Public; Seagrams has a low basis in DuPont stock

DuPont redeems Seagram’s stock until Seagram’s only owns 1.2%. DuPont writes a $500m warrant to Seagram’s to buy all of those DuPont shares back. European style options. DuPont has right of first refusal to buy out Seagram’s options if Seagram attempts to exercise or sell them.

Seagrams wants a dividend; fails 302 tests because it has warrants to repurchase stock;

Reasons for Seagrams to be concerned: 802(b)(1): meaningful reduction because Seagrams has lost control of company; but under 318 must pretend that options have been exercised. So company has a good case for a distribution.

Then, under 1059(e)(1)(A)(ii) Seagram’s basis is reduced by value of DRD (8.3 B dividend – 6.64B DRD = 1.66B in taxable income) old basis = 3B – 6.64B = -3.64B basis. Negative basis was permitted at the time.

Govt responded by amending 1059 to eliminate suspense accounts (negative basis); when basis goes to zero start recognizing gain [economically identical to turning off DRD] [instead, could have amended 302 attribution to push corporations toward sale or exchange]

Reddam OPIS
Economic Substance doctrine: codified 7701(o): 1. Objective prong (whether transaction had an economic effect on TP – often measured by whether TP had profit potential or whether TP cost effectively reduced risk exposure); 2. Subjective (TP has a nontax purpose for entering into transaction)

A. Objective Inquiry
-TC rejects IRS testimony that transaction had negative NPV as decisive b/c 1) otherwise would destroy tax planning since all tax planning involves taking a lower rate of return on investment in exchange for tax benefit; 2) doesn’t take into account possibility of making profit

Proposed regulations to remedy Reddam OPIS (near slide 72)
-Case A: A holds 100 shares in corp; 25 were bought for $25; 75 have a basis of $175; E+P = 100 [separate basis in each share] 301 Dividend distribution of 2 per share; must apply dividend proportionally across blocks of shares. TP takes a $25 gain and still has $25 in basis.
-Case B: 302 Redemption. H and W each own 100 shares with 100 basis. Corporation has 80 E+P. H is redeemed for $80. Under old regulations, wife picks up H’s basis; under new regulations H takes a deferred loss, can claim loss whenever his ownership fails under 302? 301?(b)(1), (2) or (3). All attributes and characteristics of loss are determined on day of redemption and held constant. If less than all of H’s shares are redeemed, then basis flows to remaining shares. This makes complete vs. partial redemption inconsistent b/c H must wait until wife sells to take loss if fully redeemed, but can take loss immediately by selling share if only partially redeemed

start w/304 attribution rules. 318 rules apply in a modified way.

Intent of 304:

A owns X and Y; Y buys X stock from A; Without 304, A gets capital gains treatment and basis

Overview:
(a)(1): normal
(a)(2): unusual

(b): operating rules

(c): path to 304 treatment control: 304(c)(1): owning 50% of total combined voting power of corp or 50% of combined value apply modified 318 attribution rules for -modified: for upstream attribution, 50% limitation on upstream attribution for corporation changes to 5%.
Same for downstream. Also for downstream, pro rata rule if 5-50 control.
Also, “control of control” rule???
Finally, any stock acquired in transaction counts for computing control
Sidewise: can’t go down then up, but up then down is OK

304(a)(2)
A – 100 - X – 100 – Y; Y buys 51% of X from A.
Result: A – 49 – X Y – 51 – X X – 100 – Y

How much of X does A own? Under 304(a)(2), treat purchase as a redemption of X’s stock. Apply 302(b) to determine treatment of the redemption.
A keeps old basis in X
Y’s basis in X stock is fmv.

304(a)(1) – read for monday

A is in control of P and T
P acquired T stock from A in return for property
Now 304(a) applies
Corporations are treated as partnerships
Look at A’s interest in issuing to test whether 301 or 302 applies to the eventual redemption of P stock
If 301 appplies, then Dividend Distribution under 301 to extent that either P or T has E+P (do acquirer first).
Tax according to this rule: pretend that A contributes T stock to P in exchange for P stock (taxed under 351(a)). P gets a carry over basis in T stock under 362(a). A takes basis in P stock under 358(a) = A’s basis in T stock contributed. Then A’s new P stock is auto-redeemed. A’s basis shifts over to remaining P stock
Proposed regulation: 1.302-5: non-pro rata redemption that is treated as a distribution under 301, apply A’s basis in all of P’s shares before recognizing gain
304’s tax advantage is to deny P a stepped up basis in T b/c A’s gain only comes from redemption of P stock but not 351. Allocate revenue proportionally across all stock, so some blocks of stock may have different gains.
If it’s a 304 transaction to which 302 applies; treat it as a 302 redemption where A’s fictional stock in P has the same basis and character as A’s stock in T. 1.304-2.

Slide 87 Cross-Chain purchases

A owns P and S
S owns T
P buys T from S for $300
304 Transaction b/c S is in control of P and T
Before transaction S owns 100% of T; after transaction S still owns 100% of T
Therefore, qualifies as a 301 distribution
Recast: S contributes T stock to P for fictional P stock
S takes a carryover basis in fictional P stock of $100 under 358(a)(1)
P’s basis in T stock is also $100 under 362(a)
P redeems its fictional stock for $300, giving S a $300 dividend
S gets a DRD of either 70% or 100%
1059(e)(1)(a)(iii)(II) applies, making transfer a per se extraordinary dividend
Reduce basis to 0; S recognizes $200 of gain.
Only consequence is to deny P a stepped up basis
If, counterfactually, S had a loss on T, then P’s basis in T is fmv; S has a basis of $100 in nonexistent stock. 1.302-2(c) would say that S’s basis shifts to A’s stock in P. Under proposed regulations, S has a deferred loss that it may take whenever conditions of 302(b) are met as between S and P. Can make an election under 362(e) to move basis. Or S can purchase one share of P before transaction and then sell that share after the transaction for the loss.
In loss context, main effect of 304 is to defer loss. But this is strange b/c 267 already bars recognizing losses in transactions to related parties.

304/351(b) Overlap in slides 91-93

A owns T; Basis 1000; Value 2000
A owns 100 shares of P with basis $1000
B owns 30 shares of P.
T has EP of 800; P has EP of 0
A contributes T to P for 50 shares in P and $1000 cash
Both 351 and 304 apply
A’s receipt of real P stock is a 351; A’s receipt of boot is a 304 under 304(b)(3). [under 317(a) P stock is not property].
Divide A’s basis in T up; pro-rata share goes to 351 transaction; pro-rata share goes to 304 transaction.
A: 100 old shares with basis 1000; 50 new shares with basis 500
P: ½ of P’s stock in T has a basis of $500
Other half of transaction:
P: other half of P’s stock in T also has a basis of $500 under carryover basis rules
A gets fictional P stock with a basis of $500, which is immediately redeemed under 301
$800 dividend to A; A has a $200 ROB, which is applied pro-rata to all of A’s stock in P. A gets a $1 basis reduction in each share.
Fictional stock’s extra basis shifts pro-rata to other shares. Each other share gets a $3 basis increase under 1.302-5 proposed reg.

305(b)(2):

limitations 1. Must be taxed as a 301; 2. Isolated rule

Slide 97: 1.305-3(e)(example 2); subordination of classes matter

305(b)(2) blows up event for all classes

Rev Ruling 78-60
-First analyze whether distribution is a 301 or 302. If 301, then should worry about whether remaining shareholders get taxed

Chamberlin

Preferred stock distribution, pro rata to all shareholders. Then, sell preferred stock to 3p for cash. 7 years later 3p is redeemed out, pursuant to a plan.

306. Distribution of preferred stock is still tax-free. But tax-free preferred stock, if sold, is taxed as OI backdated to time preferred stock was received.

Liquidations

Shareholder taxed under 331 + 334. Under 331, Shareholder is taxed as if he sold his stock. Under 334, Shareholder takes fmv basis in each piece of property. Under 336, corporation recognizes gain and loss on each distribution of property

If Sub liquidates into parent, 332 and 337 apply. And Under 334, parent inherits sub’s basis in assets

Court Holding

Agrees to sale of all assets to buyers. Call off sale, instead liquidate apt building to shareholders and then shareholders sell to buyer.
Recast as sale then liquidation

Cumberline Public Service
Buyer offers to buy Seller’s equipment, which it rejects. Seller then distributes to shareholders, who negotiate a sale with Buyer.
TP wins; court honors form of transaction
Difference is that offer was rejected, which was a factual matter determined by trial court. Made liquidation followed by sale single taxed, whereas sale followed by liquidation was double taxed.

Old 337: overturns Court Holding by providing that on liquidation or sale followed by liquidation, corporation recognizes no gain

General Utilities Repeal: alive and affects current transactions
1. Meaningless distinction between liquidation and nonliquidation
2. Incumbents v. acquirer [advantage for acquirers because acquirer could get a stepped up basis, which would give depreciation tax benefits, acquirer could get those benefits for cheap because transaction was single taxed]
3. Undermined corporate tax by granting a permanent exemption to corporate tax [but no baseline to measure assumption from]
4. Complexity from policing when a liquidation occurred

Legislative history on p.330 and actual liquidation rules in 331 + 336 and slide 103.

Under 267, cannot claim a loss on a sale to a related party; but on liquidation, they can

Current law
Simple liquidation: corporation recognizes gain/loss on its assets under 336; shareholders pay tax on their portion of gain under 331; shareholders take fmv basis on property under 334(a).

336(d)(1): Distributing to related party and either non-pro rata distribution or acquired under 351 under 336(d)(1) then denies corporation a loss on the distribution -get around with sale then leaseback -get around by distributing disqualified property to a nonrelated party -cannot get around with 1031 like kind exchange because basis in new property is determined by reference to exchanged property’s basis

336(d)(2): Applies to any shareholder; denies corporation a loss on the distribution if property was acquired as part of a plan, principal purpose of which was to gain a loss on liquidation -this provision is nonsensical given 362(e)

Parent-Sub liquidations

Parent is determined by 1504(a)(2): 80% of the vote and value, excluding plain vanilla preferred stock [this is debt]

If S liquidates into P, then under 332, P recognizes no gain or loss. S recognizes no gain or loss under 337.

Under 334(b), P takes S’s basis in S’s assets, not P’s basis in S stock. P’s basis in S stock disappears. Consequently, big difference between parent acquiring target’s assets vs. parent acquiring target’s stock

Under 336(d), subsidiary cannot take loss on property distributed to minority shareholder in a parent-sub liquidation

P owns 90% of Y, A is minority shareholder

Under 337(b), no gain or loss on distribution of property in satisfaction of debt to Y. P is taxed on gain or loss on debt.

To extent Y distributes property to A, but Y recognizes gain but not loss under 336(d)(3). A recognizes gain and loss on distribution.

No gain or loss to P on distribution of property from Y. Under 332. P takes a fmv basis in property under 334(b).

X inherits Y’s E+P and other attributes.

Riggs.
Riggs – RiggsYoung – s1 and s2
Minorities – RiggsYoung
Plan is to liquidate RiggsYoung into Riggs.
First, liquidate subsidiaries into RiggsYoung.
On 12/13/67 notify minority shareholders of sale
On 12/29/67 they sell
On 2/68 they redeem preferred stock
On 4/68 they liquidate subs
On 5/68 tender for minorities, increasing Riggs’ interestest in Riggs-Young to 95.6% from below 80%
On 6/68, they adopt a plan for liquidation
IRS
Held: Measure 80% when formally adopt liquidation plan; can rearrange before then
Result: 331/337 is essentially elective; economic substance is basically irrelevant.

Mirror Subsidiary Technique

Acquirer wants to bust up Target with no tax. Target owns Wanted and Unwanted subsidiaries.
Acquirer forms Wanted and Unwanted subsidiaries, both with cash. They jointly make a tender offer for Target stock
Liquidate target, sending wanted to wanted and unwanted to unwanted
Take position that the liquidation of target falls under 332/337 parent-sub rules
Take position that 80% ownership applies jointly to W and UW.
UW has a 40 basis in UW; W has a 40 basis in W
Acquirer sells UW for value 100, basis 100. No gain or loss.
Result: bust up advantage for acquirer.
Issue: is this event inconsistent with GU repeal? (advantage to acquirer, but doesn’t get rid of double corporate tax)
Result: Congress enacts 337(c): 80% ownership made without regard to consolidated returns. T is taxed under 336. W and UW are taxed under 332 because 337(c) doesn’t apply to 332. Takes middle road.