how does the assignment of income doctrine apply to a sec 351 exchange

Battling Uphill Against the Assignment of Income Doctrine: Ryder

Benjamin Alarie

Kathrin Gardhouse

Benjamin Alarie is the Osler Chair in Business Law at the University of Toronto and the CEO of Blue J Legal Inc. Kathrin Gardhouse is a legal research associate at Blue J Legal .

In this article, Alarie and Gardhouse examine the Tax Court ’s recent decision in Ryder and use machine-learning models to evaluate the strength of the legal factors that determine the outcome of assignment of income cases.

Copyright 2021 Benjamin Alarie and Kathrin Gardhouse . All rights reserved.

I. Introduction

Researching federal income tax issues demands distilling the law from the code, regulations, revenue rulings, administrative guidance, and sometimes hundreds of tax cases that may all be relevant to a particular situation. When a judicial doctrine has been developed over many decades and applied in many different types of cases, the case-based part of this research can be particularly time consuming. Despite an attorney’s best efforts, uncertainty often remains regarding how courts will decide a new set of facts, as previously decided cases are often distinguished and the exercise of judicial discretion can at times lead to surprises. To minimize surprises as well as the time and effort involved in generating tax advice, Blue J ’s machine-learning modules allow tax practitioners to assess the likely outcome of a case if it were to go to court based on the analysis of data from previous decisions using machine learning. Blue J also identifies cases with similar facts, permitting more efficient research.

In previous installments of Blue J Predicts, we examined the strengths and weaknesses of ongoing or recently decided appellate cases, yielding machine-learning-generated insights about the law and predicting the outcomes of cases. In this month’s column, we look at a Tax Court case that our predictor suggests was correctly decided (with more than 95 percent confidence). The Ryder case 1 has received significant attention from the tax community. It involved tax avoidance schemes marketed by the law firm Ernest S. Ryder & Associates Inc. (R&A) that produced more than $31 million in revenue between 2003 and 2011 and for which the firm reported zero taxable income. The IRS unmasked more than 1,000 corporate entities that R&A’s owner, Ernest S. Ryder , had created and into which he funneled the money. By exposing the functions that these entities performed, the IRS played the most difficult role in the case. Yet, there are deeper lessons that can be drawn from the litigation by subjecting it to analysis using machine learning.

In this installment of Blue J Predicts, we shine an algorithmic spotlight on the legal factors that determine the outcomes of assignment of income cases such as Ryder . For Ryder , the time for filing an appeal has elapsed and the matter is settled. Thus, we use it to examine the various factors that courts look to in this area and to show the effect those factors have in assignment of income cases. Equipped with our machine-learning module, we are able to highlight the fine line between legitimate tax planning and illegitimate tax avoidance in the context of the assignment of income doctrine.

II. Background

In its most basic iteration, the assignment of income doctrine stands for the proposition that income is taxed to the individual who earns it, even if the right to that income is assigned to someone else. 2 Courts have held that the income earner is responsible for the income tax in the overwhelming majority of cases, including Ryder . It is only in a small number of cases that courts have been willing to accept the legitimacy of an assignment and have held that the assignee is liable for the earned income. Indeed, Blue J ’s “Assigned Income From Services” predictor, which draws on a total of 242 cases and IRS rulings, includes only 10 decisions in which the assignee has been found to be liable to pay tax on the income at issue.

The wide applicability of the assignment of income doctrine was demonstrated in Ryder , in which the court applied the doctrine to several different transactions that occurred between 1996 and 2011. Ryder founded his professional law corporation R&A in 1996 and used his accounting background, law degree, and graduate degree in taxation for the benefit of his clients. R&A designed, marketed, sold, and administered six aggressive tax-saving products that promised clients the ability to “defer a much greater portion of their income than they ever dreamed possible, and, as a result, substantially reduce their tax liability.” 3 In 2003 the IRS caught on to Ryder ’s activities when his application to have 800 employee stock option plans qualified at the same time was flagged for review. A decade of investigations and audits of Ryder and his law firm spanning from 2002 to 2011 followed.

What is interesting in this case is that Ryder , through his law firm R&A, directly contracted with his clients for only three of the six tax-saving products that his firm designed, marketed, and sold (the stand-alone products). The fees collected by R&A from two of the stand-alone products were then assigned to two other entities through two quite distinct mechanisms. For the other three tax-saving products, the clients contracted — at least on paper — with other entities that Ryder created (the group-tax products). Yet, the court treated the income from all six tax-saving products identically. The differences between the six types of transactions did not affect the outcome of the case — namely, that it is R&A’s income in all six instances. Blue J ’s predictor can explain why: The factors that our predictor highlights as relevant for answering the question whether the assignment of income doctrine applies have less to do with the particular strategy that the income earner conjures up for making it look like the income belongs to someone else, and more to do with different ways of pinpointing who actually controls the products, services, and funds. In Ryder , the choices ultimately come down to whether that is R&A or the other entity.

We will begin the analysis of the case by taking a closer look at two of the six tax-saving products, paying particular attention to the flow of income from R&A’s clients to R&A and Ryder ’s assignment of income to the other entities. We have selected one of the tax-saving products in which Ryder drew up an explicit assignment agreement, and another one in which he tried to make it look like the income was directly earned by another entity he had set up. Regardless of the structures and means employed, the court, based on the IRS ’s evidence, traced this income to R&A and applied the assignment of income doctrine to treat it as R&A’s income.

This article will not cover in detail the parts of the decision in which the court reconstructs the many transactions Ryder and his wife engaged in to purchase various ranches using the income that had found its way to R& A. As the court puts it, the complexity of the revenues and flow of funds is “baroque” when R&A is concerned, and when it comes to the ranches, it becomes “ rococo .” 4 We will also not cover the fraud and penalty determinations that the court made in this case.

III. The Tax Avoidance Schemes

We will analyze two of the six schemes discussed in the case. The first is the staffing product, and the second is the American Specialty Insurance Group Ltd. (ASIG) product. Each serves as an example of different mechanisms Ryder employed to divert income tax liability away from R&A. In the case of the staffing product, Ryder assigned income explicitly to another entity. The ASIG product involved setting up another entity that Ryder argued earned the income directly itself.

A. The Staffing Product

R&A offered a product to its clients in the course of which the client could lease its services to a staffing corporation, which would in turn lease the client’s services back to the client’s operating business. The intended tax benefit lay “with the difference between the lease payment and the wages received becoming a form of compensation that was supposedly immune from current taxation.” 5 At first, the fees from the staffing product were invoiced by and paid to R&A. When the IRS started its investigation, Ryder drew up an “Agreement of Assignment and Assumption” with the intent to assign all the clients and the income from the staffing product to ESOP Legal Consultants Inc. ( ELC ). Despite the contractual terms limiting the agreement to the 2004-2006 tax years, Ryder used ELC ’s bank account until 2011 to receive fees paid by the various S corporations he had set up for his clients to make the staffing product work. R&A would then move the money from this bank account into Ryder ’s pocket in one way or another. ELC had no office space, and the only evidence of employees was six names on the letterhead of ELC indicating their positions. When testifying in front of the court, two of these employees failed to mention that they were employed by ELC , and one of them was unable to describe the work ELC was allegedly performing. Hence, the court concluded that ELC did not have any true employees of its own and did not conduct any business. Instead, it was R&A’s employees that provided any required services to the clients. 6

B. The ASIG Product

R&A sold “disability and professional liability income insurance” policies to its clients using ASIG, a Turks and Caicos corporation that was a captive insurer owned by Capital Mexicana . Ryder had created these two companies during his previous job with the help of the Turks and Caicos accounting firm Morris Cottingham Ltd. The policies Ryder sold to his clients required them to pay premiums to ASIG as consideration for the insurance. The premiums were physically mailed to R& A. Also , the clients were required to pay a 2 percent annual fee, which was deposited into ASIG’s bank account. In return, the clients received 98 percent of the policy’s cash value in the event that they became disabled, separated from employment, turned 60, or terminated the policy. 7

R&A’s involvement in these deals, aside from setting up ASIG, was to find the clients who bought the policies, assign them a policy number, draft a policy, and open a bank account for the client, as well as provide legal services for the deal as needed. It was R&A that billed the client and that ensured, with Morris Cottingham ’s help, that the fees were paid. R&A employees would record the ASIG policy fee paid by the clients, noting at times that “pymt bypassed [R&A’s] books.” 8 Quite an effort went into disguising R&A’s involvement.

First, there was no mention of R&A on the policy itself. Second, ASIG’s office was located at Morris Cottingham’s Turks and Caicos corporate services. Ryder also set up a post office box for ASIG in Las Vegas. Any mail sent to it was forwarded to Ryder . Third, to collect the fees, R&A would send a letter to Morris Cottingham for signature, receive the signed letter back, and then fax it to the financial institution where ASIG had two accounts. One of these was nominally in ASIG’s name but really for the client’s benefit, and the other account was in Ryder ’s name. The financial institution would then move the amount owed in fees from the former to the latter account. Whenever a client filed for a benefit under the policy, the client would prepare a claim package and pay a termination fee that also went into the ASIG account held in Ryder ’s name. The exchanges between the clients and ASIG indicate that these fees were to reimburse ASIG for its costs and services, as well as to allow it to derive a profit therefrom. But the court found that ASIG itself did nothing. Even the invoices sent to clients detailing these fee payments that were on ASIG letterhead were in fact prepared by R&A. In addition to the annual fees and the termination fee, clients paid legal fees on a biannual basis for services Ryder provided. These legal fees, too, were paid into the ASIG account in Ryder ’s name. 9

IV. Assignment of Income Doctrine

The assignment of income doctrine attributes income tax to the individual who earns the income, even if the right to that income is assigned to another entity. The policy rationale underlying the doctrine is to prevent high-income taxpayers from shifting their taxable income to others. 10 The doctrine is judicial and was first developed in 1930 by the Supreme Court in Lucas , a decision that involved contractual assignment of personal services income between a husband and wife. 11 The doctrine expanded significantly over the next 20 years and beyond, and it has been applied in many different types of cases involving gratuitous transfers of income or property. 12 The staffing product, as of January 2004, involved an anticipatory assignment of income to which the assignment of services income doctrine had been held to apply in Banks . 13 The doctrine is not limited to situations in which the income earner explicitly assigns the income to another entity; it also captures situations in which the actual income earner sets up another entity and makes it seem as if that entity had earned the income itself, as was the case with the ASIG product. 14

In cases in which the true income earner is in question, the courts have held that “the taxable party is the person or entity who directed and controlled the earning of the income, rather than the person or entity who received the income.” 15 Factors that the courts consider to determine who is in control of the income depend on the particular situation at issue in the case. For example, when a personal services business is involved, the court looks at the relationship between the hirer and the worker and who has the right to direct the worker’s activities. In partnership cases, the courts apply the similarity test, asking whether the services the partnership provided are similar to those the partner provided. In other cases, the courts have inquired whether an agency relationship can be established. In yet other cases the courts have taken a broad and flexible approach and consulted all the available evidence to determine who has the ultimate direction and control over the earnings. 16

V. Factors Considered in Ryder

Judge Mark V. Holmes took a flexible approach in Ryder . He found that none of the entities that Ryder papered into existence had their own office or their own employees. They were thus unable to provide the services Ryder claims they were paid for. In fact, the entities did not provide any services at all — the services were R&A’s doing. To top it off, R&A did nothing but set up the entities, market their tax benefits, and move money around once the clients signed up for the products. There was no actual business activity conducted. The court further found that the written agreements the clients entered into with the entities that purported to provide services to them were a sham and that oral contracts with R&A were in fact what established the relevant relationship, so that R&A must be considered the contracting party. In the case of the ASIG product, for example, a client testified that the fees he paid to Ryder were part of his retirement plan. Ryder had represented to him that the ASIG product was established to create an alternative way to accumulate retirement savings. 17

Regarding the staffing product in which there existed an explicit assignment of income agreement between R&A and ELC , the court found that ELC only existed on paper and in the form of bank accounts, with the effect that R&A was ultimately controlling the income even after the assignment. A further factor that the court emphasized repeatedly was that R&A, and Ryder personally as R&A’s owner, kept benefitting from the income after the assignment (for example, in the staffing product case) or, as in the case of the ASIG product, despite the income allegedly having been earned by a third party (that is, ASIG). 18

VI. Analysis

The aforementioned factors are reflected in Blue J ’s Assigned Income From Services predictor. 19 We performed predictions for the following scenarios:

the staffing product and R&A’s assignment of the income it generated to ELC with the facts as found by the court;

the staffing product and R&A’s assignment of the income it generated to ELC if Ryder ’s version of the facts were accepted;

the ASIG product and service as the court interpreted and characterized the facts; and

the ASIG product and service according to Ryder ’s narrative.

What is interesting and indicative of the benefits that machine-learning tools such as Blue J ’s predictor can provide to tax practitioners is that even if the court had found in Ryder ’s favor on all the factual issues reasonably in dispute, Ryder would still not have been able to shift the tax liability to ELC or ASIG respectively, according to our model and analysis.

The court found that R&A contracted directly with, invoiced, and received payments from its clients regarding the staffing product up until 2004, when Ryder assigned the income generated from this product explicitly to ELC . From then onward, ELC received the payments from the clients instead of R&A. Further, the court found that ELC did not have its own employees or office space and did not conduct any business activity. Our data show that the change in the recipient of the money would have made no difference regarding the likelihood of R&A’s liability for the income tax in this scenario.

According to Ryder ’s version of the facts, ELC did have its own employees, 20 even though there is no mention of a separate office space from which ELC allegedly operated. Yet, Ryder maintains that ELC was the one providing the staffing services to its clients after the assignment of the clients to the company in January 2004. Even if Ryder had been able to convince the court of his version of the facts, it would hardly have made a dent in the likelihood of the outcome that R&A would be held liable for the tax payable on the income from the staffing product.

With Ryder ’s narrative as the underlying facts, our predictor is still 94 percent confident that R&A would have been held liable for the tax. The taxation of the income in the hands of the one who earned it is not easily avoided with a simple assignment agreement, particularly if the income earner keeps benefiting from the income after the assignment and continues to provide services himself without giving up control over the services for the benefit of the assignee. The insight gained from the decision regarding the staffing product is that the court will take a careful look behind the assignment agreement and, if it is not able to spot a legitimate assignee, the assignment agreement will be disregarded.

The court made the same factual findings regarding the ASIG product as it did for the staffing product post-assignment. Ryder , however, had more to say here in support of his case. For one, he pointed to ASIG’s main office that was located at the Morris Cottingham offices. Morris Cottingham was also the one that, on paper, contracted with clients for the insurance services and the collection of fees was conducted, again on paper, in the name of Morris Cottingham . The court also refers to actual claims that the clients made under their policies. There is also a paper trail that indicates that the clients were explicitly acknowledging and in fact paying ASIG for its costs and services. From all this we can conclude that Ryder was able to argue that ASIG had its own independent office, had one or more employees providing services, and that ASIG engaged in actual business activity. However, even if these facts had been admitted as accurately reflecting the ASIG product, our data show that with a 92 percent certainty R&A would still be liable for the income tax payable on the income the ASIG product generated. It is clear that winning a case involving the assignment of income doctrine on facts such as the ones in Ryder is an uphill battle. If the person behind the scenes remains involved with the services provided without giving up control over them, and benefits from the income generated, it is a lost cause to argue that the assignment of income doctrine should be applied with the effect that the entity that provides the services on paper is liable for the income tax.

C. Ryder as ASIG’s Agent

Our data reveal that to have a more substantial shot at succeeding with his case under the assignment of income doctrine, Ryder would have had to pursue a different line of argument altogether. Had he set R&A up as ASIG’s agent rather than tried to disguise its involvement with the purported insurance business, Ryder would have been more likely to succeed in shifting the income tax liability to ASIG. For our analysis of the effect of the different factors discussed by the court in Ryder , we assume at the outset that Ryder would do everything right — that is, ASIG would have its own workers and office, and it would do something other than just moving money around (best-case scenario). We then modify each factor one by one to reveal their respective effect.

From this scenario testing, we can conclude that if R&A had had an agency agreement with ASIG, received some form of compensation for its services from ASIG, held itself out to act on ASIG’s behalf, and the client was interested in R&A’s service because of its affiliation with ASIG, Ryder would have reduced the likelihood to 73 percent of R&A being liable for the income tax. Add to these agency factors an element of monitoring by ASIG and the most likely result flips — there would be a 64 percent likelihood that ASIG would be liable for the income tax. If ASIG were to go beyond monitoring R&A’s services by controlling them too, the likelihood that ASIG would be liable for the income tax would increase to 82 percent. Let’s say Ryder had given Morris Cottingham oversight and control over R&A’s services for ASIG, then the question whether ASIG employs any workers other than R&A arguably becomes moot because there would necessarily be an ASIG employee who oversees R&A. Accordingly, there is hardly any change in the confidence level of the prediction that ASIG is liable for the income tax when the worker factor is absent.

Interestingly, this is quite different from the effect of the office factor. Keeping everything else as-is, the absence of having its own ASIG-controlled office decreases the likelihood of ASIG being liable to pay the income tax from 82 to 54 percent. Note here that our Assigned Income From Services predictor is trained on data from relatively old cases; only 14 are from the last decade. This may explain why the existence of a physical office space is predicted to play such an important role when the courts determine whether the entity that allegedly earns the income is a legitimate business. In a post-pandemic world, it may be possible that a trend will emerge that puts less emphasis on the physical office space when determining the legitimacy of a business.

The factor that stands out as the most important one in our hypothetical scenario in which R&A is the agent of ASIG is the characterization of ASIG’s own business activity. In the absence of ASIG conducting its own business, nothing can save Ryder ’s case. This makes intuitive sense because if ASIG conducts no business, it must be R&A’s services alone that generate the income; hence R&A is liable for the tax on the income. Also very important is the contracting party factor: If the client were to contract with R&A rather than ASIG in our hypothetical scenario, the likelihood that R&A would be held liable for the income tax is back up to 72 percent, all else being equal. If the client were to contract with both R&A and ASIG, it is a close case, leaning towards ASIG’s liability with 58 percent confidence. Much less significant is who receives the payment between the two. If it is R&A, ASIG remains liable for the income tax with a likelihood of 71 percent, indicating a drop in confidence by 11 percent compared with a scenario in which ASIG received the payment.

To summarize, if Ryder had pursued a line of argument in which he set up R&A as ASIG’s agent, giving ASIG’s employee(s) monitoring power and ideally control over R&A’s services for ASIG, he would have had a better chance of succeeding under the assignment of income doctrine. As we have seen, the main prerequisite for his success would have been to convince the court that it would be appropriate to characterize ASIG as conducting business. Ideally, Ryder also would have made sure that the client contracted for the services with ASIG and not with R&A. However, it is significantly less important that ASIG receives the money from the client. The historical case law also suggests that Ryder would have been well advised to set up a physical office for ASIG; however, given the new reality of working from home, this factor may no longer be as relevant as these older previously decided cases indicate.

VII. Conclusion

We have seen that R&A’s chances to shift the liability for the tax payable on the staffing and the ASIG product income was virtually nonexistent. The difficulty of this case from the perspective of the IRS certainly lay in gathering the evidence, tracing the money through the winding paths of Ryder ’s paper labyrinth, and making it comprehensible for the court. Once this had been accomplished, the IRS had a more-or-less slam-dunk case regarding the applicability of the assignment of income doctrine. As mentioned at the outset, an assignment of income case will always be an uphill battle for the taxpayer because income is generally taxable to whoever earns it.

Yet, in cases in which the disputed question is who earned the income and not whether the assignment agreement has shifted the income tax liability, the parties must lean into the factors discussed here to convince the court of the legitimacy (or the illegitimacy, in the case of the government) of the ostensibly income-earning entity and its business. Our analysis can help decide which of the factors must be present to have a plausible argument, which ones are nice to have, and which should be given little attention in determining an efficient litigation strategy.

1   Ernest S. Ryder & Associates Inc. v. Commissioner , T.C. Memo. 2021-88 .

2   Lucas v. Earl , 281 U.S. 111, 114-115 (1930).

3   Ryder , T.C. Memo. 2021-88, at 7.

4   Id. at 32.

5   Id. at 17, 19, and 111-112.

6   Id. at 51-52, 111-112, and 123-126.

7   Id. at 9-12.

8   Id. at 96.

10  CCH, Federal Taxation Comprehensive Topics, at 4201.

11   Lucas , 281 U.S. at 115.

12   See , e.g. , “familial partnership” cases — Burnet v. Leininger , 285 U.S. 136 (1932); Commissioner v. Tower , 327 U.S. 280 (1946); and Commissioner v. Culbertson , 337 U.S. 733 (1949). For an application in the commercial context, see Commissioner v. Banks , 543 U.S. 426 (2005).

13   Banks , 543 U.S. at 426.

14   See , e.g. , Johnston v. Commissioner , T.C. Memo. 2000-315 , at 487.

16   Ray v. Commissioner , T.C. Memo. 2018-160 .

17   Ryder , T.C. Memo. 2021-88, at 90-91.

18   Id. at 48, 51, and 52.

19  The predictor considered several further factors that play a greater role in other fact patterns.

20  The court mentions that ELC’s letterhead set out six employees and their respective positions with the company.

END FOOTNOTES

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Properly Executing a Section 351 Exchange

Owners of real property or other assets with built-in gain (and a low tax basis) may wish to transfer the appreciating property to a newly formed corporation in exchange for stock. By exchanging property for shares of a corporation’s stock, the property owner can also realize tax benefits through Section 351 of the Internal Revenue Code (IRC). 

Many times, transferring property to a corporation in exchange for stock results in a taxable event. The IRS eviews this transaction as the property owner “cashing out” his or her assets for a capital gain (so long as the asset has appreciated). Through a Section 351 exchange, the entity that transferred the appreciated property in exchange for stock may defer taxes on the gain or loss of the otherwise-taxable event until they sell the shares of stock.

The federal government created this provision in the Internal Revenue Code to encourage the creation of corporations. It is often used by property owners who transfer their property into corporations they created themselves.

Eligibility Criteria for 351 Exchanges

Not every property-for-stock transaction is eligible for tax deferral under Section 351. Property owners must satisfy three main prerequisites in order to take advantage of this tax treatment: 

• The transferor (property owner) must transfer property—and ONLY property—to the corporation. In other words, the transferor may not provide services for the stock. The law spells out what property is not , in the context of Section 351, so it is important to make sure contributions would actually be considered property before exchanging.
• The transferor must receive STOCK for the property. Section 351 exchanges must be relatively clean transactions: property for stock. Confer with your attorney before assuming the contributions would actually be considered property. 
• The transferor must receive controlling stock for the property . In exchange for the property, the transferor (or a group of transferors if there are multiple people transferring property) must receive enough stock (at least 80 percent) so that he or she (or they, if a group) actually assumes a controlling share of the corporation. 

Example of a Potential Section 351 Exchange

Let’s picture two individuals who wish to form a corporation. Individual 1 has an asset with a fair market value of $500 and a tax basis of $300. Individual 2 wants to contribute services to the corporation and, in exchange, receive 30 percent ownership in the new corporation. Both individuals wish to receive controlling stock in exchange for their contributions. 

This transaction, while exceedingly common in the business world, would not qualify either individual for preferential Section 351 tax treatment, as it violates the first criteria we explained above. Individual 1 will have to report a capital gain of $200 (the difference between the fair market value and tax basis of the property contributed). Additionally, because Individual 2 contributed services/non-property for 30 percent ownership, Individual 2 will be taxed on the fair market value of the services contributed.

Therefore, Individuals 1 and 2 will pay taxes upon contributing to the corporation.

These same principles apply to an partnership, or an LLC taxed as a partnership, but the rules are more lenient than with corporations. 

Consult an Experienced California Business Attorney Before the Transaction

Owning property that’s useful to a future or existing corporation is a good thing to have. Executing the transaction with Legal Zoom or some DIY legal service could help you go through with your transaction, but knowledgeable legal counsel can help you realize advantageous tax treatments and other financial benefits you never knew existed. 

The other side of the coin is improperly executing what you thought would qualify as a Section 351 exchange. Furthermore, being taxed sooner rather than later might also work to your advantage. Regardless of your situation, experienced legal representation will help you get the most out of your property and company. Reach out to our firm today to get the help of a true business advisor .

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26 U.S. Code § 351 - Transfer to corporation controlled by transferor

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

In determining control for purposes of this section, the fact that any corporate transferor distributes part or all of the stock in the corporation which it receives in the exchange to its shareholders shall not be taken into account.

If the requirements of section 355 (or so much of section 356 as relates to section 355) are met with respect to a distribution described in paragraph (1), then, solely for purposes of determining the tax treatment of the transfers of property to the controlled corporation by the distributing corporation, the fact that the shareholders of the distributing corporation dispose of part or all of the distributed stock, or the fact that the corporation whose stock was distributed issues additional stock, shall not be taken into account in determining control for purposes of this section.

A transfer of property of a debtor pursuant to a plan while the debtor is under the jurisdiction of a court in a title 11 or similar case (within the meaning of section 368(a)(3)(A) ), to the extent that the stock received in the exchange is used to satisfy the indebtedness of such debtor.

Clauses (i), (ii), and (iii) of subparagraph (A) shall apply only if the right or obligation referred to therein may be exercised within the 20-year period beginning on the issue date of such stock and such right or obligation is not subject to a contingency which, as of the issue date, makes remote the likelihood of the redemption or purchase.

The term “ preferred stock ” means stock which is limited and preferred as to dividends and does not participate in corporate growth to any significant extent. Stock shall not be treated as participating in corporate growth to any significant extent unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation. If there is not a real and meaningful likelihood that dividends beyond any limitation or preference will actually be paid, the possibility of such payments will be disregarded in determining whether stock is limited and preferred as to dividends.

A person shall be treated as related to another person if they bear a relationship to such other person described in section 267(b) or 707(b).

The Secretary may prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection and sections 354(a)(2)(C) , 355(a)(3)(D) , and 356(e) . The Secretary may also prescribe regulations, consistent with the treatment under this subsection and such sections, for the treatment of nonqualified preferred stock under other provisions of this title.

2005—Subsec. (g)(3)(A). Pub. L. 109–135 inserted at end “If there is not a real and meaningful likelihood that dividends beyond any limitation or preference will actually be paid, the possibility of such payments will be disregarded in determining whether stock is limited and preferred as to dividends.”

2004—Subsec. (g)(3)(A). Pub. L. 108–357 inserted at end “Stock shall not be treated as participating in corporate growth to any significant extent unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation.”

2002—Subsec. (h)(1). Pub. L. 107–147 inserted comma after “liability”.

1999—Subsec. (h)(1). Pub. L. 106–36 struck out “, or acquires property subject to a liability,” after “liability”.

1998—Subsec. (c). Pub. L. 105–206, § 6010(c)(3)(A) , reenacted heading without change and amended text generally. Prior to amendment, text read as follows: “In determining control for purposes of this section—

“(1) the fact that any corporate transferor distributes part or all of the stock in the corporation which it receives in the exchange to its shareholders shall not be taken into account, and

“(2) if the requirements of section 355 are met with respect to such distribution, the shareholders shall be treated as in control of such corporation immediately after the exchange if the shareholders own (immediately after the distribution) stock possessing—

“(A) more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote, and

“(B) more than 50 percent of the total value of shares of all classes of stock of such corporation.”

Subsec. (c)(2). Pub. L. 105–277 inserted “, or the fact that the corporation whose stock was distributed issues additional stock,” after “dispose of part or all of the distributed stock”.

Subsec. (g)(1)(A) to (C). Pub. L. 105–206, § 6010(e)(1) , inserted “and” at end of subpar. (A), added subpar. (B), and struck out former subpars. (B) and (C) which read as follows:

“(B) subsection (b) shall apply to such transferor, and

“(C) such nonqualified preferred stock shall be treated as other property for purposes of applying subsection (b).”

1997—Subsec. (c). Pub. L. 105–34, § 1012(c)(1) , amended heading and text of subsec. (c) generally. Prior to amendment, text read as follows: “In determining control, for purposes of this section, the fact that any corporate transferor distributes part or all of the stock which it receives in the exchange to its shareholders shall not be taken into account.”

Subsec. (e)(1). Pub. L. 105–34, § 1002(a) , inserted last two sentences.

Subsecs. (g), (h). Pub. L. 105–34, § 1014(a) , added subsec. (g) and redesignated former subsec. (g) as (h).

1990—Subsec. (e)(2). Pub. L. 101–508 substituted “is used” for “are used”.

1989—Subsec. (a). Pub. L. 101–239, § 7203(a) , struck out “or securities” after “stock”.

Subsecs. (b), (d), (e)(2). Pub. L. 101–239, § 7203(b)(1) , struck out “or securities” after “stock”.

Subsec. (g)(2). Pub. L. 101–239, § 7203(b)(2) , substituted “stock or property” for “stock, securities, or property”.

1988—Subsecs. (f), (g). Pub. L. 100–647 added subsec. (f) and redesignated former subsec. (f) as (g).

1982—Subsec. (f)(5). Pub. L. 97–248 added par. (5).

1980—Subsec. (a). Pub. L. 96–589, § 5(e)(2) , struck out provision that stock or securities issued for services shall not be considered as issued in return for property for purposes of this section.

Subsec. (d). Pub. L. 96–589, § 5(e)(1) , added subsec. (d). Former subsec. (d) redesignated (e)(1).

Subsec. (e). Pub. L. 96–589, § 5(e)(2) , redesignated former subsec. (d) as par. (1) and added par. (2). Former subsec. (e) redesignated (f).

Subsec. (f). Pub. L. 96–589, § 5(e)(1) , redesignated former subsec. (e) as (f).

1976—Subsec. (a). Pub. L. 94–455, § 1901(a)(48)(A) , struck out “(including, in the case of transfers made on or before June 30, 1967 , an investment company) ” after “property is transferred to a corporation”.

Subsec. (d). Pub. L. 94–455, § 1901(a)(48)(B) , among other changes, substituted “Exception” for “Application of June 30, 1967 , date” in heading and in text provision that this section does not apply to a transfer of property to an investment company for provisions relating to treatment of a transfer of property to an investment company as made on or before June 30, 1967 .

1966—Subsec. (a). Pub. L. 89–809, § 203(a) , inserted “(including, in the case of transfers made on or before June 30, 1967 , an investment company) ” after “if property is transferred to a corporation”.

Subsecs. (d), (e). Pub. L. 89–809, § 203(b) , added subsec. (d) and redesignated former subsec. (d) as (e).

Amendment by Pub. L. 109–135 effective as if included in the provision of the American Jobs Creation Act of 2004 , Pub. L. 108–357 , to which such amendment relates, see section 403(nn) of Pub. L. 109–135 , set out as a note under section 26 of this title .

Pub. L. 108–357, title VIII, § 899(b) , Oct. 22, 2004 , 118 Stat. 1649 , provided that:

Pub. L. 106–36, title III, § 3001(e) , June 25, 1999 , 113 Stat. 184 , provided that:

Amendment by Pub. L. 105–277 effective as if included in the provision of the Taxpayer Relief Act of 1997 , Pub. L. 105–34 , to which such amendment relates, see section 4003(l) of Pub. L. 105–277 , set out as a note under section 86 of this title .

Amendment by Pub. L. 105–206 effective, except as otherwise provided, as if included in the provisions of the Taxpayer Relief Act of 1997 , Pub. L. 105–34 , to which such amendment relates, see section 6024 of Pub. L. 105–206 , set out as a note under section 1 of this title .

Pub. L. 105–34, title X, § 1002(b) , Aug. 5, 1997 , 111 Stat. 909 , provided that:

Pub. L. 105–34, title X, § 1012(d) , Aug. 5, 1997 , 111 Stat. 917 , as amended by Pub. L. 105–206, title VI, § 6010(c)(1) , July 22, 1998 , 112 Stat. 813 , provided that:

Pub. L. 105–34, title X, § 1014(f) , Aug. 5, 1997 , 111 Stat. 921 , provided that:

Pub. L. 101–239, title VII, § 7203(c) , Dec. 19, 1989 , 103 Stat. 2334 , provided that:

Pub. L. 100–647, title I, § 1018(d)(5)(G) , Nov. 10, 1988 , 102 Stat. 3580 , provided that the amendment made by that section is effective with respect to transfers on or after June 21, 1988 .

Amendment by Pub. L. 97–248 applicable to transfers occurring after Aug. 31, 1982 , except for certain transfers pursuant to an application to form a BHC filed with the Federal Reserve Board before Aug. 16, 1982 , see section 226(c) of Pub. L. 97–248 , set out as a note under section 304 of this title .

Amendment by Pub. L. 96–589 applicable to transactions which occur after Dec. 31, 1980 , other than transactions which occur in proceedings in bankruptcy cases or similar judicial proceedings or in proceedings under Title 11, Bankruptcy, commencing on or before Dec. 31, 1980 , except as otherwise provided, see section 7 of Pub. L. 96–589 , set out as a note under section 108 of this title .

Pub. L. 94–455, title XIX, § 1901(a)(48)(C) , Oct. 4, 1976 , 90 Stat. 1772 , provided that:

Pub. L. 89–809, title II, § 203(c) , Nov. 13, 1966 , 80 Stat. 1577 , provided that:

Chapter Two - Formation of a Corporation

Fundamental income tax elements:, 1) transferor:  §351(a) - nonrecognition treatment is applicable to the asset transferor (if certain conditions are met); otherwise: §1001 gain recognition on the asset transfers., 2) corporation: tax-free treatment to corporation issuing its shares in the exchange. §1032., 3) carryover income tax bases (a) to shareholder (for shares) and (b) to corporation (for assets)., section 351 qualification requirements                    p.59, §351(a) - specific requirements:, a) one or more persons must transfer to corp.;, b) they must transfer “property”;, c) the transfer must be in exchange for “stock" of the issuing corporation - not “securities”; and,, d) the transferor “group” must be in “control” immediately after the exchange  (but not be an “investment company”)., what is the income tax objective for this treatment, ancillary income tax rules for §351 transfers       p.58, basis   §358 - to shareholders - basis of stock shall be same as the basis for their transferred property.  potential for double level of income taxation, i.e., to both the corporation & the shareholder., corporation: §362(a) - transferred basis for assets shifted into corporation .  limit on built-in losses., holding period :  §1223(1) - transferor has a substituted holding period for stock;   §1223(2) - carryover holding period to the corporation., limitation to the transferee when built-in loss            p.59, potential for duplication of economic loss., irc §362(e)(2) provides limit on transferee’s “ net built-in loss” when aggregate adjusted bases for properties transferred exceeds their total fmv., allocation of built-in loss is made proportionately to various corporate assets., possible election to reduce specific shareholder’s stock basis to fair market value & keep the loss basis at the corp. level.    irc §362(e)(3)(c). , incorporation transaction problem                             p.60, is §351(a) exchange treatment available, a) each party is a transferor of property (including the transferor of money)., b) each party has received x corporation stock in the exchange., c) the transferors (as a group) are in “control” of x corporation., d) no transferor has received "boot" in this transaction., problem              p.60, cont., treatment to a :    a has no gain realized., $25,000 basis for stock received., need to clarify that money is “property” - otherwise, only 75% (less than 80%) of the stock is issued to “transferors” for §351 purposes., treatment to b:   realized gain of $5,000., basis to b of stock received by b is $5,000., no tacked holding period for this stock - since inventory has been transferred., treatment to c :, realizes a $5,000 loss on the land;  but the loss is not recognized on this transfer., substituted $25,000 basis for stock under §358(a)., land is a capital asset – the holding period is tacked - §1223(1)., should c have sold the land to realize & recognize the loss for c’s income tax purposes, treatment to d:, $20,000 gain is realized on the equipment transfer, but no gain recognition is required., depreciation recapture under §1245  code § provides that “such gain shall be recognized notwithstanding any other provision.”  , but, see §1245(b)(3)  - an exception is provided in the §351 context.  the depreciation recapture potential is preserved at the corporate level., treatment to e:    disposition of an “installment obligation” does occur., §453b(a) requires the recognition of the gain upon the “disposition” of an installment obligation.  the amount realized is $20,000;  tax basis in the note is $2,000  = $18,000 gain, but: reg. §1.453-9(c)(2) specifies that no gain recognition is required upon the disposition of an installment obligation in a §351 transfer., stock basis to the shareholder is $2,000., problem, part (b)          p.60, tax consequences to the corporation :, 1)   §1032 - no gain on its stock issuance., 2)   tacked holding period(s) for the assets received - §1223(2) - but not for inventory received., 3)  carryover tax basis for the various assets received (§362):   inventory - $5,000;   land - 20,000 (not 25,000); but, possible election under §362(e)(2)(c));  equipment - 5,000;  installment note - 2,000., problem, part (c)          p.60, c transfers two properties:, parcel 1:         10x fmv                     15x basis   (loss), parcel 2:         10x fmv                     8x    basis   (gain)                         20x                                  23x  , 3x net loss is realized., §362(e)(2) requires a tax basis reduction by 3x., netting of gains and losses is permitted to corp., reduce tax basis of parcel 1 from 15x to 12x.         , option to reduce c’s stock basis to 20x., problem, part (d)          p.60, potential double taxation of inventory gain:,     $5,000 gain to b on the stock sale.,     $5,000 gain to corporation on inventory., how prevent double gain (or double loss) if so desired    step-up the shareholder’s basis if the corporation realizes the gain.  step-down the shareholder's basis if the loss is recognized by the corporation.   cf., partnership tax treatment when “inside gain” is realized (and to be recognized)., “control” requirement defined                         p.61, §§351(a)  & 368(c) – requirement in the exchange:,      80% of voting power, and,      80% of the total value of all other stock., if several transferors:, -  an “integrated plan” is necessary, -  need not transfer all assets simultaneously, -  must, however, transfer with “expedition consistent with orderly procedure.”, immediate stock disposition after transfer, what if a disposition of the stock occurs immediately after its acquisition, cannot be disposed of pursuant to a pre-existing binding agreement (then not received in exchange). , intermountain lumber case   -  p.62, issue: what tax basis of corporation's assets (i.e., intermountain, the acquirer) for purposes of tax depreciation;  i.e., was the original transfer of the assets to the corporation really a taxable “sale”, rev. rul. 2003-51        p.66 holding co. structure, transfer of assets to 1st corporation for stock., then:  (1) transfer of stock of 1st corp to 2 nd corp & (2) transfer of assets to 2 nd corp by another transferor & (3) transfer of all assets to lower tier sub., prearranged binding agreement., but:  the nontaxable disposition (not a “sale”) of 1 st corp. stock after the 1 st §351 transaction does not violate the “control” requirement., problem 1(a)                      p.67 code § 351 eligibility, a as transferor is entitled to §351 treatment:, 50 of 60 shares. exchanged basis of $10,000 in newco stock. tacked holding period under §1223(1) - assuming not inventory. , corporation - §1032.  no gain on its issuance of shares & asset cost basis to corp.   reg. §1.1032-1(d)., b's transfer - not under §351.  b as the sole transferor.   b owns only non-voting preferred (and is not part of the 80% group)., problem 1(b)            p.67, cont. integrated plan, a & b transfer as part of an integrated plan ., both a & b each have code §351 eligibility., b can take only preferred stock.  but, it must be qualified preferred stock   -  cf., code §351(g)., simultaneous exchanges are not critical if linkage exists.  reg. §1.351-1(a)(1) specifies the transferors must proceed with an expedition consistent with orderly procedure ., problem 1(c)            p.67,cont. post §351 gift transfer, 1)  same as (b) - i.e., integrated transaction; but  march 5 transfer to daughter by a as a gift three days after b's transfer.  transfer by a to d as a post-transfer transaction.  presumably not a binding commitment by a to dispose of these shares & control test satisfied., 2)  january 5 transfer  to d - 3 days after a's transfer.  related  d (holding 50% of common) is not a transferor for §351 purposes.  b’s transfer fails §351 eligibility .   ok for a – if no linkage to b., problem 1(d)        p.67,cont., shares sold under a preexisting agreement., if the transfer was an integral part of the incorporation only 35 of the 50 shares (70%) were received under §351., what about a “step transaction,” and inclusion of e as part of the transferor group   no – e is not a transferor., a and b to recognize gain on the exchange., e would take a cost basis for e’s shares., transfers of “property” and services                       p.67, definition of “ property”.      stock received for “ services” is not for property - §351(d)., what are “services”  attorney;  promoter; goods provided with an installation/repair arrangement., effect on measurement for 80% requirement on:,  1) solely a service provider - not a “transferor.”,  2) both property (more than de minimis ) & services - included in control group , but some stock may be gross income to the service provider/transferor., solely for “stock”         p.68, “stock” means an equity investment in the corporation and does not include:, 1)  stock rights or warrants (defined), 2)  securities (i.e., long term debt).  previously “securities” (how defined) were permitted but eliminated from enabling §351 eligibility;  or, 3)  non-qualified preferred stock - §351(g)., (how defined see §351(g)(2)(a);  put & call features, or debt-like characteristics)., problem a                      p.70 incorporation planning, transferors (nate & venturer) only own 350 of 500 (70%) shares & the control requirement (i.e., 80%) is not satisfied.  manager receives the other 30%., §351(d) specifies that stock for services is not considered as issued for property ., nate must recognize all realized gain.  issue is not relevant to venturer since transferring cash., manager has compensation income – what fmv of the stock after the manager’s receipt of her shares, problem b                      p.70 cash for stock, manager pays cash for her stock. therefore, manager is a member of the “control” group., nate can then postpone gain recognition. §351., if a  promissory note is issued - is this "property"  is the issuance of stock for a promissory note permitted under local (corporate) law, consider the cash flow effect to manager - $80,000 salary, less:  (i) her income tax,  (ii)  $30,000 note principal payment,  and (iii) note interest expense., problem c                      p.70 limited cash for mgr. stock, manager pays $1,000 for 150 shares., shares are worth much more and the shares are really for performance of future services ., manager is not a §351 “transferor” after examining the substance of the transaction., therefore, nate is required to recognize all his realized gain on the java transfer., manager:  ordinary income ($149,000) over the $1,000 cost., problem d                          p.70 more than 10% cash for stock, manager pays $20,000 cash (not $1,000)., assuming $1,000 per share, the $20,000 transferred by the manager will exceed 10% of value of the shares for services.  but, $130,000 is compensation., manager is treated as a transferor - all stock is counted for the transfer rule ;  the property transferred by manager will not be considered to be of "relatively small value.", nate - no gain recognized since 80% control group., problem e                     p.70 delayed stock delivery, manager receives only 20 shares without restrictions and another 130 shares subject to restriction -  a code §83 issue exists., are the 130 shares counted for §351 purposes, if so, §351 qualification - if manager’s shares.  are the 130 shares treated as treasury stock and not counted for § 351 purposes, §83(a) - no income until the restrictions lapse. §83(h).  function of the §83(b) election cash to pay her taxes, problem f   possible multi-class structure           p.70, venturer receives nonvoting () preferred shares.  drd eligibility.   if nonqualified preferred stock,  should be received after the initial §351 transfers and in an unrelated transaction.  use (convertible) debt - to enable an interest expense deduction and repayment of the debt without dividend  consequences to venturer., nate - 51% to nate & the remaining common shares to manager  lower the issue price and increase the incentive to the manager., treatment of “boot” received in incorporation, §351(b);    §358(a), (b)(1);   §362(a)., gain realized is to be recognized, but only to the extent of any “boot ” received from the corp. , tax basis limits the total amount of realized gain ., allocation of the boot is made ( on a fmv basis ) among the transferred assets for tax purposes., tax character of the gain is determined by pro rata reference to the several asset(s) transferred., stock basis calculation when “boot” is received, §358(a)  - tax basis for distributed stock :, 1)  tax basis of the asset transferred to corp., 2)  less:  fmv of the boot received, 3)  plus:   gain amount recognized, 4)  equals:  basis to the transferee shareholder of the stock received., any unrecognized gain remains in the stock., tax basis for the boot :  fair market value, since full gain recognition occurs upon its receipt., rev. rul. 68-55                  p.73 allocating boot gain, multiple asset transfers; determining the several gain amounts, etc., when receiving boot (§351(b)):, 1) asset-by-asset allocation, i.e., separately., 2) allocation of the boot consideration on a relative fair market value of assets basis., 3) no loss recognition permitted; no netting., 4) divided holding period for each share received., 5) asset tax bases to the corp. are adjusted for the boot gain recognized & loss not recognized. , stockholder’s holding period - corporation’s tax basis   p.75, shareholder’s holding period for stock:,          split holding period for each share of stock, dependent upon each asset, including, if partially  sourced to inventory, no tacked holding period for that portion., transferee corporation’s basis for various assets received:  (1) transferred basis, plus (2) any boot/gain recognition allocable to each particular item of property., timing considerations for boot gain recognition, installment gain treatment upon a boot transfer (e.g., stock is received, plus corporate debt ), 1) when must the gain be recognized later., 2) what impact to the shareholder's stock basis under §358 for the stock received in the incorporation transaction current basis increase ., 3) delayed impact under §362(a) to the corporation's tax bases for these assets received  cf., crane case analysis re debt (nonrecourse)., tax basis allocation when boot is installment debt, allocation of shareholder’s tax basis – page 78, 1)  first to the nonrecognition property., 2)  any remaining (i.e., excess) basis is then, allocated to boot to limit gain realized amount., 3)  if installment note is received (as boot) --, allocation of any remaining basis is made under the installment method, i.e., proportionately., (shareholder’s gain recognition timing affects the, corp’s basis for the assets transferred to it.)., problem: transferor a                      p.79, transferor a :  equipment: $22,000 fmv;, 15,000 basis; 7,000 realized gain (all §1245)., receives (i) common stock,  (ii) preferred stock (not “nonqualified”),  & (iii) $2,000 cash boot (gain).  a's tax basis computation for (combined) stock:, adjusted basis                                             15,000, less boot:                                                2,000, plus: income (§1245):       2,000    =   15,000, transferor a, continued                p.79, allocation of the $15,000 shareholder basis between two types of stock (based on their relative fair market values – 15 & 5 = 20 fmv):,             3/4ths to common stock =  11,250,             1/4th to preferred stock =    3,750,                                                                 15,000, corporation’s tax basis for a’s asset received:, 15,000 plus 2,000 gain recognized =  17,000, transferor b                 p.79 boot allocation issue, $13,000 gain on inventory - $20,000 fmv., $3,000 accrued loss on land - $10,000 fmv., b receives: $15,000 in stock & $15,000 cash., boot is to be allocated based on the relative fmvs of the two transferred assets., boot allocated to inventory is 20/30 times the $15,000 cash boot - equals $10,000 gain., boot allocated to land is 10/30 times $15,000 equals $5,000 - but, no loss recognition. cont., transferor b,      p.79, cont., b's basis in the stock :     code §358(a),                         7,000   inventory basis,                         13,000  land basis, less:                 15,000  boot received, plus:                10,000   gain recognized, equals: 15,000   (20,000 less 5,000 cash). , stock holding period is proportionate for each share of stock received.                               cont., corporation's basis for assets received:  , 1) inventory 7,000 + 10,000 gain = 17,000, 2) land                                                  13,000, note:  $30,000 aggregate basis does not exceed the $30,000 fair market value and, therefore, no built-in loss/§ 362(e)(2) applicability., transferor c                 p.79 two types of boot received, land basis is $20,000 and fmv is $50,000., $30,000 realized gain on c’s transfer of land., stock is received & two types of boot are received :  (1) 5x cash & (2) a two year 35x note (total 40x)., all $30,000 gain is to be recognized ( not $40,000) - see §351(b)(1).  all gain is ltcg., basis is allocated first to the non-recognition property.                                           continued, transferor c        p.79,cont., when reporting on the installment method:, basis 1st to the nonrecognition property, (i.e., the x stock – the first $10,000 of $20,000)., remaining $10,000 is excess basis to the boot., gross profit ratio 30,000   (10,000 for basis),                                40,000  -    ¾ as gain, 3/4 of the 5,000 cash equals 3,750 current gain., 3/4 of 35,000 note = 26,250 - recognized in 2 years., transferor c             p.79,cont. shareholder’s stock basis, c’s stock basis computation:, land basis:                             20,000, less:  boot received: 40,000, plus: gain recognized:            30,000, equals:                                    10,000, shareholder treated as electing out of §453 installment treatment for shareholder tax basis purposes., problem (b)                        p.79 §453(i), c transfers depreciable equipment (instead of land):, same basis:                           20,000, same fmv:                50,000, original cost:              50,000, entire $30,000 would be §1245 gain to be recaptured into income immediately ., tax basis to the shareholder (10x for stock) & corporation – 50x (20x + 30x gain) for equipment, assumption of liabilities §357                              p.79, remember the crane case: debt relief constitutes an “amount realized.”, §357(a) - the assumption of liability (or the taking of property subject to a liability) will:,             (1) not constitute “ boot, ” and,,             (2) not prevent §351 treatment., how take this into account adjust tax basis, as required under §358(d ).  reduce the tax basis by treating the debt assumption as money received., section 357(b)        exception if a “tax avoidance purpose”, §357(b).  tax avoidance purpose limitation., a liability assumption is treated entirely as boot if the taxpayer's principal purpose in transferring some liability was the avoidance of federal income tax or was not for a bona fide purpose., bona fides measured at the corporate level., purpose:  to avoid a pre-§351 cash “bailout ” (i.e. borrowing against property immediately before an incorporation transfer)., section 357(c)    exception if liabilities exceed total basis, §357(c). liabilities in excess of tax basis of the transferred property produce a gain amount., total of the liabilities in excess of the total of asset bases triggers applicability of this provision., the excess is treated as gain from the sale or exchange of property., exception for those liabilities deductible when paid.  §357(c)(3).  this enables avoiding a gain problem for cash basis taxpayers (i.e., accounts payable). , the excess liabilities problem                             p.83, how solve this liabilities exceeding total tax basis problem –  to avoid gain recognition at the time of the incorporation (e.g., when assuming payables), -  contribute cash to equalize debt & basis, -  contribute high-basis debt-free property, -  contribute a promissory note in an amount at least equal to the “negative basis”, -  remain personally liable on the debt property, peracchi case                    p.84 promissory note & tax basis, taxpayer contributes real estate to his corporation.  real estate subject to debt in excess of its tax basis., the taxpayer also contributes his promissory note - face value of note in excess of the §357(c) amount., held : the note has a tax basis equivalent to the face amount - eliminating the §357(c) problem ., the note is either to be paid by the taxpayer or collected in the corporation’s bankruptcy estate., the note is not a “sham” (p. 91-92).  see irs stipulation re business purpose existing (p. 92). , alternative §357(c) planning – retain liability, p. 94.  retention by the shareholder of the personal liability for that liability which is attached to the transferred asset.  does this enable the avoidance of the §357(c) effects  no avoidance.  (tax court). , what effect of entering into an agreement that the shareholder (not the corporation) will satisfy the debt (e.g., guarantee agreement )   court position:  guarantees are not the same as a direct debt (including the shareholder’s promissory note). , see next slide., seggerman farms footnote 8, p.96, taxpayers contributed assets subject to liabilities exceeding tax basis., but, taxpayers remained liable as guarantors of these liabilities., court of appeals ruled §357(c) gain is to be recognized on the transfer., personal guarantee of the shareholders is not the equivalent of  primary liability .  correct result, what are the terms in a guarantee agreement, problem 1(a) -  liabilities not exceeding basis                p.98,                         basis                            fmv, inventory        20,000             10,000, land                20,000             40,000,                         40,000             50,000, land (recourse) debt is 30,000 & x corp. (as transferee) takes land subject to this debt. , stock is issued for 20,000 (50 fmv less 30 debt).  , no gain is to be recognized (basis exceeds liability). , stock basis: 40,000 less 30,000 debt = 10,000 excess., problem 1(b) – liabilities exceeding basis                p.98,                         basis                         fmv, inv.                  20,000             10,000, land                5,000                         40,000,                         25,000             50,000, debt assumed is 30,000 (30 exceeds 25 tax basis). , gain to be recognized is 5,000;  stock = 20x fmv., stock tax basis:  25,000 less 30,000,  plus 5,000 (gain to be recognized ) equals 0 basis., problem 1(c)                      p.98 tax character of 5,000 gain, what tax character of a's recognized gain, see reg. §1.357-2(b). , allocate the §357(c) gain of $5,000 between the transferred assets based on their relative fair market values (without consideration of the debt or tax basis for the several properties)., inventory   10,000/50,000         20% = 1,000, land              40,000/50,000      80% = 4,000,                                                           5,000                                                                      , problem 1(d)                      p.98 tax basis allocation, 1) if allocating the entire gain to the land (since the land is the only appreciated asset):, inventory                    20,000 basis, land                             5,000 - plus 5,000 gain = 10k  gain recognized and total basis for land is $10,000., 2)  if allocation is on the basis of asset fmv :, inventory                  21,000 (20,000 plus 1,000), land                               9,000 (5,000 plus 4,000), problem 1(e)                      p.98 avoiding gain recognition, avoiding gain recognition:, 1) transfer into corp:  (a) $5,000 cash, or (b) any other asset with an adjusted basis of at least $5,000., 2)  remain personally liable on at least $5,000 of the mortgage.    probably  not., 3) transfer a personal promissory note for $5,000 into the corporation (e.g., peracchi). , problem 2(a)                      p.98 liabilities assumed, building is transferred - basis $100,000;  fair market value - $400,000; subject to $80,000 first mortgage;  borrowed $10,000 on the building two weeks before incorporation of y; and, issuance by y of $310,000 in stock (400 less 80 and less 10)., code §357(b) is applicable - assuming no bona fide business purpose for the borrowing for personal reasons immediately prior to incorporation transfer. bailout amount 90x (not 10x).           cont., problem 2(a), cont.               p.98, b’s basis in the y stock would be determined as follows:, transferred tax basis of the, building:         $100,000        , less:              $90,000     liabilities assumed, plus:              $90,000      gain recognized, equals:         $100,000   basis, problem 2(b)                      p.98 only cash boot, cash - bank to y corp , then to shareholder., b will only recognize the $10,000 cash boot ., b’s basis in the y corp stock would be:,             $100,000 transferred basis of building,             less:              $80,000  liabilities assumed,             less:              $10,000 cash received,             plus:              $10,000 gain recognized,             equals:           $20,000 basis for stock, incorporation of a going business                       p.99, transferred assets might include:,     land & building (depreciated),     machinery & equipment,     goodwill,     accounts receivable and inventory,     previously deducted supplies, assumed liabilities might include long term debt, accounts payable & contingent liabilities., hempt brothers                 p.99 accounts receivable to corp., facts: $662,000 in zero basis “accounts receivable” transferred to a new corporation in exchange for stock in a §351 transaction., 1) irs claims partnership's zero basis in the receivable is carried over to corporation - corp. then realizing income upon collection ., 2)  corporation contended receivables were not “property” & the transfer to the corporation was an “assignment of income” & therefore gain recognition occurred to the transferor., rev. rul. 95-74           p.103 environmental liabilities, §357 effect of potential future liabilities ., parent drops assets into sub – with possible environmental liabilities (cercla)., these liabilities are assumed by a subsidiary., 1) these potential liabilities are not “liabilities” for §357(c)(1)  (and §358(d)) purposes., 2) liabilities assumed by the sub are deductible (or to be capitalized) when paid (by the cash basis taxpayer)., possible code §351 abuse situations                  p.106, 1) applicability of the “assignment of income” doctrine to cause income to transferor., 2) code §482 can be used to appropriately allocate income among taxpayers (e.g., cannot accelerate deductions and deflect related income to corporation)., 3) “tax benefit rule” - deduction of the cost of property prior to its transfer to corp.  recovery of deduction by transferor  note hillsboro (p. 108)., problem (a)                      p.108 incorporation transfers, possible income tax consequences: , is gain to be recognized by transferor, do the assumed liabilities exceed tax basis,     no, consider §357(c)(3)., liability assumed of $30,000 (not 100x) is less than the $60,000 tax basis., tax basis for the shares received by shareholder:,      $60,000 less 30,000 = $30,000, stock holding period partially tacked., problem (b)                 p.109 cash basis taxpayers, collection of zero basis accounts receivable:, 1) architect is not taxed because the a/rs  are "property" under §351 and can be assigned to the corporation without income recognition.  the corporation has income when the “zero basis” a/rs  are collected (i.e., a cash basis taxpayer)., 2) the “assignment of income” doctrine does not apply if a valid business purpose exists for the transfer of the accounts receivable to corp., problem (c)                 p.109 accounts payable assumed, deduction by the corporation of accounts payable which were assumed, yes, deduction to the transferee of the  accounts payable is permitted under code §162 when accounts payable are paid by transferee - unless evidence exists of tax avoidance or the distortion of income by transferor., environmental remediation costs – deduction or capitalization permitted., problem (d)                      p.109 partial transfer, payment of the accounts payable by transferor but transfer of the accounts receivable to corporation., is the “assignment of income” doctrine applicable in this situation, evidence of tax avoidance or the distortion of income existent here probably., what relevance of §446(b)  (“clear reflection of income”), problem (e)                      p.109 accrual basis transferor, payment of the accounts payable by transferor but transfer of the accounts receivable to corporation. but, architect is an accrual basis taxpayer., receivables previously would have been included in gi.  payables would have been deducted & an assumed liability to corp., stock basis:  60 plus 60 = 120 less 100 debt = 20 basis (and no § 357(c) gain). , problem (f)                       p.109 accounting method, limitations of the choice of accounting method  see §448., design probably a “qualified personal service corporation”  - see §448(b)(2) & (d)(2) – and,  the accrual method is not required., is the calendar year required  yes,  see, §441(i)(2)., contributions to capital -  p.109, 1) no receipt of stock for the property contributed to corporation., 2) no gain is to be recognized; but, an increase to shareholder of tax basis for his stock by the cash and adjusted basis of property transferred to corp., 3) this contribution is excludable from the gross income of the transferee corporation.  §118(a)., 4) transferred tax basis to the corporation for the assets received. §362(a)(2), (c)., commissioner v. fink,    p.110 loss deductibility, controlling shareholder surrenders some shares to corporation, but retains control (72% to 68%)., what (if any) deductibility (ordinary loss) of the tax basis for the surrendered shares, held:  a voluntary surrender of some shares results & this constitutes a contribution to the capital of the corporation.  objective:  to enhance the corp., no immediately deductible (ordinary) loss actually sustained during taxable year.  reallocate tax basis., intentional avoidance of code §351                   p.110, code §351 is not an elective provision., objectives when seeking to avoid §351:,   1)  enable a loss deduction (ordinary).,   2)  step up a property’s tax basis for depreciation.,   3)  freeze capital gain potential., techniques for avoiding code §351:,   1)  immediately breaking 80% control.,   2)  sale of an asset to the corporation (with possible §453 installment sale treatment). p.111., organizational expenses - is a deduction available, p. 112    code §195, §212(3) & §248, §248 – $5,000 deduction (with phase-out) & 180 months amortization for organizational expenses., §248(b) - defining “organizational expenses”:, legal fees for drafting the articles of incorporation, but not the costs for issuing or selling the stock., §195 – $5,000 start-up expenditures are deductible (but phase-out), with 180 month amortization for remainder., problems                          p.113 appraisal fees, a) $3,000 fees paid for appraisals of a's proprietorship (property).   a's personal cost and not an expense of the incorporation.  an expense of acquiring the stock and added to the shareholder’s tax basis for the stock., b) fee paid by the corporation.  treated as a liability of  shareholder a which is assumed by the corporation and is subject to §357 liability treatment.  probably 357(b) &(c) not applicable., problem c                        p.113 document preparation,  i)  drafting the articles of incorporation, - §248 election enables an expense deduction ($5000) & amortization.  reg. §1.248-1(b)(2)., ii) deeds, etc. - constitute costs of the specific assets & to be added to the tax basis of these assets. , iii) application to issue stock - not considered an organizational expense;  also,  not otherwise deductible or amortizable. frozen into franchise. reg. §1.248-1(b)(3)(i).                                continued, problem c                   p.113, iv) §212(3) deduction treatment is not available since not applicable to corporations., not a §162(a) expense, but should be includible in the organizational expenses under code §248 and amortizable., v) buy-sell agreement - organizational expense under code §248  and, therefore, amortizable.

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• CORPORATIONS & SHAREHOLDERS

A walk through the step-transaction doctrine

• C Corporation Income Taxation
• Tax Planning; Tax Minimization

The economics surrounding the COVID-19 p andemic may be causing many taxpayers to enter into transactions to preserve capital and reduce financial risk. The IRS may challenge the validity of transactions that appear primarily motivated by tax considerations. To best defend a taxpayer's reported tax treatment of a series of transactions, taxpayers and their advisers should understand the possible grounds for a challenge of that treatment. The IRS frequently attempts to recharacterize a series of separate transactions as a single transaction for tax purposes based on the step-transaction doctrine. An overview and analysis of the step-transaction doctrine's application should enable more secure and efficient tax planning and aid an informed judgment of the strength of the IRS's position if it invokes the doctrine in a challenge to the taxpayer's treatment of a series of transactions.

The step - transaction doctrine is a rule of substance over form. It "treats a series of formally separate 'steps' as a single transaction if such steps are in substance integrated, interdependent, and focused toward a particular result." 1 Whether the doctrine applies is a question of fact. 2

Impact of application

If taxpayers arrange to meet all the statutory requirements for each of a series of transactions but manipulate either the economics or the timing of the transactions to obtain favorable tax treatment, the IRS may be able to apply the step - transaction doctrine to deny the taxpayer the favorable tax benefits Examples where the IRS has successfully used the doctrine include:

• Loan and option transactions under the guise of a reorganization and financing arrangement constituted the sale of a partnership interest (from nontaxable to a taxable transaction). 3
• Impermissible attempts to create amortizable term interests out of nondepreciable property (amortization deduction was disallowed). 4
• A parent's sale of its 80% owned subsidiary to another company, which was followed by the parent corporation's repurchase of all of the subsidiary's assets except the assets of a single grocery store (loss was disallowed). 5
• Advance royalty payments under nonoperating coal leases were allowed as deductions from ordinary income only if the taxpayer's intent was to mine coal at the time that he entered into the leases (deductions under Sec. 631(c) disallowed). 6
• Lease-stripping transactions as multiple-party transactions intended to allow one party to realize rental income and to allow another party to report deductions (improperly separated income from related deductions, and, thus, the tax consequences of the deductions were disallowed). 7
• Transfers of a corporation's stock by stockholders to a second corporation in exchange for stock of the second corporation, cash, and notes, followed by the merger of the first corporation into the second corporation, were a tax-free reorganization under Sec. 368(a)(1)(A). Thus, the transfer of the stock, cash, and notes was found to be a distribution of a dividend (in the amount of the cash and notes) rather than a sale of the stock, cash, and notes. 8

Three tests for determining if the doctrine applies

As the Tax Court stated:

The step transaction doctrine generally applies in cases where a taxpayer seeks to get from point A to point D and does so stopping in between at points B and C. The whole purpose of the unnecessary stops is to achieve tax consequences differing from those which a direct path from A to D would have produced. In such a situation, courts are not bound by the twisted path taken by the taxpayer, and the intervening stops may be disregarded or rearranged. 9

The courts generally have used one of three tests to determine whether the step - transaction doctrine should be applied to a series of transactions: the end - result test, the interdependence test, and the binding - commitment test. However, courts have seldom applied the binding - commitment test, which requires that there be a binding commitment at the time the first step was entered into to take the later steps claimed to be part of a single transaction. 10

End-result test

Under the end - result test, "purportedly separate transactions will be amalgamated into a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result." 11 "A prerequisite to application of the end result test is proof of an agreement or understanding between the transacting parties to bring about the ultimate result." 12 Thus, to avoid the application of the step - transaction doctrine under the end - result test, the taxpayer should show that there was no agreement or understanding among the parties to cause the ultimate result of the transaction.

In addition, where a taxpayer is the sole shareholder of the involved entity, the Tax Court requires a "firm and fixed plan" to bring about that result: "If the taxpayer is the sole shareholder of a closely held corporation and could easily change his mind regarding the implementation of the alleged plan, this Court has demanded compelling evidence of the taxpayer's commitment to the plan before it will find that a firm and fixed plan existed." 13 Thus, taxpayers should be ready to show that, according to their understanding, the transactions were not a prearranged scheme of purportedly separate steps or in actuality a single transaction.

The step - transaction doctrine may be invoked under the end - result test only if the taxpayer intended a sole outcome when entering into a series of transactions and if no other outcome can be discerned. A taxpayer should not know and not be able to control what form the ultimate transaction will take so that the taxpayer does not have an intent to "reach a particular result." 14

Furthermore, courts have held that the step - transaction doctrine may not be invoked under the end - result test where the form of the ultimate transaction is not known at the time of formation of the relevant entities. For example, in Weikel , 15 the Tax Court refused to apply the end - result test where the taxpayer formed a corporation and later exchanged the corporation's stock for stock of a publicly held company. The court found the test was not satisfied because at the time the corporation was formed, negotiations with the publicly held company were still in progress and it was not clear that the taxpayer's purpose in forming the corporation was to engage in a tax - free sale of the corporation's assets in exchange for the publicly held company's stock. The Tax Court accepted the taxpayer's testimony concerning why the corporation was incorporated, through notes, memos, or other written evidence. 16

Each step, standing alone, should have economic significance and risk to withstand attack. Courts have indicated that the end - result test, like the interdependence test, applies only to "steps" that have no interdependent economic significance. 17 The limitation reflects the reality that the test cannot possibly be applied literally because, if it were, it would apply to all business transactions that, for purely business reasons, are consummated in segments.

The end - result test cannot be used to disregard ownership, even "transitory," by a true owner for tax purposes. This principle is confirmed by Esmark , 18 where the Tax Court respected arguably transitory stock ownership in the process of rejecting the IRS's attempt to apply the end - result test, because the taxpayer had all the "incidents of ownership" while it owned the stock at issue.

The existence of an overall plan alone does not mean the step - transaction doctrine will apply under the end - result test. With respect to tax - motivated transactions, the courts have refused to apply the step - transaction doctrine in several cases. The step - transaction doctrine was held not to apply to an otherwise qualifying Sec. 357 transaction, despite the existence of a prearranged plan to dispose of the stock representing control. 19 Perhaps the leading case in which a court held that the step - transaction doctrine did not apply to a tax - motivated transaction is Esmark . In that case, the Tax Court held that a taxpayer's form will be respected when each step has "permanent economic consequences," notwithstanding that reduction of taxes is a significant factor in structuring the transaction. The court rejected the IRS's attempt to apply the step - transaction doctrine to recast the transactions at issue, even though the transaction could have been accomplished differently. 20 The court said the "existence of an overall plan does not alone . . . justify application of the step - transaction doctrine." 21

The IRS generally cannot reorder the steps actually taken or invent new steps just to create an additional tax liability. 22 As the Tax Court has stated, to collapse a transaction, the IRS must have "a logically plausible alternative explanation that accounts for ALL the results of the transaction." 23 In any event, the courts have limited the expansive scope of the end - result test, and case law strongly suggests that the courts are reluctant to reorder the actual steps taken by the parties or to invent new steps. In Esmark ,the Tax Court refused to apply the step - transaction doctrine because it would require the addition of steps to the transaction that did not occur. 24 The IRS has agreed, at least under one fact pattern, that the step - transaction doctrine cannot be applied to reverse the order of the transactions. 25

Interdependence test

The interdependence test asks whether "the steps were so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series." 26 Accordingly, the most important factor in determining if the step - transaction doctrine applies under this test is whether the transactions are so interdependent that none of the transactions would have occurred without the others. Thus, courts have held that even when two or more transactions are intended, and each transaction is planned before the first is consummated, the transaction may not be integrated if each transaction has substance by itself and has its own separate business purpose. 27

The interdependence test looks at the relationship between the steps and whether one step would have occurred without the other steps. For example, in Associated Wholesale Grocers , 28 the court applied the interdependence test to integrate two purportedly independent transactions — a sale of a subsidiary's assets, followed by a repurchase by the parent of all those assets except the stock of a second - tier subsidiary — and denied the loss claimed on the asset sale, because the two agreements were, by their terms, dependent on each other. To avoid application of the step - transaction doctrine based on the interdependence test, each step in the transaction should have "reasoned economic justification standing alone." 29 Stated differently, the economic motivation supporting each individual transaction should be sufficiently meaningful on its own account and not be dependent on another transaction for its substantiation.

The interdependence test is generally applied where the transactions occur between related parties. For example, in Kuper , 30 shareholders of a realty - owning corporation contributed all their shares to an automobile dealership corporation owned by the same shareholders, which, in turn, made a cash capital contribution on the same day to the realty corporation. On the following day, the automobile corporation exchanged the realty corporation's shares for one stockholder's one - third ownership of the automobile corporation. The Fifth Circuit found that it was unlikely any one of these steps would have been undertaken except in contemplation of the others and were done to disguise a stock - for - stock transaction at the shareholder level. Therefore, the court treated the steps as a taxable exchange of stock. 31

Binding-commitment test

The binding - commitment test, set out by the Supreme Court in Gordon , 32 is seldom applied by the courts. 33 It is the narrowest of the three step - transaction doctrine tests and typically favors the party that desires to have the separate transactions respected. 34 The binding - commitment test "is applicable only where a substantial period of time has passed between the steps that are subject to scrutiny." 35

In the foremost case applying the test, McDonald's Restaurants , 36 the court noted that the test was intended to deal with transactions that span several tax years and could have remained "not only indeterminable but unfixed for an indefinite and unlimited period in the future, awaiting events that might or might not happen." 37 Under the binding - commitment test, "if one transaction is to be characterized as a 'first step' there must be a binding commitment to take the later steps," otherwise, the step - transaction doctrine should not apply. 38 In addition, "if there were a moment in the series of the transactions during which the parties were not under a binding obligation, the steps cannot be collapsed under this test." 39

Tax planning points

Taxpayers can have an overall plan in carrying out a series of transactions without running afoul of the step - transaction doctrine, but taxpayers should take actions to make sure that the doctrine cannot be successfully invoked by the IRS. To strengthen the position of transactions as independent transactions and withstand an IRS attack using the step - transaction doctrine, taxpayers should:

• Design each transaction so that it has substance by itself and has its own separate business purpose.
• Not have an agreement or understanding with other parties to the transaction to cause the actual result of the transaction in a prearranged plan.
• Not intentionally design the form of the transaction to reach a particular result.
• Not make a binding commitment at the time of the first transaction to complete the other transactions.
• Ensure there is economic motivation, significance, and risk for each transaction.
• Not undertake the transactions solely with related parties.
• Not attempt to disguise the economic reality of the ultimate result obtained by using multiple transactions.
• Be cognizant that transactions undertaken over a short period of time are more likely to be viewed as a single transaction with multiple steps.

A path to comfort

Taxpayers who know and understand the IRS's transaction challenge approach using the step - transaction doctrine should be more effective and efficient in their tax planning for transactions and whether to defend or settle upon a challenge of transactions. Only then can they feel comfortable in their tax planning that a series of transactions will withstand an IRS challenge.

1 Penrod , 88 T.C. 1415, 1428 (1987).

2 Jacobs , 224 F.2d 412, 413 (9th Cir. 1955), citing Cumberland Pub. Serv. Co. , 338 U.S. 451 (1950); Court Holding Co. , 324 U.S. 331 (1945).

3 Field Service Advice 1999 - 1095 .

4 Kornfeld , 137 F.3d 1231 (10th Cir. 1998), aff'g T.C. Memo. 1996 - 472 .

5 Associated Wholesale Grocers, Inc. , 927 F.2d 1517 (10th Cir. 1991).

6 Brown , 782 F.2d 559 (6th Cir. 1986).

7 See Notice 95 - 53 .

8 King Enterprises, Inc. , 418 F.2d 511 (Ct. Cl. 1969).

9 Smith , 78 T.C. 350, 389 (1982).

10 Gordon , 391 U.S. 83, 88 (1968).

11 Security Indus. Ins. Co. , 702 F.2d 1234, 1244 (5th Cir. 1983), quoting King Enterprises, Inc. , 418 F.2d 511, 516 (Ct. Cl. 1969).

12 Long Term Capital Holdings , 330 F. Supp. 2d 122, 191 (D. Conn. 2004).

13 Merrill Lynch & Co. ,120 T.C. 12, 53 (2003), aff'd in part, remanded in part, 386 F.3d 464 (2d Cir. 2004).

14 True , 190 F.3d 1165, 1175 (10th Cir. 1999).

15 Weikel , T.C. Memo. 1986 - 58 .

17 McDonald's Restaurants of Ill. , 688 F.2d 520 (7th Cir. 1982).

18 Esmark, Inc. , 90 T.C. 171, 195 (1988), aff'd, 886 F.2d 1318 (7th Cir. 1989).

19 See, e.g., Esmark , 90 T.C. at 171; American Bantam Car Co. , 11 T.C. 397 (1948), aff'd, 177 F.2d 513 (3d Cir. 1949).

20 Esmark , Inc. , 90 T.C. at 196.

21 Id. at 195-98.

22 Grove , 490 F.2d 241, 247-48 (2d Cir. 1973), aff'g T.C. Memo. 1972 - 98 (citing S heppard , 361 F.2d 972, 972 (Ct. Cl. 1966)); see also Esmark, 90 T.C. at 196.

23 Turner Broadcasting System, Inc. , 111 T.C. 315 (1998); see also Del Commercial Props. Inc. , 251 F.3d 210, 213-14 (D.C. Cir. 2001), aff'g T.C. Memo. 1999 - 411 , and Penrod , 88 T.C. at 1428, 1430.

24 Esmark, Inc. , 90 T.C. 171 (1988).

25 Rev. Rul. 78 - 197 .

26 King Enterprises , 418 F.2d 511, 516 (Ct. Cl. 1969), quoting Paul and Zimet, "Step Transactions," Selected Studies in Federal Taxation , p. 254 (2d Series 1938).

27 Weikel , T.C. Memo. 1986 - 58 ; H.B. Zachry Co. , 49 T.C. 73 (1967).

28 Associated Wholesale Grocers , 927 F.2d 1517 (10th Cir. 1991).

29 Security Indus. Ins. Co. , 702 F.2d 1234, 1247 (5th Cir. 1983).

30 Kuper , 533 F.2d 152 (5th Cir. 1976).

31 See also True , 190 F.3d 1165 (10th Cir. 1999).

32 Gordon , 391 U.S. 83, 96 (1968).

33 Kornfeld , 137 F.3d 1231 (10th Cir. 1987).

34 Andantech LLC , T.C. Memo. 2002 - 97 .

36 McDonald's Restaurants of Ill. , 688 F.2d 520 (7th Cir. 1982).

37 Id. at 525, quoting Gordon , 391 U.S. at 96.

38 Redding , 630 F.2d 1169, 1178 (7th Cir. 1980), quoting Gordon , 391 U.S. at 96.

39 IRS, Coordinated Issue Paper, Distressed Asset Trust (DAT) Tax Shelters (March 23, 2010).

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