ASPEN PUBLISHERS

FEDERAL INCOME TAXATIONOF CORPORATIONS ANDPARTNERSHIPS

Fourth Edition

RICHARD L. DOERNBERGK. H. Gyr Professor of Law Emeritus, Emory UniversityEmory University School of Law

HOWARD E. ABRAMSProfessor of Law, Emory UniversityEmory University School of Law

DON A. LEATHERMANW. Allen Separk Distinguished Professor of LawUniversity of Tennessee College of Law

Wolters KluwerLaw & Business

AUSTIN BOSTON CHICAGO NEWYORK THE NETHERLANDS

SUMMARY OF CONTENTS

Contents xiPreface xxvii

ISUBCHAPTER C CORPORATIONS 1

1 Introduction to the Corporate Income Tax 32 Corporate Formation 73 Corporate Operation 774 Distributions of Cash and Property 1035 Redemptions and Partial Liquidations 1516 Distributions of Stock 2117 Liquidations 2478 Integration of the Corporate and Individual

Income Taxes 2819 Taxable Acquisitions 297

10 Acquisitive Reorganizations 32711 Divisive Reorganizations • , 38912 One-Party Reorganizations 42313 Combining Tax Attributes: Net Operating Losses

and Affiliated Corporations 43114 Penalty Provisions 45915 The Corporation as a Separate Taxable Entity 473

II ,SUBCHAPTER S CORPORATIONS 495

16 S Corporations: Overview 49717 S Corporations: Selected Topics 52118 Transition Issues 541

I X

x Summary of Contents

IIISUBCHAPTERS K PARTNERSHIPS 551

19 The Structure of Partnership Taxation 55320 Determining Distributive Shares 56921 A Partner's Outside Basis 62322 Nonliquidating Distributions 65123 A Partner's Transactions with the Partnership 68124 Acquisitions of Partnership Interests 70525 Dispositions of Partnership Interests 72526 Loss Limitations v- . _— 75327 Inside Basis Adjustments 77128 Partnership-Level Issues 799

Table of Cases 817Table of Revenue Rulings and Procedures 821Index 823

CONTENTS

Preface xxvii

ISUBCHAPTER C CORPORATIONS

1.

Introduction to the Corporate Income Tax

Corporate Formation 7

A. Introduction 71. The §351 Philosophy 72. The Statutory Terrain 9

B. Qualification under §351 111. Property " 11

James v. Commissioner 11Notes 15

2. Stock 173. Control 18

Kamborian v. Commissioner 19Notes * 23Intermountain Lumber Co. v. Commissioner 25Notes 30Problems 33

C. Tax Consequences of §351 Exchange 331. In General 33

Rev. Rul. 68-55 34Rev. Rul 85-164 36

XI

xii Contents

2. Assumption of Liabilities 40Peracchi v. Commissioner 43Notes 53

3. Securities 554. Boot and Installment Method 565. Review Problems 56

Problems 56D. Interaction of §351 With Other Code Sections and Legal

Doctrines 57Bradshaw v. United States 57C-lec Plastics v. Commissioner 63Notes 66Hempt Bros., Inc. v. United States 69Notes 72Problems 74

Corporate Operation 77

A. Corporate Tax Rates and Base 771. Taxable Entity 772. Tax Rate 773. Taxation of Capital Gains and Losses 794. Corporate Tax Base 795. Passive Loss Limitations 826. Taxable Year and Accounting Methods 837. Corporate Alternative Minimum Tax 84

Problems 87B. Capital Structure 87

Joint Committee on Taxation, Federal IncomeTax Aspects of Corporate Financial Structures 88

Bauer v. Commissioner • 92Notes 97Problems 102

Distributions of Cash and Property 103

A. Cash Distributions 104Rev. Rul. 74-164 105Divine v. Commissioner 107Notes 112Problems 117

B. Property Distributions 1171. The Effect of a Distribution of Property on the

Distributing Corporation's Income 117

Contents xiii

2. The Effect of a Distribution of Property on the DistributingCorporation's Earnings and Profits 123

3. The Effect of a Distribution of Property on Shareholders 124Problems 124

C. Disguised or Constructive Dividends 124Baumer v. United States 125Gilbert v. Commissioner 132Notes 136Problems 142

D. Intercorporate Dividends ', 142Litton Industries, Inc. v. Commissioner 142Notes 147Problems 150

Redemptions and Partial Liquidations 151

A. Treatment of Shareholders 1511. Complete Terminations under §302(b) (3) 153

Seda v. Commissioner 153Notes 156Problems 159

2. Substantially Disproportionate Redemptions under §302(b)(2) 159Notes 161Problems 162

3. Redemptions Not Essentially Equivalent to a Dividend 163United States v. Davis 163Henry T. Patterson Trust v. United States 167Notes 172Problems 177

4. Partial Liquidations under §302(b) (4) . 177Rev. Rul. 60-322 . 178Notes ' 179Problems 181

B. Treatment of the Corporation 182C. Redemptions Related to Other Transactions 183

1. Redemptions in Lieu of Buy-Sell Agreements 183Holsey v. Commissioner 183Sullivan v. United States 186Notes 189Problems 190

2. Redemptions as Part of Bootstrap Acquisitions 190Problems 191

3. Redemptions for More or Less than Stock Value 191Commissioner v. Fink 193Notes 196Problems 198

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D. Redemptions by Related Corporations — §304 198Rev. Rul. 71-563 198Notes 200Problems 204Citizens Bank & Trust Co. v. Commissioner 205Notes 209

6Distributions of Stock 211

A. Distributions of Stock and Stock Rights under §305 2111. The General Rule of Nontaxability under §305(a) 2112. Exceptions to the General Rule: §305 (b) and (c) 212

a. Actual Distributions 212Frontier Savings Association v. Commissioner 213Rev. Rul. 78-375 217Notes 220

b. Constructive Distributions 221Rev. Rul. 78-60 222Rev. Rul. 83-42 224Notes 225Problems 227

B. Tainting of Stock under §306 227Chamberlin v. Commissioner 228Fireoved v. United States 231Rev. Rul. 81-91 238Rev. Rul. 76-387 239Notes 240Problems 245

Liquidations 247

Rendina v. Commissioner 249Notes 254

A. Section 331 Liquidations , 2551. Treatment Shareholders 255

a. Exchange Treatment under §331 255b. Treatment of Liabilities 255c. Contingent Assets 256d. Installment Notes 256e. Allocation of Stock Basis to Liquidating

Distributions 2572. Treatment of Liquidating Corporation 257

a. Recognition of Gain or Loss at the Corporate Level 257b. Treatment of Liabilities 258

Contents

c. Treatment of Corporate-Level Losses 259d. Costs of a Liquidation 261

3. The Court Holding Co. Doctrine and Former §337 262Commissioner v. Court Holding Co. 262Notes 263Problems 266

Subsidiary Liquidations and Related Provisions 2661. Section 332 Liquidations 266

Associated Wholesale Grocers, Inc. v. United States 267Notes , 276Problems 'v 279

Integration of the Corporate and Individual Income Taxes 281

A. The Incidence and Effects of the Corporate Tax 281Integration of the Individual and Corporate

Tax Systems: Taxing Business Income Once 3-11 282Investing in America's Future: Report of the Department

of Treasury on the Economic Effects of Cutting Dividendand Capital Gains Taxes in 2003 (March 14, 2006) 286

Notes 289B. Methods of Integration 290

Reporter's Study of Corporate Tax Integration 292Notes 294Problems 295

Taxable Acquisitions 297

A. Asset Purchase -, 2971. Overall Tax Treatment 2972. Allocation of Purchase Price 299

B. Stock Purchase 3001. Individual Purchaser 3002. Corporate Purchaser: §338 301

Notes 303Problems 307

C. Bootstrap Acquisitions 308D. Expenses in Connection with an Acquisition 308

INDOPCO, Inc. v. Commissioner 308Notes 314

E. Corporate Acquisitions and the Use of Debt 317Joint Committee on Taxation, Federal

Income Tax Aspects of CorporateFinancial Structures 317

Notes 325

xvi Contents

10.Acquisitive Reorganizations 327

A. Introduction 327B. Judicial Requirements 329

1. Continuity of Proprietary Interest 330Notes 331Kass v. Commissioner 333Notes 336Problems 341

C. Definitional Issues 3411. The A Reorganization: Statutory Mergers and

Consolidations 3422. The B Reorganization: Stock for Stock 343

Chapman v. Commissioner 344Notes 354Problems 356

3. The C Reorganization: Stock for Assets 356Notes 357Problems 359

4. The Nondivisive D Reorganization 359Smothers v. United States 360Notes 367Problems 369

5. Remote Continuity 3696. Triangular Reorganizations 370

Problems 372D. Taxation 372

1. Overview 3722. Corporate-Level Taxation 373

Problems 3763. Shareholder-Level Taxation : 377

Notes , 378Problems ' 382

E. The Status of Creditors in Corporate Reorganizations 382F. Reorganizations of Insolvent or Financially Distressed

Corporations 383Problems 386

G. Policy 386

11Divisive Reorganizations 389

A. Taxation under §355 389Coady v. Commissioner 389Rev. Rul. 59-400 394Notes 395Problems 405

Contents xvii

B. Variations 407Bhada v. Commissioner 407Notes 412Problems 412Commissioner v. Morris Trust 412Notes 418Problems 422

12.One-Party Reorganizations 423

A. Recapitalizations 423Bazley v. Commissioner 424Notes 426

B. Reincorporations 429Problems 430

13.Combining Tax Attributes: Net Operating Lossesand Affiliated Corporations 431

A. Carryover of Tax Attributes 4311. Section 381 4322. Section 382 433

Notes 4353. Section 383 4414. Section 384 4415. Section 269 443

Commissioner v. British Motor Car Distributors 444Notes - 446Problems 448

B. Affiliated Corporations 449Notes 450Problems 456

14.Penalty Provisions 459

A. Accumulated Earnings Tax 459Notes 461Problems 468

B. Personal Holding Company Tax 468Notes 469

xviii Contents

15The Corporation as a Separate Taxable Entity 473

A. Definition of a Corporation 4731. Morrissey v. Commissioner 4732. Professional Corporations 4733. The Association Regulations 4744. Larson and Limited Partnerships 4745. The "Check-the-Box" Regulations 4756. Limited Liability Companies 477

B. Dummy Corporations " 478Commissioner v. Bollinger 478Notes 483Problems 483

C. Reallocation of Income and Related Issues 4841. Section 482 in General 484

a. Sales 485b. Services 488c. Rentals of Tangible Property 489d. Licenses of Intangible Property 489e. Loans 490

2. The Interplay of §482 and Foreign Law 490Problems 491

3. Income Shifting and the Assignment of Income Doctrine 492Problems 493

4. Denial of Tax Benefits under §269A 4935. The "Graduated Bracket Amount" and §1561 (a) 494

IISUBCHAPTER S CORPORATIONS 495

16 :S Corporations: Overview 497

A. Introduction 497B. The S Corporation Election 499

Kean v. Commissioner 499Rev. Rul. 86-110 502Notes 505Problems 506

C. Formation 506D. Pass-Thru of Corporate Income and Deduction 508

Problems 509E. Nonliquidating Distributions 510

Problems 512F. Dispositions of Shares and Liquidating Distributions 513

1. Disposition of Stock Not in Redemption 513Problems 514

Contents xix

2. Redemptions of Stock 5153. Liquidating Distributions 518

17.S Corporations: Selected Topics 521

A. One Class of Stock 521Notes 521Problems ^ 523

B. Qualified Subchapter S Subsidiaries —" 524Notes 524Problems 527

C. Stock and Debt Basis 527Estate of Leavitt v. Commissioner 529Notes 534Problems 537

D. Assignment of Income Concerns 5381. Precontribution Appreciation and Related

Problems 5382. Family Ownership and Section §1366(e) 538

Problems 539E. Sales of Stock and the Section 338 (h) (10) Election 539

Problems 540

18Transition Issues 541

A. From C Corporation to S Corporation 5411. Shareholder Taxation of Distributions 541

Problems 5442. Corporate-Level Tax on Built-in Gains •. 544

Problems 5453. Disabilities Associated with Passive Investment Income 546

Notes 546Problems 548

4. No Carryover from C Year to S Year 548B. From S Corporation to C Corporation ' 549

IIISUBCHAPTER K PARTNERSHIPS 551

19The Structure of Partnership Taxation 553

A. Note on Limited Liability Companies 553

xx Contents

B. The Pass-Thru of Partnership Income 554United States v. Basye 555Problems 560

C. Formation and Operation of the Partnership 560Problems 562

D. Nonliquidating Distributions 562Problems 567

E. Dispositions of Partnership Interests 568

20 - -—

Determining Distributive Shares 569

A.

B.

C.

D.

E.

F.

G.

H.

Basic Maintenance of Capital AccountsProblems

Economic Effect I: The General TestNotesProblems

Economic Effect II: The Alternate TestRev. Rul. 97-38NotesProblems

Failure to Satisfy the Economic Effect TestNotes

Allocations with Respect to Contributed Property1. Allocations to the Contributing Partner under Section

§704(c)(l)(A)ProblemsNotesProblems

2. Reverse Section §704 (c) Allocations to the Existing PartnersProblems

Allocations of Deductions Attributable to Nonrecourse Debt1. Definitions

a. Nonrecourse Liabilityb. Minimum Gainc. Nonrecourse Deductions

2. General Principles3. Distribution of Refinancing Proceeds4. Book/Tax Disparities5. Partner Nonrecourse Debt

ProblemsSubstantiality under §704 (b)

NotesProblems

Prohibitions on Retroactive AllocationsProblems

570571572579581581582585587588590594

594597602603603604605605605606607608614615615616616619620620622

Contents xxi

21A Partner's Outside Basis 623

A. Basic Principles under §705 623B. Partnership Indebtedness and Outside Basis 625

1. History and Basic Principles 626Abramson v. Commissioner 626

2. Allocations under the Regulations 631Notes 632

a. Recourse Liabilities ', 633i. The Regulatory Scheme v - — 633

Notes 634Problems 635

ii. Some Questions 635b. Nonrecourse Liabilities 636

Problems 640C. Why §752? 640D. Holding a Partnership Interest Through a Disregarded

Entity 6411. Guarantee of a Disregarded Entity's Partnership

Obligation 6422. The Impact of Assets Owned by the Disregarded Partner 644

E. Bifurcated Holding Period of a Partnership Interest 645F. The Effect of Indebtedness on Partnership Allocations 647

1. Allocations under the Alternate Test for EconomicEffect 647

2. Property Encumbered by Multiple Indebtedness 6483. Partial Guarantees 649

a. Last Dollar Guarantee 649b. First Dollar Guarantee 650

22.Nonliquidating Distributions 651

A. Distributions Not Subject to §751 (b) 6511. Basic Taxation Rules 651

a. Recognition of Gain and Loss , 651b. Basis of Distributed Property and Outside Basis 651c. The Timing of Taxation 653

Notes 654Problems 654

2. Distributions and Capital Accounts 654a. Excess Cash 654b. Appreciated and Loss Property 655

i. Predistribution Book/Tax Disparities 656ii. Book/Tax Disparity Caused by Asset Revaluation 657

xxii Contents

iii. Book/Tax Disparity Caused by InsufficientOutside Basis 658Problems 658

3. Distributions of Encumbered Property 659Rev. Rul. 79-205 659Notes 662Problems 663

4. Distribution of Marketable Securities 664Problems 664

5. Disposition of Distributed Assets 665Problems v - — 666

B. Distributions Subject to §751 (b) 6661. The Definition of Unrealized Receivables 6662. The Definition of Substantially Appreciated Inventory 667

a. Partnership Inventory Items 667b. Substantial Appreciation 668

s3. Operation of §751 (b) 669Notice 2006-14 669

C. Distributions and the Dynamic Nature of Recourse Debt 674

23A Partner's Transactions with the Partnership 681

A. Guaranteed and Similar Payments 681Problems 683

B. Disguised Sales 6841. The Rules 684

a. Basic Principles 684b. Simultaneous Contributions and Distributions 685

i. Contributions of Unencumbered Property 685ii. Contributions of Encumbered Property 686

c. Nonsimultaneous Disguised Sales . 689i. The Two-Year Presumptions 689ii. Rebutting the Presumptions 689iii. The Timing Rules 690

d. Effect on Other Provisions 6932. The Exceptions 693

a. Reasonable Guaranteed Payments 693b. Reasonable Preferred Returns 693c. Operating Cash-Flow Distributions 693d. Preformation Expenditures 694e. The Disclosure Rules 694

Problems 694B. Distributions of Contributed Property: §704(c) (1) (B) 695

Problems 696C. Swap Transactions under §737 697

Notes 698Problems 699

Contents xxiii

D. Capitalization Avoidance and §707(a) (2) (A) 699Problems 701

E. Limitations Applicable to Controlled Partnerships 7011. Disallowed Losses 701

Notes 7032. Capital Gains 703

Problems 704

24.Acquisitions of Partnership Interests ~~~ 705

A. Contributions of Property 7051. Basic Principles 7052. Encumbered Property 706

Problems 7093. Payables and Receivables 709

Problems 7104. Promissory Notes 7105. Holding Periods 7106. Disposition of Contributed Property 712

Problems 7137. Contributions to Investment Companies 713

B. Contributions of Services 7141. Taxation of the Contributing Partner 715

Revenue Procedure 93-27 715Notes 716Problems 721

2. Taxation of the Partnership 721C. Noncontribution Acquisitions 723

Problems 724

25Dispositions of Partnership Interests 725

A. Distributions in Liquidation of a Partnership Interest 7251. A Note on §§731-732 726

Notes ' 7292. Application of §736 730

a. A First Note on the Application of §736 730b. Classification of Payments under §736 731c. Taxation of Payments in Liquidation of a General

Partnership Interest When Capital Is Not a MaterialIncome-Producing Factor 733

d. Taxation of Payments under §751 (b) 734e. Deferred Payments under §736 736f. Section 736, Partnership Goodwill, and the §704 (b)

Regulations 737

xxiv Contents

g. A Final Note on the Application of §736 738Problems 740

B. Disposition of a Partnership Interest 7401. Basic Rules 7402. Application of §751 (a) 741

Problems 7423. Taxation of the Capital Gains Portion 744

a. Holding Period 744b. Capital Gain Rate 745

4. Non-Sale Dispositions 7455. Closing of the Taxable Year v - —- 7456. Termination of the Partnership 746

Notes 749Problems 749

7. Death of a Partner 750C. Partial Dispositions 750

vl. No Partnership Liabilities 751a. Partial Sale of a Single Interest 751b. Sale of One Interest Out of Many 751

2. Partnership Liabilities Are Present 751

26Loss Limitations 753

A. Section 704 (d): The Outside Basis Limitation 7531. The Relation of §704(d) to §704(c) 7542. Transfers of Partnership Interests 755

Problems 756B. Section 465: The At-Risk Limitation 757

1. An Overview of §465 7572. The §465 Proposed Regulations 7593. Application of §465 to Partners and Partnerships 760

Problems ' 762C. A Reexamination of §704(d) and its Relation to §704(b) 762

1. Misallocation of Loss 762Problems 765

2. Contributions of Notes 765D. Section 469: The Passive Loss Limitations 766E. Section 163(d): The Investment Interest Limitation 768

Problems 769

27.Inside Basis Adjustments 771

A. The Inside Basis Adjustment under §734(b) 7721. Distributions Triggering the Inside Basis Adjustment 772

Contents xxv

a. Nonliquidating Distributions of Excess Cash 772b. Nonliquidating Distributions of High-Basis Property 773c. Liquidating Distributions 774

2. The Amount of the Adjustment under §734(b) 7743. Allocating the §734 (b) Adjustment under §755 775

a. Allocation of Positive §734 (b) Adjustments 776b. Allocation of Negative §734 (b) Adjustments 777c. Allocation of §734 (b) Adjustments to Depreciable

Property 778Notes I 778Problems 'v 779

4. The Flaw in the §734 (b) Inside Basis Adjustment 779Problems 782

B. The Inside Basis Adjustment under §743(b) 7821. Two-Way Adjustments under §743 (b) 7832. Allocating the §743 (b) Adjustment under §755 789

a. Basic Rules 789b. Allocation of §743 (b) Adjustments to Depreciable

Property 791c. Partnership Disposition of Adjusted Property 791

3. Distribution of Property Subject to a §743(b) BasisAdjustment 792

Notes 793Problems 793

C. Mechanics of the Election 794Notes 795

D. Optional Basis Adjustments and Capital Accounts 795E. Basis Adjustments under §732 (d) 796

28Partnership-Level Issues 799

A. Classification as a Partnership 7991. Elective Classification 800

Notes 801Problems 803

2. Publicly Traded Partnerships 8033. Recognizing Partner Status 804

a. General Principles 804b. Family Partnerships 804

Problems 807B. Partnership Elections 807

1. Taxable Year 807Problems 809

2. Method of Accounting 809C. Special Issues 810

1. The Anti-Abuse Rules 810

xxvi Contents

a. The General Anti-Abuse Rule 810Problems 812

b. The Abuse of Entity Rule 8122. Treatment of Organization and Syndication Expenses 812

Problems 8133. Cancellation of Indebtedness Income and §108 814

Table of Cases 817Table of Revenue Ruling and Procedures 821Index v 823