## Facts

- Stephan Schaffan wholly owned two New Jersey corporations: Atlas Tool Co., Inc. (Atlas) and Fletcher Plastics, Inc. (Fletcher).
- Atlas was the principal purchaser of Fletcher’s manufactured products.
- In 1970, Atlas purchased for cash substantially all of Fletcher’s operating assets (including machinery, equipment, and inventory).
- Atlas hired Fletcher’s employees and later used the transferred assets to produce the same products Fletcher had made; there was an approximately three-month period of minimal use while Atlas attempted to rely on foreign suppliers.
- After selling its operating assets, Fletcher distributed its remaining cash to Schaffan (about $482,246.82) and dissolved.
- Fletcher had accumulated earnings and profits (E&P) of about $440,342.56.
- Schaffan reported the cash distribution as long-term capital gain, asserting it was a complete liquidation under I.R.C. § 331.
- The Commissioner treated the overall series of steps as a tax-free reorganization under I.R.C. § 368(a)(1)(D), with the shareholder cash distribution treated as boot taxable as a dividend under I.R.C. § 356(a)(2) to the extent of E&P.
- The Commissioner also asserted (i) Atlas’s transferee liability for Fletcher’s tax deficiencies under New Jersey successor-liability doctrines and (ii) accumulated earnings tax liability against Atlas for fiscal years ending June 30, 1969 and June 30, 1970.

## Issues

1. Whether the asset sale, liquidation, and cash distribution were a complete liquidation under I.R.C. § 331 or were integral steps in a § 368(a)(1)(D) reorganization.
2. If a § 368(a)(1)(D) reorganization occurred, whether the shareholder’s cash constituted boot under § 356(a), and whether dividend treatment under § 356(a)(2) is limited by the E&P of the target only or by the combined E&P of target and acquirer.
3. Whether the reorganization’s “substantially all” requirement was satisfied where the target distributed substantial cash to its shareholder but transferred its operating assets to the acquirer.
4. Whether Atlas was liable as a transferee for Fletcher’s tax liabilities under New Jersey law based on de facto merger and “mere continuation.”
5. Whether Atlas was liable for accumulated earnings tax for its fiscal years ending June 30, 1969 and June 30, 1970.

## Decision

- The Third Circuit affirmed the Tax Court’s determination that the steps were part of a § 368(a)(1)(D) reorganization, not a § 331 liquidation.
- The court held the shareholder cash distribution was boot under § 356(a) and was treated as a dividend under § 356(a)(2) to the extent of Fletcher’s E&P, with any excess treated as capital gain.
- The court affirmed that, for § 356(a)(2), the relevant E&P limitation was Fletcher’s E&P, not the combined E&P of Fletcher and Atlas.
- The court agreed that the “substantially all” requirement was satisfied because Fletcher transferred substantially all operating assets to Atlas; the distribution of substantial cash to the shareholder did not defeat that requirement.
- The court affirmed Atlas’s transferee liability for Fletcher’s tax deficiencies under New Jersey de facto merger and “mere continuation” doctrines.
- The court upheld accumulated earnings tax liabilities determined against Atlas for the fiscal years in issue.

## Legal Principles

- Separate transactional steps may be treated as a single integrated plan under substance-over-form and step-transaction principles when the steps function together as a reorganization.
- A transfer of substantially all operating assets to an acquiring corporation, followed by liquidation of the transferor, can qualify as a § 368(a)(1)(D) reorganization notwithstanding retention and distribution of non-operating cash.
- In a reorganization, shareholder cash received can be boot under § 356(a) and treated as a dividend under § 356(a)(2) to the extent it has the effect of a dividend, limited by the transferor/target’s E&P on these facts.
- Transferee liability for federal tax may attach under state successor-liability rules where a transaction constitutes a de facto merger or the acquirer is a mere continuation of the transferor.
- Accumulated earnings tax may be imposed when corporate earnings are accumulated beyond reasonable business needs with a purpose of avoiding shareholder-level tax.

## Conclusion

The Third Circuit upheld characterization of the Atlas–Fletcher transactions as a § 368(a)(1)(D) reorganization, treated the shareholder’s cash as boot taxable as a dividend only up to Fletcher’s E&P, sustained the “substantially all” test based on operating assets, imposed transferee liability on Atlas under New Jersey successor doctrines, and affirmed accumulated earnings tax liabilities against Atlas.


Atlas Tool Co. v. Comm’r, 614 F.2d 860 (3d Cir. 1980)