## Facts

- A North Carolina state bank operated a longstanding insurance department while also conducting its banking business.
- The state bank sought to merge into a federally chartered national bank, with the combined institution operating under the national bank charter.
- Federal banking law generally prohibited a national bank from operating an insurance department in the relevant locality.
- To remove the regulatory obstacle to the merger, the state bank formed a new corporation to hold the insurance business.
- The state bank transferred the insurance department’s assets to the new corporation in exchange for all of its stock.
- The state bank distributed the new corporation’s stock pro rata to the state bank’s shareholders (a spin-off).
- Immediately after the distribution, the state bank merged into the national bank, which survived and continued the combined banking business under the national charter.
- The Commissioner treated the distribution as taxable ordinary income to the shareholders; the Tax Court held the distribution qualified for nonrecognition under I.R.C. § 355.

## Issues

1. Whether the pro rata distribution of the spun-off insurance company’s stock qualified for nonrecognition under I.R.C. § 355 when it preceded a planned merger of the distributing bank into another bank.
2. Whether § 355(b)(1)(A)’s requirement that the distributing corporation be engaged in the active conduct of a trade or business “immediately after the distribution” was satisfied despite the distributing corporation’s near-immediate disappearance in a merger.

## Decision

- The Fourth Circuit affirmed the Tax Court.
- The court held that the distribution satisfied § 355 and did not produce recognizable gain to the shareholders.
- The court rejected the Commissioner’s view that the merger’s effect on the distributing corporation’s corporate form negated the “immediately after” active business requirement.

## Legal Principles

- A § 355 distribution may qualify for nonrecognition when the statutory requirements are met and the transaction reflects continuity of the business enterprise and shareholder interests, even if the distributing corporation soon changes form through a merger.
- The “immediately after the distribution” active business condition focuses on the uninterrupted continuation of an active business, not on preserving the distributing corporation’s separate corporate shell for a particular period.
- Step-transaction concerns do not automatically defeat § 355 treatment where the integrated steps do not function as a disguised dividend, cash-out, or extraction of liquid assets, and where shareholders’ economic ownership in the continuing enterprise remains substantially intact.
- A strong, non-tax business purpose—here, compliance with banking-law restrictions necessary to complete the merger—supports respecting the spin-off as a qualifying divisive reorganization rather than recharacterizing it as taxable.

## Conclusion

The court upheld tax-free treatment under I.R.C. § 355 for a spin-off undertaken to separate a regulated line of business before a merger, reasoning that the banking business continued without interruption through the surviving entity and the overall transaction did not operate as a shareholder bail-out or other taxable substitute.


Commissioner v. Mary Archer W. Morris Trust, 367 F.2d 794 (4th Cir. 1966)