## Facts

- The petitioner was The Edna Louise Dunn Trust, Morgan Guaranty Trust Company, Trustee, which owned 400 shares of AT&T common stock.
- The Commissioner determined a $29.64 federal income tax deficiency for the trust’s taxable year ended May 31, 1984.
- The case was submitted fully stipulated under Tax Court Rule 122, so the dispute turned on the legal effect of stipulated corporate transactions.
- AT&T owned a large majority of Pacific Telephone and Telegraph Company (“Pacific”) voting stock before 1982 but did not own Pacific’s nonvoting preferred stock.
- In 1982, AT&T acquired the remaining Pacific voting stock (both common and preferred) through a merger structure in which Pacific voting shareholders received AT&T stock and cash.
- Because AT&T lacked “control” of Pacific (as defined in I.R.C. § 368(c)) immediately before the 1982 merger—due to its not owning the nonvoting preferred—the 1982 acquisition was treated as a taxable transaction to the Pacific voting shareholders.
- In 1983, as part of the Bell System divestiture plan, AT&T formed Pacific Telesis Group (“PacTel”), a new holding company.
- AT&T transferred all of its Pacific stock, along with other assets, to PacTel in exchange for all of the PacTel stock; AT&T treated that exchange as nontaxable and obtained control of PacTel.
- Effective January 1, 1984, AT&T distributed PacTel stock (and stock of other regional holding companies) pro rata to AT&T shareholders.
- The Dunn Trust received PacTel shares in the distribution and did not report income from the receipt, treating the distribution as tax-free under I.R.C. § 355.
- The Commissioner asserted that a portion of the PacTel stock distributed should be treated as “other property” under § 355(a)(3)(B), measured by the value attributable to the Pacific voting stock AT&T had acquired in the 1982 taxable merger, and therefore proposed the deficiency.

## Issues

1. Whether any portion of the PacTel stock distributed to AT&T shareholders was “other property” under I.R.C. § 355(a)(3)(B) because AT&T had acquired Pacific voting stock in a taxable transaction within five years before the distribution.
2. Whether § 355(a)(3)(B) applies indirectly when the distributing corporation does not distribute the recently acquired stock itself (Pacific), but instead distributes stock of a controlled holding company (PacTel) that owns the subsidiary stock.

## Decision

- The Tax Court held for the petitioner.
- No portion of the PacTel stock distributed to AT&T shareholders constituted “other property” under § 355(a)(3)(B).
- The Commissioner’s deficiency determination was not sustained.

## Legal Principles

- Section 355(a)(3)(B) addresses stock of the “controlled corporation” that the distributing corporation acquired within five years in a transaction in which gain or loss was recognized; such acquired stock is treated as “other property” if it is the stock being distributed.
- The statute’s focus on stock “of such controlled corporation” does not authorize treating stock of a different corporation as boot merely because that corporation’s assets include stock acquired in an earlier taxable deal.
- The phrase “by reason of any transaction” in § 355(a)(3)(B) does not create a general look-through rule that recharacterizes a portion of holding-company stock based on the history of assets held below the holding company.
- Respect for separate corporate entities matters in applying § 355(a)(3)(B): distributing PacTel stock is not the same as distributing Pacific stock, even if PacTel’s principal asset is Pacific stock.
- Concerns about abusive separations are addressed by other limits within § 355 (such as the device restriction), not by expanding § 355(a)(3)(B) beyond its text.

## Conclusion

Edna Louise Dunn Trust v. Commissioner held that AT&T’s distribution of PacTel holding-company stock to its shareholders in the Bell System divestiture was not partly taxable under § 355(a)(3)(B) merely because PacTel held Pacific voting shares that AT&T had acquired in a taxable merger within the prior five years; because AT&T distributed PacTel stock rather than the recently acquired Pacific stock, no part of the distribution was treated as “other property,” and the asserted deficiency was rejected.


Edna Louise Dunn Trust v. Commissioner, 86 T.C. 745 (1986)