## Facts

- Thorval J. Lockwood and Margaret K. Lockwood were the sole shareholders of Lockwood Grader Corporation, a Nebraska corporation formed in 1946 from a prior partnership.
- Lockwood Grader manufactured and sold potato sorting and related equipment and maintained operations serving multiple potato-growing regions in the United States.
- By no later than 1949, Lockwood Grader conducted recurring sales and service activity in Maine related to its potato equipment business.
- In 1956, the Lockwoods caused Lockwood Grader to form Lockwood Graders of Maine, Inc. and transferred to it assets associated with the Maine operations.
- Stock of the new corporation was distributed to the Lockwoods, who reported the transaction as a tax-free distribution under I.R.C. § 355.
- The Commissioner determined the distribution was taxable because the five-year active-conduct requirement of § 355(b)(2)(B) was not met.
- The Tax Court sustained the deficiency; the taxpayers (the estate and the widow) sought review.

## Issues

1. Whether the spun-off Maine operation satisfied I.R.C. § 355(b)(2)(B)’s requirement that the trade or business be actively conducted throughout the five-year period ending on the distribution date.
2. Whether § 355 requires the controlled corporation (or a separately organized corporate unit) to have existed and operated as a distinct business for the full five years, or whether a divisional/branch business within the distributing corporation can satisfy the requirement.

## Decision

- The court reversed the Tax Court and held the 1956 distribution qualified for nonrecognition under § 355.
- It concluded the Maine activity constituted an “active” trade or business and had been conducted for at least five years before the spin-off.
- The court rejected the view that the five-year test fails merely because the Maine operations were not previously conducted in a separate corporate entity.
- The case was remanded for entry of judgment consistent with treating the distribution as tax-free under § 355.

## Legal Principles

- For § 355(b)(2)(B), the five-year requirement focuses on continuity of the underlying trade or business, not on the existence of a separate corporate shell for the entire period.
- A trade or business may satisfy § 355’s active-conduct requirement when it is operated as a division or branch of the distributing corporation and later transferred to a controlled corporation in a spin-off.
- Where historical facts are largely undisputed, whether those facts amount to an “active” trade or business meeting § 355’s five-year standard is a legal characterization subject to appellate correction.

## Conclusion

A spin-off can qualify as tax-free under I.R.C. § 355 when the controlled corporation receives an established line of business that the distributing corporation actively conducted as a branch operation for at least five years, even if the controlled corporation itself was newly formed at the time of the distribution.


Lockwood’s Estate v. Comm’r, 350 F.2d 712 (8th Cir. 1965)