## Facts

- Ridge Pallets, Inc. (Ridge) was a Florida S corporation owned by three individual shareholders.
- Sunbelt Forest Products, Inc. (Sunbelt) was a Florida C corporation; Ridge owned 50% and an individual (Hutto) owned the other 50%.
- Ridge had guaranteed Sunbelt’s bank debt, later withdrew the guaranty, and purchased Sunbelt’s loan from the bank to gain leverage over Sunbelt.
- Ridge and Hutto arranged for Sunbelt to redeem Hutto’s shares for cash and real estate.
- To fund the redemption, Sunbelt borrowed $900,000 from Ridge, which supplied most of the consideration used to redeem Hutto’s stock.
- Hutto treated the redemption as a taxable transaction and recognized capital gain.
- The redemption left Ridge as the 100% owner of Sunbelt, giving Ridge “control” of Sunbelt for purposes of I.R.C. § 355.
- On January 15, 1993, the same day as the redemption, Ridge distributed all Sunbelt stock pro rata to Ridge’s shareholders, intending a tax-free spin-off under § 355.
- The IRS determined the distribution did not qualify under § 355, required Ridge to recognize gain under § 311(b), and treated the gain as passing through to the shareholders under § 1366(a).

## Issues

1. Whether Ridge’s distribution of Sunbelt stock qualified for nonrecognition as a § 355 spin-off when Ridge acquired control of Sunbelt less than five years before the distribution in a transaction in which gain or loss was recognized.
2. If § 355 did not apply, whether Ridge recognized gain under § 311(b) on the distribution and whether that gain flowed through to Ridge’s S corporation shareholders under § 1366(a).

## Decision

- The Tax Court held for the Commissioner.
- The court ruled that the distribution failed the active business requirement of § 355(a)(1)(C) and § 355(b)(2)(D)(ii) because Ridge distributed Sunbelt stock less than five years after acquiring control of Sunbelt in a recognition transaction.
- As a result, § 355 nonrecognition did not apply; Ridge recognized gain under § 311(b) on the distribution of appreciated Sunbelt stock.
- Because Ridge was an S corporation, the recognized gain flowed through and was taxable to the shareholders under § 1366(a).

## Legal Principles

- A distribution intended to qualify under § 355 must satisfy the active business requirement, including that the distributing corporation’s control of the subsidiary not be acquired within the five-year period in a transaction in which gain or loss was recognized. I.R.C. § 355(a)(1)(C), (b)(2)(D)(ii).
- Acquiring control through a stock redemption that results in recognized gain to the redeemed shareholder can constitute an acquisition of control “in a transaction in which gain or loss was recognized” for § 355(b)(2)(D)(ii).
- When a corporate distribution of property does not qualify for § 355 nonrecognition, § 311(b) generally requires the distributing corporation to recognize gain as if the property were sold at fair market value.
- For an S corporation, corporate-level gain recognized under § 311(b) passes through and is taxed to shareholders under § 1366(a).

## Conclusion

The Tax Court denied § 355 spin-off treatment because Ridge acquired control of Sunbelt in a recognition transaction and distributed the Sunbelt stock on the same day, failing § 355’s five-year active business requirement; the distribution therefore triggered gain recognition under § 311(b) that flowed through to Ridge’s shareholders under § 1366(a).


McLaulin v. Commissioner, 115 T.C. 255 (2000)