## Facts

- South Tulsa Pathology Laboratory, Inc. (South Tulsa) operated an anatomic pathology business and a clinical laboratory business.
- South Tulsa’s shareholders negotiated a sale of the clinical laboratory business to National Health Laboratories, Inc. (NHL).
- To carry out the transaction, South Tulsa formed a new corporation, Clinpath, Inc.
- On October 29, 1993, South Tulsa transferred the clinical laboratory assets (basis \$105,015) to Clinpath in exchange for all Clinpath stock, intending § 368(a)(1)(D) treatment.
- On October 30, 1993, South Tulsa distributed all Clinpath stock to its shareholders, claiming the distribution qualified as a § 355 spin-off.
- On the same day as the distribution, Clinpath’s shareholders sold all Clinpath stock to NHL for \$5,530,000 pursuant to a prearranged plan.
- South Tulsa had accumulated earnings and profits (E&P) and failed to prove that South Tulsa and Clinpath lacked current E&P as of October 30, 1993.
- The IRS determined a corporate-level deficiency of \$1,926,232 for the year ended June 30, 1994, treating the distribution as taxable and requiring gain recognition under § 311(b)(1).

## Issues

1. Whether the Clinpath stock distribution qualified for nonrecognition as part of a § 368(a)(1)(D) reorganization with a § 355 distribution, or failed because it was used principally as a “device” to distribute E&P.
2. If § 355 failed, whether Clinpath stock’s fair market value for § 311(b)(1) gain recognition was the \$5,530,000 NHL purchase price or a lower value based on Clinpath’s assets.

## Decision

- The court held the spin-off failed § 355 because it was a device for distributing E&P, given the prearranged, same-day sale of the spun-off stock and the existence of E&P.
- Because § 355 failed, the intended nonrecognition structure under §§ 368(a)(1)(D) and 355 did not apply.
- The court held Clinpath stock’s fair market value under § 311(b)(1) was \$5,530,000, as shown by the contemporaneous arm’s-length sale to NHL.
- Decision for the Commissioner; the deficiency was sustained.

## Legal Principles

- A § 355 distribution is disqualified if used principally as a device for distributing the E&P of the distributing or controlled corporation; a prearranged spin-off followed by an immediate stock sale is strong device evidence.
- The taxpayer bears the burden to show that nondevice factors (including business purpose) outweigh device evidence and to substantiate facts relevant to the device analysis, including E&P.
- If a distribution of appreciated property does not qualify for nonrecognition, § 311(b)(1) requires the distributing corporation to recognize gain as if the property were sold at fair market value.
- A contemporaneous arm’s-length sale price is highly probative evidence of fair market value for § 311(b)(1) purposes absent persuasive contrary proof.

## Conclusion

The Tax Court treated the spin-off-and-sale transaction as a taxable distribution because the spin-off served as a device to distribute E&P, and it measured corporate-level gain under § 311(b)(1) using the arm’s-length sale price paid in the same-day, prearranged stock sale.


S. Tulsa Pathology Lab., Inc. v. Commissioner, 118 T.C. 84 (2002)