Category: Corporations
Subject: Reorganizations
Title: Spin-off and Subsequent Merger of Spun-Off Business, Morris Trust Issues
IRC Sections: 355, 368
Filename: 1066.html
Date Produced: 9/97

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Background
As I understand it, Dr. S's professional corporation (PC) has for many years been engaged in two distinct lines of business: A) conduct of drug studies, and B) a traditional medical practice. Another practitioner, Dr. J, has a corporation, separate from Dr. J's medical practice, that is also engaged in drug studies.

It has been suggested that Dr. S's PC spin-off the drug study business into a new corporation and then merge the new company into the drug testing company owned by Dr. J. It has been suggested that all this can be accomplished on a tax-free basis.

Discussion
At one time, it was possible to do something rather similar to what has been described above on a tax-free basis. That is no longer the case. The technique is referred to as the Morris Trust technique so called because of the tax case Comr. v. Morris Trust, 367 F 2d 794 (4th Cir. 1966). Under this technique, it would have been possible for Smith to spin off the medical practice (not the drug study business) into a newly-formed corporation, NEWPC. Then, the drug study business (now residing in the corporate shell originally containing both the drug study business and the medical practice, OLDPC) would be merged into Jones's drug study company.

This technique has effectively been outlawed by the 1997 tax legislation recently passed. In the parlance of Section 355 and the D-reorganization provisions, NEWPC is the controlled corporation and OLDPC is the distributing corporation.

Under the new law, if either the distributing corporation or the controlled corporation is acquired in certain applicable transactions, the stock of the controlled corporation is not qualified property for purposes of the initial spin-off. Applicable transactions include a merger of one corporation into another if the acquiring corporation acquires a 50%-or-more interest in the target company.

These new rules result in OLDPC's distribution of the stock of NEWPC to Dr. S and Dr. B not being protected by the reorganization provisions. Thus, any difference between the fair market value of such stock and its basis would be treated as gain inside the distributing corporation. In addition, Dr. S and Dr. B would be taxed as a dividend on receipt of the stock of NEWPC.