Burke v. Commissioner
42 T.C. 1021; 1964 U.S. Tax Ct. LEXIS 46 (1964)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
The tax-free division of a single, integrated business is permissible under I.R.C. § 355. The five-year active business requirement is satisfied if the overall business has been actively conducted for five years, even if the specific assets or branch being spun off into a new corporation were established less than five years prior to the distribution.
Facts:
- L. B. Walker started a radio parts wholesale business in Pueblo, Colorado in 1921, which was incorporated as L. B. Walker Radio Co. of Pueblo (Pueblo) in 1947.
- The Pueblo company served a large territory, including western Colorado, using salesmen who operated out of the Pueblo store.
- In April 1954, to better serve its growing customer base in western Colorado, the Pueblo company rented space and established a branch store and warehouse in Grand Junction.
- The Grand Junction branch was highly integrated with and dependent on the Pueblo headquarters, which handled bookkeeping, accounts receivable, credit, collections, and supplied approximately 80% of the branch's merchandise.
- The Grand Junction branch manager, H. B. Pearce, was instrumental in the branch's growth and expressed a desire to invest in the local operation.
- To enable Pearce to acquire an ownership stake, Pueblo's board of directors decided in December 1956 to form a new corporation for the Grand Junction operation.
- On January 7, 1957, the L. B. Walker Radio Co. of Grand Junction (Grand Junction) was incorporated, the assets of the branch were transferred to it in exchange for all of its stock, and this stock was then distributed pro rata to the shareholders of the Pueblo company (the petitioners).
- Following the spin-off, Pearce contributed land to the Grand Junction company in exchange for stock, and the new company became operationally independent.
Procedural Posture:
- Petitioners L. B. Walker, Mildred O. Walker, and Patricia W. Burke filed their 1957 federal income tax returns treating the receipt of Grand Junction company stock as a non-taxable distribution.
- The Commissioner of Internal Revenue determined that the stock distribution was a taxable dividend and asserted income tax deficiencies against the petitioners for the 1957 calendar year.
- The petitioners challenged the Commissioner's determinations by filing petitions in the Tax Court of the United States.
- The individual cases were consolidated for trial and briefing before the Tax Court.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Does the spin-off of a branch operation, which was established less than five years prior but was part of a larger business actively conducted for over five years, qualify as a tax-free distribution under I.R.C. § 355 when supported by a valid business purpose?
Opinions:
Majority - Hott, Judge
Yes. The spin-off of the Grand Junction branch qualifies as a tax-free distribution under I.R.C. § 355 because it was part of a single business that had been actively conducted for more than five years and the transaction was not a device for distributing earnings and profits. First, the court rejected the Commissioner's argument that the Grand Junction branch was a new business started in 1954 that failed the five-year active business requirement. The court found that prior to the spin-off, the Grand Junction operation was not a separate business but merely a branch outlet and a 'continuation and furtherance of the existing business.' This was evidenced by its lack of operational independence, as Pueblo handled all significant financial and administrative functions. Therefore, the single, integrated wholesale business had been actively conducted for well over five years. Second, citing its own precedent in Edmund P. Coady and the Commissioner's recent acquiescence, the court dismissed the argument that § 355 does not apply to the division of a single business. Finally, the court found the transaction was not a device for distributing earnings because it was motivated by a legitimate business purpose: enabling a key employee, Pearce, to invest in the operation he managed.
Analysis:
This decision, along with Edmund P. Coady, solidified the judicial position that I.R.C. § 355 permits the tax-free division of a single, integrated business (a 'vertical' division), not just the separation of two distinct, pre-existing businesses. It established that for the purpose of the five-year active business rule, the focus is on the history of the overall enterprise, not the specific branch or location being spun off. This provides taxpayers with greater flexibility in corporate reorganizations, allowing them to separate functional or geographical parts of a single business for valid commercial reasons without triggering immediate tax consequences for shareholders. The case also provides a functional framework for analyzing whether a branch is an integrated part of a larger business or a separate enterprise.
Unlock the full brief for Burke v. Commissioner