Tax Section 311 Taxability of a Corporation on Dividends

A corporation that distributes property that has appreciated in value must recognize a gain at the time of distribution. The corporation is treated as if it had sold the property. The gain equals the property’s fair market value less its adjusted basis. Code Sec. (b). However, the corporation does not recognize a loss if the property had declined in value. Also, the corporation recognizes no gain or loss if t distributes its own stock rights to its shareholders. Code Sec. (a). The character of the recognized gain depends on the property distributed; thus it may be ordinary income, capital gain, or Section 1231 gain.

An example illustrating this section was the Tax Court, deciding in favor of the IRS, held in Pope & Talbot, Inc., v. Com, 104 TC __, No. 29, that a corporation which distributed discrete partnership units of property composed of timber and resort interests in the Northwest, must recognize distribution gain under IRC Sec. 311(d) as if it had instead sold the entire interest to a single purchaser. The taxpayer had argued that the fair market value of the distributed property for purposes of determining Internal Revenue Code Sec. 311 gain must be equal to the sum of the distributed partnership interests, which were publicly traded on the date of distribution.

The facts surrounding the case are as followed. The commissioner proposed an $18.7 million deficiency determination against Pope & Talbot for the 1985 and 1986 taxable years, alleging that Pope &Talbot had incorrectly calculated the corporation's gain under IRC Sec.31(d). [IRC Sec. 311(d) was amended in 1986 and is now IRC Sec. 311(b).]

Pope & Talbot had, in 1985, contributed its timber, land development, and resort business to a newly formed Delaware limited partnership. Immediately thereafter, the partnership interests were distributed pro rata to Pope &Talbots's shareholders. The transaction was similar to a IRC Sec. 355 spin-off, except that the equity interests were those of a newly created partnership.

The units were publicly traded on the Pacific Stock Exchange at $11.50 on the date of distribution. Based on this price, Pope & Talbot had calculated the fair market value of the sum of distributed partnership units to be $40.3 million. Each shareholder was issued a Form 1099 reflecting those figures for purposes of reporting IRC Sec. 301 dividend gain. In calculating its $40.3 million corporate gain, Pope & Talbot advanced a legal theorem referred to throughout its legal brief as the "equality principle," This theorem provided as follows:

The FMV of the property for purposes of calculating Pope & Talbot's gain under IRC Sec. 311, was unknown. However, the FMV of distributed property for purposes of calculating shareholder gain under IRC Sec. 301, was known to be $40.3 million. Pope & Talbot then postulated that the FMV of the distributed partnership units for purposes of IRC Sec. 301 must equal the FMV of the same property for purposes of IRC Sec. 311. Therefore, Pope & Talbot concluded, the FMV of the distributed property for purposes of IRC Sec. 311 was $40.3 million.

Pope & Talbot moved for an order ruling that the FMV of the distributed property for purposes of determining Pope & Talbot's amount realized under IRC Sec. 311(d) was equal to the FMV of the property distributed to its shareholders under IRC Sec. 301. Pope & Talbot then asserted that the inviolability of the equality principle was demonstrated by the "symmetrical" nature of IRC Secs. 301, 311, and 1001. Pope & Talbot concluded that the term FMV was identical for