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A gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c) [26 USCS § 368(c)]) of the corporation. I.R.C. § 351.
Plaintiff taxpayers owned some 76 percent of X corporation stock, and two of them, as trustees for the wife of another, held slightly in excess of 13 percent. Taxpayers individually owned all of the stock of Y corporation. X corporation decided to acquire the Y stock in exchange for X shares. The exchange was recorded by a formal agreement which included the purchase of 418 X shares by the trust. Taxpayers' X holdings increased to 77.3 percent. The combined holdings of taxpayers and trust remained in excess of 80 percent, and taxpayers took the position that the transaction was, accordingly, to be viewed as a tax-free exchange. The Commissioner disagreed, claiming that the "control" group, or the transaction, was to be limited to taxpayers as the former owners of the Y stock. The Tax Court ruled in favor of the Commissioner, and taxpayers sought review.
Was the plaintiff’s exchange of stock in one corporation for the stock of another eligible for tax-free treatment?
The court held that the transaction was not a tax-free exchange. Other than the fact that the trust's participation was incorporated into the acquisition agreement, there was no relation between the exchange of Y shares and the trust's minor purchase.