Intermountain Lumber Co. v. Commissioner

United States Tax Court · 1976 · Corporations

CorporationsSection 351ControlCorporate formationTax-free incorporationIRC section 351IRC section 368(c)control immediately after the exchange

Facts

Dee Shook transferred all of S & W Sawmill, Inc.'s property to the newly formed corporation in July 1964 and received 364 shares, while he and Milo Wilson each also received 1 incorporator share. On the same date, and as part of the incorporation transaction, Shook and Wilson executed an "Agreement for Sale and Purchase of Stock" under which Shook was to sell Wilson 182 of Shook's shares on an installment basis, with interest, proportional transfers as principal was paid, and Wilson receiving voting power over those shares for a year through an irrevocable proxy. Corporate minutes, later agreements, the loan documents, and a later letter all reflected that Shook and Wilson intended equal ownership and treated the arrangement as a sale, not an option. Intermountain later purchased all S & W stock and argued that section 351 had not applied at formation, so the assets should take a fair market value basis rather than a carryover basis.

Issue

When an incorporator receives stock for property but, as part of the same incorporation transaction, is already bound by an irrevocable agreement to sell half of that stock to another person, does the incorporator "control" the corporation immediately after the exchange within the meaning of sections 351(a) and 368(c)?

Rule

For purposes of section 351, "control" under section 368(c) requires ownership of the requisite stock immediately after the exchange. Ownership depends on the transferee's obligations and freedom of action with respect to the stock when acquired; legal title, voting rights, and possession of certificates are not conclusive. If, as part of the acquisition transaction, the transferee has irrevocably relinquished the legal right to decide whether to keep the shares, those shares are not treated as owned for section 351 control, whereas a later disposition pursuant only to a nonbinding plan does not defeat control.

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In Boise, Idaho, Nora Kim transferred all operating assets of Ridgeview Millworks to newly formed Sawtooth Components, Inc. in exchange for 100 voting shares. At the same closing, Nora signed a binding contract requiring her to sell 25 of those shares to Evan Pike over three years, with the shares placed in escrow and Evan holding an irrevocable proxy over them for one year.

Does Nora satisfy the section 368(c) control requirement immediately after the exchange for section 351 purposes?

Explanation. Control for section 351 turns on ownership immediately after the exchange. Ownership depends on the transferor's obligations and freedom of action with respect to the stock, not merely legal title, possession, or voting formalities. Because Nora was bound as part of the same transaction to dispose of 25 shares and had relinquished the legal right to keep them, those shares are not counted as owned by her for section 368(c) control.