Nielsen v. Commissioner, 61 T. C. 311 (1973)

A corporate division under IRC § 355 requires that each resulting business must have been actively conducted for five years prior to the distribution if the businesses are deemed separate.

Summary

Oak Park Community Hospital operated two hospitals, one in Stockton and one in Los Angeles, the latter acquired less than five years before a corporate split-up. The Tax Court held that the distribution of stock in the Los Angeles hospital did not qualify for tax-free treatment under IRC § 355 because the Los Angeles operation was considered a separate business lacking the requisite five-year active conduct history. This decision underscores the importance of assessing whether operations constitute a single or multiple businesses when planning a tax-free corporate division.

Facts

Oak Park Community Hospital, Inc. , owned a hospital in Stockton, California, since its inception in 1956. In 1961, Oak Park acquired a hospital in Los Angeles. Each hospital operated independently, serving different patient populations and maintaining separate medical staffs. Due to shareholder disputes, Oak Park was split into two corporations in 1964, with the Los Angeles hospital transferred to Germ Hospital, Inc. , and distributed to certain shareholders. The Los Angeles hospital had been operated by Oak Park for less than five years before the split-up.

Procedural History

The Commissioner of Internal Revenue challenged the tax-free status of the distribution under IRC § 355. The case was heard by the United States Tax Court, which had previously addressed a similar issue in a related case, Lloyd Boettger v. Commissioner, involving other shareholders of Oak Park.

Issue(s)

1. Whether the distribution of Germ Hospital, Inc. , stock by Oak Park Community Hospital, Inc. , to its shareholders was tax-free under IRC § 355 because the Los Angeles and Stockton hospitals were part of a single business actively conducted for five years prior to the distribution.

Holding

1. No, because the Los Angeles and Stockton hospitals were considered two separate businesses, and only the Stockton hospital had been actively conducted for the required five-year period under IRC § 355(b).

Court’s Reasoning

The court determined that the operations of the Stockton and Los Angeles hospitals constituted two separate businesses, not a single integrated business. This conclusion was based on the hospitals’ independent operation, separate patient bases, and distinct medical staffs. The court rejected the petitioners’ argument that the shared management and services indicated a single business, noting that such sharing could occur between any two businesses. The court applied IRC § 355(b), which requires that each business resulting from a corporate division must have been actively conducted for five years. Since the Los Angeles hospital had been operated by Oak Park for less than five years, the distribution did not qualify for tax-free treatment. The court also distinguished this case from prior cases like Patricia W. Burke and Lockwood’s Estate v. Commissioner, where the acquired assets were integrated into the existing business.

Practical Implications

This decision clarifies that for a corporate division to be tax-free under IRC § 355, each resulting business must independently satisfy the five-year active conduct requirement if they are deemed separate businesses. Legal practitioners must carefully analyze whether a corporation’s operations constitute a single business or multiple separate businesses when planning corporate divisions. This case highlights the need for thorough due diligence and strategic planning to ensure tax-free treatment. Subsequent cases, such as Rev. Rul. 2003-75, have further refined the analysis of what constitutes a single business under § 355, emphasizing factors like integrated operations and centralized management.