The Business Purpose Test in Section 355 Distributions: Major Pitfalls for Close Corporation Planning

Since 1918, Congress has recognized the economic necessity of stimulating growth in the business sector by encouraging productive corporate divisions. The unhappy task of more than sixty years has been to draft a statute which maximizes flexibility while precluding tax avoidance abuses. Charting its way by piecemeal legislation, Congress appears to have intended tax-free treatment for stock distributions pursuant to corporate divisions motivated by reasonable business needs. Curiously, although Congress clearly has assumed that a valid business purpose must be the primary motivation for such transactions, it never has expressly addressed the matter by statute.

Instead, it has devised numerous complex requirements and left the development of this capstone concept to the Treasury Department and the courts. In so doing, Congress has fostered unwarranted uncertainty in the business community and indirectly encouraged abuse and economic waste.