The phantom business purpose requirement
for section 351

May 2013
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The phantom business purpose requirement for section 351

At a glance

In this article, Willis explains why the section 351 business purpose requirement is a phantom.

Congress neither enacted nor authorized a business purpose requirement for section 351, yet the IRS argues that a requirement exists and must be met. The question has been debated since 1938, when one court distinguished Gregory v. Helvering, 293 U.S. 465 (1935), based on clear differences between reorganizations and the predecessor to section 351. Several times since 1938, including as recently as 2010, courts have rejected the IRS’s contention. The nonrecognition treatment obtained by shareholders in qualifying exchanges is nearly as old as the code itself, and one of its most basic transactions.

With check-the-box (CTB) elections resulting in section 351 exchanges since 1997, one potentially must now contend with a new set of arguments regarding the existence of a business purpose requirement for a CTB formation versus the incorporation of a new legal entity. Despite those concerns, there is little authority or commentary on the topic. After over 90 years of deliberation, the mystery surrounding the existence of the requirement seems ripe for resolution.