Gregory v. Helvering, 293 U.S. 465 (1935), aff'g 69 F.2d 809 (2nd Cir., 1934)

Facts: Evelyn Gregory owned all the stock of United Mortgage Corp. United owned appreciated stock in Monitor Securities Corp. A buyer wanted to purchase the Monitor stock, and Mrs. G wanted the money for her personal account.

The "natural" transaction -- to have UMC sell the Monitor stock and pay the money to Mrs. G -- means a double tax. UMS would have a taxable gain, and Mrs. G would have dividend income, with no corporate deduction for the amount paid out.

So Mrs. Gregory is sad.

There was no tax when a new corporation was formed and capitalized.

There was no tax on a "spin-off". (A distribution of stock to divide a corporate business in two.)

The fair market value of property distributed when winding-up and terminating a corporation was treated as a payment to the shareholder in exchange for stock. (Low-taxed capital gain.)

Step 1: UMS will set up a new subsidiary, Averill Corporation, and capitalize Averill by transferring the Monitor stock.

Step 2: UMS will distribute the Averill shares to Mrs G. as a tax-free "spinoff" of a corporate subsidiary

Her basis ("tax cost") in UMS is prorated between the UMS stock and the new Averill stock in proportion to their FMV's

Step 3: Mrs. G liquidates Averill, ending its corporate existence. She gets the Monitor stock as a liquidating distribution. She recognizes a capital gain as tho she sold her Averill stock at fair value, and takes a FMV basis in the Monitor stock.

Step 4: Mrs. G sells the Monitor stock to the buyer. Her basis was already set to FMV in step 3, so she doesn't recognize any more gain.

Mrs. Gregory is very happy.

The IRS is not happy at all.

Mrs. G. and the IRS go to court.