Redding v. Commissioner of Internal Revenue

Gerald and Dorothy Redding and Thomas and Anne Moses (taxpayers) (plaintiffs) owned stock in Indianapolis Water Company (water company), a public utility. The water company distributed stock rights to its shareholders to grant the right to purchase the stock of its wholly owned subsidiary, Shorewood Corporation. The water company offered 80 percent of the Shorewood shares in this distribution. Pursuant to the plan, one stock right was distributed for each share of the water company held; shareholders could purchase one share of Shorewood upon exercising two rights and paying $5, which was less than fair market value. The stock rights could be transferred, and a market developed. Shares not purchased by the exercise of rights were sold to underwriters. Immediately after the distribution, the water-company shareholders held more than 50 percent of Shorewood stock, and the water company retained 20 percent of the shares. The taxpayers exercised rights and contended that both the receipt and exercise were tax-free. The commissioner of the Internal Revenue Service (defendant) assessed tax on the distribution of stock rights. The taxpayers appealed to the United States Tax Court, which treated the two distributions as a single transaction under the step-transaction doctrine and eligible for nonrecognition as a spin-off under § 355 of the Internal Revenue Code. The commissioner appealed to the United States Court of Appeals for the Seventh Circuit.