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CCH Incorporated




Gordon Warnke's article makes a significant contribution. It helps to map a largely unexplored continent of tax law, the use and determination of adjusted basis in corporate shares in connection with certain nonrecognition transactions, recently elaborated in Reg. §1.358-2.2 The regulation provides guidance of particular relevance to the allocation of basis when the shareholder owns two or more batches of stock with differing adjusted bases. As Gordon's article makes clear, apparently simple tax law directives concerning the treatment of adjusted basis raise difficult questions and choices, often in common situations. In this article, I propose to make explicit some of the polarities that underlie the choices in this area and to state some places where I differ from Gordon as to their resolution.

Ownership of shares of corporate stock performs two different investment functions and the ambiguities that arise in the measurement of a shareholder's adjusted basis in corporate stock reflect them. Investors may hold shares as representing a fractional interest in the activities of the corporation itself, looking directly to the enterprise for primary returns on investment. In the extreme case, a sole shareholder depends entirely on the corporation's activities for its rewards. Other investors may hold shares as a financial instrument that produces income, gain or loss with some independence from the activities of the corporation. Thus, the risks and returns to an investor in a publicly traded company depend at least as much on the operation of financial market forces as on the corporation's successes or failures. A long history reflects this duality. Each of these functions points to a different kind of income measurement, either based on consideration of the entire investment or based on a relevant portion of it. The differences emerge starkly in determining how to treat a partial disposition of shares in a taxable transaction. When a shareholder sells to a third party less than all the shares owned, tax law determines gain or loss on a share by share basis, reflecting the status of each share as a separate financial investment.4 When a shareholder sells some shares directly to the issuing corporation, however, the Code determines whether to characterize the transaction as a sale or a corporate distribution by reference to the change in the shareholder's relative stake in the corporation and not by reference to each share. Application of an aggregate approach occasionally produces a different measure of gain than the separate unit approach.

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