The Definition of Voting Stock and the Computation of Voting Power Under Sections 368(c) and 1504(a) : Recent Developments and Tax Lore

Although the concepts of "voting stock" and "voting power" are pervasive throughout the Code, until recently, courts, commentators and the Service have devoted minimal energy to demystifying the confusion surrounding the definition of voting stock and even less to expanding upon the methodology of computing voting power. Recent developments, however, may prompt practitioners to take a second look at these terms. While a 1995 decision by the Tax Court adds little to the existing body of authority with respect to the determination of the owner of voting stock, the Service's analysis of the voting power requirement in a 1994 private letter ruling sheds new light on the method of computing voting power. This article reviews and analyzes the current state of the law concerning the voting stock and voting power requirements in two areas of the tax law: section 368(c), which defines the level of stock ownership in a corporation that a taxpayer must possess in order to qualify for many forms of tax-free reorganizations, and section 1504(a), which requires a corporation attempting to form an "affiliated group" with a subsidiary corporation to own an amount of voting stock in the subsidiary having a specified level of voting power. Part II of this article briefly explains the statutory requirements of both section 368(c) and section 1504(a). Part III reviews the case law and administrative precedents that have shaped the definition of voting stock and attempts to distinguish the ownership requirement of section 368(c) from the direct ownership requirement of section 1504(a). Accordingly, part III of this article also analyzes the Tax Court's most recent decision regarding the meaning of the term "direct ownership." Part IV examines the mechanical test developed by the courts and the Service for computing the voting power inherent in the stock of a corporation, explores ways in which taxpayers have attempted to manipulate a corporation's capital structure in order to satisfy the control requirement of section 368(c), and discusses the Service's latest pronouncement regarding the use of this mechanical test in measuring voting power. Finally, this article highlights the remaining ambiguities that continue to create uncertainty for taxpayers with regard to the voting stock definition and the voting power formula