Nightfall Corporation is the parent of an affiliated group consisting of three subsidiary corporations. The group does not file consolidated returns. During Nightfalls tax year ending December 2017, Nightfall wanted to sell two of its subsidiaries. The sales were expected to generate large taxable capital gains and ordinary income for 2017. Nightfalls outside accountants at Smith & Smith CPAs, approached the officers with an idea that would provide significant tax savings. That idea is outlined below. Nightfall had a group benefits plan under which it provided health benefits to its eligible employees and their dependents and deducted the costs of those benefits as ordinary and necessary business expenses. Nightfall's subsidiaries included two inactive corporations, Nightfall Specialties, Inc. (NS) and Nightfall Widgets, Inc. (NW). Nightfall entered into a series of interrelated transactions in 2017 that included a recapitalization (ignore this in your solution since we havent covered it yet) of NW (renamed Nightfall Welfare Management Co., Inc. (NWM)); a transfer by Nightfall to NS of $40 million and the assumption of $39,878,000 in contingent liabilities consisting of Nightfall's obligations to pay medical plan benefits under its benefits plans in exchange for NS common stock; and NS's transfer of the $40 million and the contingent medical plan benefits (a liability) to NWM in exchange for its newly issued class C stock. Nightfall reported that the transfers qualified under 351 and that NS had a basis in the class C stock of $40 million. Each share of class C stock was entitled to receive annual dividends of $10.00 and was not allowed to receive any other dividend. The Nightfall group also planned that NWM's payment of the medical plan benefits would result in medical expense deductions under 162(a) or capital expenditures under 263. The class C stock could be redeemed by NWM and the class C shareholders at two specific times, five and seven years after its issuance. The redemption price would be the greater of $125/share or an amount equal to a percent of any cumulative cost savings in the medical benefits plans. At the time of the issuance of the class C stock it was highly likely that it would be redeemed within the five- and seven-year periods and that the redemption payment would be $125 per share. Two months after the transfer to NWM, NS sold its class C stock to a former employee of a Nightfall subsidiary for $122,000 (i.e., the difference between $40 million and $39,878,000). NS claimed a $39,878,000 short-term capital loss on the sale, and used that loss to offset other unrelated capital gains totaling a similar amount. After the transactions, Nightfall continued to process claims for medical benefits plans and Nightfall's handling of the claims transferred to NWM was the same as the handling of claims with respect to employees whose medical benefits plans were not transferred to NWM. NWM's reimbursements to Nightfall for claims were made through intercompany entries recorded on Nightfall's books as a receivable due from NWM and on NWM's books as a payable. NWM lent $38 million to a subsidiary of Nightfall, and NWM planned to reimburse the medical benefits plans when NWM received payments on the loan. (a) How did NS calculate its basis in the class C stock in order to generate the large STCL on the sale? Be explicit, citing the proper IRC section(s) and providing a detailed explanation. (b) Do you agree with the result in (a)? Provide an explicit argument, not just a simple yes or no answer. (c) Is there anything else about this series of transactions that you believe would either allow or disallow the STCL that NS claimed? You may cite judicial doctrine and/or specific IRC section(s) in support of your argument.