The Arrowroot Corporation is engaged in the manufacture and distribution of fine spices for the restaurant market. It has been in this business for 30 years. Arrowroot has also been in the specialty foods business for 10 years selling gourmet foods through large grocery chains. Both businesses have been very profitable and Arrowroot has significant earnings and profits. Arrowroot is owned entirely by Bob Hughes. In June of 2019 Arrowroot decides to expand its specialty food business through catalogue sales. Needing financing to expand its business Arrowroot approaches its Bank who suggests separating the two businesses and having them separately owned by Bob as brother-sister corporations. The Bank would then loan money to the specialty foods business for its expansion purposes.

(a) You are asked as to whether the separation of the businesses can be done without federal income tax. If so, how can it be done?

(b) Assume that Arrowroot transfers its gourmet food business into a separate corporation and Arrowroot continues to have the spice business. One month after transferring the gourmet food business and before the Bank provides any financing, the Silver Palate Corporation, a publicly traded corporation, approaches Arrowroot with an offer to purchase the spice business for all voting stock. The Silver Palate offers 10,000 shares of its stock, which, if issued, would represent about 5% of the Silver Palate issued and outstanding stock of the Silver Palate, to acquire Arrowroot’s spice business. Bob Hughes is agreeable to this but would like to get some money and Silver Palate stock. He asks you what you would recommend and how can he get the most money and still receive the Silver Palate stock tax free.

(c) Melissa Dolan is director of taxes for the Silver Palate. Silver Palate is paying significantly more than the value of the stated assets on the balance sheet of Arrowroot for the spice business. Arrowroot has extensive goodwill. Part of the Silver Palate’s strategy is that it will be able to amortize and take as a tax deduction the amount paid for goodwill and going concern value. What do you think of this strategy?