Sec. 312. Effect on earnings and profits
 
 (a) General rule
 Except as otherwise provided in this section, on the distribution
 of property by a corporation with respect to its stock, the
 earnings and profits of the corporation (to the extent thereof)
 shall be decreased by the sum of -
 (1) the amount of money,
 (2) the principal amount of the obligations of such corporation
 (or, in the case of obligations having original issue discount,
 the aggregate issue price of such obligations), and
 (3) the adjusted basis of the other property, so distributed.
 (b) Distributions of appreciated property
 On the distribution by a corporation, with respect to its stock,
 of any property (other than an obligation of such corporation) the
 fair market value of which exceeds the adjusted basis thereof -
 (1) the earnings and profits of the corporation shall be
 increased by the amount of such excess, and
 (2) subsection (a)(3) shall be applied by substituting ''fair
 market value'' for ''adjusted basis''.
 For purposes of this subsection and subsection (a), the adjusted
 basis of any property is its adjusted basis as determined for
 purposes of computing earnings and profits.
 (c) Adjustments for liabilities
 In making the adjustments to the earnings and profits of a
 corporation under subsection (a) or (b), proper adjustment shall be
 made for -
 (1) the amount of any liability to which the property
 distributed is subject, and
 (2) the amount of any liability of the corporation assumed by a
 shareholder in connection with the distribution.
 (d) Certain distributions of stock and securities
 (1) In general
 The distribution to a distributee by or on behalf of a
 corporation of its stock or securities, of stock or securities in
 another corporation, or of property, in a distribution to which
 this title applies, shall not be considered a distribution of the
 earnings and profits of any corporation -
 (A) if no gain to such distributee from the receipt of such
 stock or securities, or property, was recognized under this
 title, or
 (B) if the distribution was not subject to tax in the hands
 of such distributee by reason of section 305(a).
 (2) Prior distributions
 In the case of a distribution of stock or securities, or
 property, to which section 115(h) of the Internal Revenue Code of
 1939 (or the corresponding provision of prior law) applied, the
 effect on earnings and profits of such distribution shall be
 determined under such section 115(h), or the corresponding
 provision of prior law, as the case may be.
 (3) Stock or securities
 For purposes of this subsection, the term ''stock or
 securities'' includes rights to acquire stock or securities.
 ((e) Repealed. Pub. L. 98-369, div. A, title I, Sec. 61(a)(2)(B),
 July 18, 1984, 98 Stat. 581)
 (f) Effect on earnings and profits of gain or loss and of receipt
 of tax-free distributions
 (1) Effect on earnings and profits of gain or loss
 The gain or loss realized from the sale or other disposition
 (after February 28, 1913) of property by a corporation -
 (A) for the purpose of the computation of the earnings and
 profits of the corporation, shall (except as provided in
 subparagraph (B)) be determined by using as the adjusted basis
 the adjusted basis (under the law applicable to the year in
 which the sale or other disposition was made) for determining
 gain, except that no regard shall be had to the value of the
 property as of March 1, 1913; but
 (B) for purposes of the computation of the earnings and
 profits of the corporation for any period beginning after
 February 28, 1913, shall be determined by using as the adjusted
 basis the adjusted basis (under the law applicable to the year
 in which the sale or other disposition was made) for
 determining gain.
 Gain or loss so realized shall increase or decrease the earnings
 and profits to, but not beyond, the extent to which such a
 realized gain or loss was recognized in computing taxable income
 under the law applicable to the year in which such sale or
 disposition was made. Where, in determining the adjusted basis
 used in computing such realized gain or loss, the adjustment to
 the basis differs from the adjustment proper for the purpose of
 determining earnings and profits, then the latter adjustment
 shall be used in determining the increase or decrease above
  provided. For purposes of this subsection, a loss with respect
 to which a deduction is disallowed under section 1091 (relating
 to wash sales of stock or securities), or the corresponding
 provision of prior law, shall not be deemed to be recognized.
 (2) Effect on earnings and profits of receipt of tax-free
 distributions
 Where a corporation receives (after February 28, 1913) a
 distribution from a second corporation which (under the law
 applicable to the year in which the distribution was made) was
 not a taxable dividend to the shareholders of the second
 corporation, the amount of such distribution shall not increase
 the earnings and profits of the first corporation in the
 following cases:
 (A) no such increase shall be made in respect of the part of
 such distribution which (under such law) is directly applied in
 reduction of the basis of the stock in respect of which the
 distribution was made; and
 (B) no such increase shall be made if (under such law) the
 distribution causes the basis of the stock in respect of which
 the distribution was made to be allocated between such stock
 and the property received (or such basis would, but for section
 307(b), be so allocated).
 (g) Earnings and profits - increase in value accrued before March
 1, 1913
 (1) If any increase or decrease in the earnings and profits for
 any period beginning after February 28, 1913, with respect to any
 matter would be different had the adjusted basis of the property
 involved been determined without regard to its March 1, 1913,
 value, then, except as provided in paragraph (2), an increase
 (properly reflecting such difference) shall be made in that part
 of the earnings and profits consisting of increase in value of
 property accrued before March 1, 1913.
 (2) If the application of subsection (f) to a sale or other
 disposition after February 28, 1913, results in a loss which is
 to be applied in decrease of earnings and profits for any period
 beginning after February 28, 1913, then, notwithstanding
 subsection (f) and in lieu of the rule provided in paragraph (1)
 of this subsection, the amount of such loss so to be applied
 shall be reduced by the amount, if any, by which the adjusted
 basis of the property used in determining the loss exceeds the
 adjusted basis computed without regard to the value of the
 property on March 1, 1913, and if such amount so applied in
 reduction of the decrease exceeds such loss, the excess over such
 loss shall increase that part of the earnings and profits
 consisting of increase in value of property accrued before March
 1, 1913.
 (h) Allocation in certain corporate separations and reorganizations
 (1) Section 355
 In the case of a distribution or exchange to which section 355
 (or so much of section 356 as relates to section 355) applies,
 proper allocation with respect to the earnings and profits of the
 distributing corporation and the controlled corporation (or
 corporations) shall be made under regulations prescribed by the
 Secretary.
 (2) Section 368(a)(1)(C) or (D)
 In the case of a reorganization described in subparagraph (C)
 or (D) of section 368(a)(1), proper allocation with respect to
 the earnings and profits of the acquired corporation shall, under
 regulations prescribed by the Secretary, be made between the
 acquiring corporation and the acquired corporation (or any
 corporation which had control of the acquired corporation before
 the reorganization).
 

Sections 355(a), (c)(1) Ex. 2, 368(a)(1)(D) Ex. 1, 312(h), 358(c) Ex. 2, 361(c) Ex. 1

Assumptions: X has conducted both Widget and Cog businesses directly for 25 years.  The transaction was not used principally as a device for the distribution of earnings and profits.

Treatment:  The transaction qualifies as a divisive D reorganization pursuant to § §355 and 368(a)(1)(D).  X recognizes none of its realized gain of 50 in its exchange with Newco.  §361(b).  Newco recognizes no gain or loss on the distribution of Newco stock to A.  §361(c).  A recognizes no gain or loss on the receipt of the Newco stock.  §355(a).  A's basis in X and Newco will be 60 each based on their respective FMVs.  §§358(a)(1), and (c) and Reg. §§1.358-2(a)(1) and (2).  E&P is likewise allocated 60/60 based on relative FMVs.  §312(h).  The entire NOL stays with X.  Newco will AB of 50 in the Cog assets.  §362(b).  N.b., §355(c) does not apply because the transaction is a reorganization.

 
 
 (i) Distribution of proceeds of loan insured by the United States
 If a corporation distributes property with respect to its stock
 and if, at the time of distribution -
 (1) there is outstanding a loan to such corporation which was
 made, guaranteed, or insured by the United States (or by any
 agency or instrumentality thereof), and
 (2) the amount of such loan so outstanding exceeds the adjusted
 basis of the property constituting security for such loan,
 then the earnings and profits of the corporation shall be increased
 by the amount of such excess, and (immediately after the
 distribution) shall be decreased by the amount of such excess. For
 purposes of paragraph (2), the adjusted basis of the property at
 the time of distribution shall be determined without regard to any
 adjustment under section 1016(a)(2) (relating to adjustment for
 depreciation, etc.). For purposes of this subsection, a commitment
 to make, guarantee, or insure a loan shall be treated as the
 making, guaranteeing, or insuring of a loan.
 
 (j) Deleted [by PL 108-357 Sec. 413(c)(4)].
 
 (k) Effect of depreciation on earnings and profits
 (1) General rule
 For purposes of computing the earnings and profits of a
 corporation for any taxable year beginning after June 30, 1972,
 the allowance for depreciation (and amortization, if any) shall
 be deemed to be the amount which would be allowable for such year
 if the straight line method of depreciation had been used for
 each taxable year beginning after June 30, 1972.
 (2) Exception
 If for any taxable year a method of depreciation was used by
 the taxpayer which the Secretary has determined results in a
 reasonable allowance under section 167(a) and which is the
 unit-of-production method or other method not expressed in a term
 of years, then the adjustment to earnings and profits for
 depreciation for such year shall be determined under the method
 so used (in lieu of the straight line method).
 (3) Exception for tangible property
 (A) In general
 Except as provided in subparagraph (B), in the case of
 tangible property to which section 168 applies, the adjustment
 to earnings and profits for depreciation for any taxable year
 shall be determined under the alternative depreciation system
 (within the meaning of section 168(g)(2)).
  (B) Treatment of amounts deductible under section 179, 
 179A, 179B, 179C, 179D, or 179E.
 For purposes of computing the earnings and profits of a
 corporation, any amount deductible under section 179, 179A,
 179B, 179C, 179D, or 179E shall be allowed as a deduction 
 ratably over the period of 5 taxable years (beginning with 
 the taxable year for which such amount is deductible under 
 section 179, 179A, 179B, 179C, 179D, or 179E as the case may be).
 (4) Certain foreign corporations
 The provisions of paragraph (1) shall not apply in computing
 the earnings and profits of a foreign corporation for any taxable
 year for which less than 20 percent of the gross income from all
  sources of such corporation is derived from sources within the
 United States.
 (5) Basis adjustment not taken into account
 In computing the earnings and profits of a corporation for any
 taxable year, the allowance for depreciation (and amortization,
 if any) shall be computed without regard to any basis adjustment
 under section 50(c).
 (l) Discharge of indebtedness income
 (1) Does not increase earnings and profits if applied to reduce
 basis
 The earnings and profits of a corporation shall not include
 income from the discharge of indebtedness to the extent of the
 amount applied to reduce basis under section 1017.
 (2) Reduction of deficit in earnings and profits in certain cases
 If -
 (A) the interest of any shareholder of a corporation is
 terminated or extinguished in a title 11 or similar case
 (within the meaning of section 368(a)(3)(A)), and
 (B) there is a deficit in the earnings and profits of the
 corporation,
 then such deficit shall be reduced by an amount equal to the
 paid-in capital which is allocable to the interest of the
 shareholder which is so terminated or extinguished.
 (m) No adjustment for interest paid on certain
 registration-required obligations not in registered form
 The earnings and profits of any corporation shall not be
 decreased by any interest with respect to which a deduction is not
 or would not be allowable by reason of section 163(f), unless at
 the time of issuance the issuer is a foreign corporation that is
 not a controlled foreign corporation (within the meaning of section
 957), and the issuance did not have as a purpose the
 avoidance of section 163(f) of this subsection (FOOTNOTE 1)
 (FOOTNOTE 1) Subsec. (m) was enacted without a period at the
 end.
 (n) Adjustments to earnings and profits to more accurately reflect
 economic gain and loss
 For purposes of computing the earnings and profits of a
 corporation, the following adjustments shall be made:
 (1) Construction period carrying charges
 (A) In general
 In the case of any amount paid or incurred for construction
  period carrying charges -
 (i) no deduction shall be allowed with respect to such
 amount, and
 (ii) the basis of the property with respect to which such
 charges are allocable shall be increased by such amount.
 (B) Construction period carrying charges defined
 For purposes of this paragraph, the term ''construction
 period carrying charges'' means all -
 (i) interest paid or accrued on indebtedness incurred or
 continued to acquire, construct, or carry property,
 (ii) property taxes, and
 (iii) similar carrying charges,
 to the extent such interest, taxes, or charges are attributable
 to the construction period for such property and would be
 allowable as a deduction in determining taxable income under
 this chapter for the taxable year in which paid or incurred.
 (C) Construction period
 The term ''construction period'' has the meaning given the
 term production period under section 263A(f)(4)(B).
 (2) Intangible drilling costs and mineral exploration and
 development costs
 (A) Intangible drilling costs
 Any amount allowable as a deduction under section 263(c) in
  determining taxable income (other than costs incurred in
 connection with a nonproductive well) -
 (i) shall be capitalized, and
 (ii) shall be allowed as a deduction ratably over the
 60-month period beginning with the month in which such amount
 was paid or incurred.
 (B) Mineral exploration and development costs
 Any amount allowable as a deduction under section 616(a) or
 617 in determining taxable income -
 (i) shall be capitalized, and
 (ii) shall be allowed as a deduction ratably over the
 120-month period beginning with the later of -
 (I) the month in which production from the deposit
 begins, or
 (II) the month in which such amount was paid or incurred.
 (3) Certain amortization provisions not to apply
 Sections 173 and 248 shall not apply.
 (4) LIFO inventory adjustments
 (A) In general
 Earnings and profits shall be increased or decreased by the
 amount of any increase or decrease in the LIFO recapture amount
 as of the close of each taxable year; except that any decrease
 below the LIFO recapture amount as of the close of the taxable
 year preceding the 1st taxable year to which this paragraph
 applies to the taxpayer shall be taken into account only to the
 extent provided in regulations prescribed by the Secretary.
 (B) LIFO recapture amount
 For purposes of this paragraph, the term ''LIFO recapture
 amount'' means the amount (if any) by which -
 (i) the inventory amount of the inventory assets under the
 first-in, first-out method authorized by section 471, exceeds
 (ii) the inventory amount of such assets under the LIFO
 method.
 (C) Definitions
 For purposes of this paragraph -
 (i) LIFO method
 The term ''LIFO method'' means the method authorized by
 section 472 (relating to last-in, first-out inventories).
 (ii) Inventory assets
 The term ''inventory assets'' means stock in trade of the
 corporation, or other property of a kind which would properly
 be included in the inventory of the corporation if on hand at
 the close of the taxable year.
 (iii) Inventory amount
 The inventory amount of assets under the first-in,
 first-out method authorized by section 471 shall be
 determined -
 (I) if the corporation uses the retail method of valuing
 inventories under section 472, by using such method, or
 (II) if subclause (I) does not apply, by using cost or
 market, whichever is lower.
  (5) Installment sales
 In the case of any installment sale, earnings and profits shall
 be computed as if the corporation did not use the installment
 method.
 (6) Completed contract method of accounting
 In the case of a taxpayer who uses the completed contract
 method of accounting, earnings and profits shall be computed as
 if such taxpayer used the percentage of completion method of
 accounting.
 (7) Redemptions
 If a corporation distributes amounts in a redemption to which
 section 302(a) or 303 applies, the part of such distribution
 which is properly chargeable to earnings and profits shall be an
 amount which is not in excess of the ratable share of the
 earnings and profits of such corporation accumulated after
 February 28, 1913, attributable to the stock so redeemed.
 (8) Special rule for certain foreign corporations
 In the case of a foreign corporation described in subsection
 (k)(4) -
 (A) paragraphs (4) and (6) shall apply only in the case of
 taxable years beginning after December 31, 1985, and
 (B) paragraph (5) shall apply only in the case of taxable
 years beginning after December 31, 1987.
 (o) Definition of original issue discount and issue price for
 purposes of subsection (a)(2)
 For purposes of subsection (a)(2), the terms ''original issue
 discount'' and ''issue price'' have the same respective meanings as
 when used in subpart A of part V of subchapter P of this chapter.