Stock retains qualified small business status through conversions

Plain-English summary

Taxpayers originally formed a C corporation, later changed its name, converted it to a limited liability company that elected C corporation treatment, and then converted it back to corporate form. Their ownership interest was exchanged for all the common stock of the resulting corporation, and they later sold that stock to an unrelated buyer. The IRS explained that federal tax stock ownership turns on economic rights in management, profits, and assets, not merely on formal stock certificates. It ruled that the resulting corporation stock met the qualified small business stock definition under sections 1202(c), (f), and (h). The ruling did not decide whether the corporation otherwise qualified under section 1202, satisfied the active-business test, or whether the conversions and name changes were section 368 reorganizations.

Ruling snapshot

• Question: Did the taxpayers' stock continue to meet the qualified small business stock definition after the entity and name changes?
• Outcome: Approved, subject to stated caveats about the corporation's underlying section 1202 qualification and the reorganizations.
• Key authorities: IRC §§ 1202(c), (f), and (h), 351, and 368(a)(1)(F); Rev. Rul. 69-591.

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201636003                                              Third Party Communication: None
Release Date: 9/2/2016                                         Date of Communication: Not Applicable
Index Number: 1202.00-00
                                                               Person To Contact:
------------------------------------------------               -------------------, ID No. ----------------
-------------------------                                      Telephone Number:
---------------------------------                              --------------------
                                                               Refer Reply To:
                                                               CC:ITA:B05
                                                               PLR-102539-16

                                                               Date:
                                                               June 01, 2016

                  TY:------

Legend

Taxpayers =                                  ------------------------------------------------
Date 1=                                      ---------------------
Name 1=                                      --------------------------
Date 2=                                      ------------------
Name 2=                                      -------------------------
Date 3=                                      -------------------------
Name 3=                                      ------------------------
Date 4=                                      --------------------
Corporation=                                 --------------
X=                                           ------------------
Y=                                           ----------------------------------------------
Year 5=                                      ------


Dear ---------------------:

This letter responds to your request for a ruling under §§§ 1202(c), 1202(f) and 1202(h)
of the Internal Revenue Code, dated December 15, 2015.

Taxpayer has represented the facts to be as follows:

The taxpayers originally incorporated as a C corporation on Date 1 as Name 1. On
Date 2, the taxpayers amended their articles of incorporation solely to change the name
of the corporation from Name 1 to Name 2.

Effective Date 3, the taxpayers converted Name 2 to Name 3 based upon the advice of
an accountant. The company made a late entity classification election to treat Name 3
as an association taxed as a C corporation.
PLR-102539-16                                2

On Date 4, a Certificate of Conversion from an LLC to a corporation was filed, changing
the name to Corporation and converting X in Name 3 owned by the taxpayers to Y in
Corporation representing all the common stock in Corporation after conversion.

The taxpayers have not acquired additional shares nor have they redeemed any shares
since inception.

In Year 5, the taxpayers sold all of their common stock in Corporation as part of a sale
of 100% of the company stock to an unrelated party.

Section 1202(a) provides that, in the case of a taxpayer other than a corporation, gross
income shall not include 50% of any gain from the sale or exchange of qualified small
business stock held for more than 5 years.

Section 1202(c)(1) provides that the term “qualified small business stock” means any
stock in a C corporation which is originally issued after the date of the Revenue
Reconciliation Act of 1993, if as of the date of the issuance, such corporation is a
qualified small business, and except as provided in subsections (f) and (h), such stock
is acquired by the taxpayer at its original issue (i) in exchange for money or other
property (not including stock), or (ii) as compensation for services provided to such
corporation.

Section 1202(f) provides that if any stock in a corporation is acquired solely through the
conversion of other stock in such corporation which is qualified small business stock in
the hands of the taxpayer (1) the stock so acquired shall be treated as qualified small
business stock in the hands of the taxpayer and (2) the stock so acquired shall be
treated as having been held during the period during which the converted stock was
held.

Section 1202(h) provides that in the case of a transaction described in § 351 or a
reorganization described in § 368, if qualified small business stock is exchanged for
other stock which would not qualify as qualified small business stock but for this
subparagraph, such other stock shall be treated as qualified small business stock
acquired on the date on which the exchanged stock was acquired.

Section 368(a)(1)(F) provides that the term “reorganization” means a mere change in
identity, form or place of organization of one corporation, however effected.

While ownership of a corporation is normally tied to stock ownership, and under state
law LLC owners hold a member interest and not formal stock, the term “stock” for
federal tax purposes is not restricted to cases where formal stock certificates have been
issued. Rather, it has been consistent Service position that for federal tax purposes
stock ownership is a matter of economic substance, i.e., the right to which the owner
has in management, profits, and ultimate assets of a corporation. The presence or
PLR-102539-16                                  3

absence of pieces of paper called “stock” representing that ownership is
immaterial. See Rev. Rul. 69-591, 1969-2 C.B. 172.
Therefore, based on the facts and representations submitted, we rule that the
Corporation stock meets the definition of qualified small business stock under §§§
1202(c), 1202(f) and 1202(h).
Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed or implied concerning 1) the
qualification of the Corporation under § 1202, 2) whether Corporation meets the active
business requirements of § 1202(e), and 3) whether any conversion or name change
since the time of the original issuance of Name 1 stock qualify as a § 368(a)(1)(F)
reorganization.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                           Sincerely,



                                           William Jackson
                                           Branch Chief, Branch 5
                                           Office of Associate Chief Counsel
                                           (Income Tax & Accounting)




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