QSub conversions and S revocation do not withdraw construction fund

Plain-English summary

An S corporation maintained a merchant-marine capital construction fund and owned vessels through qualified subchapter S subsidiaries. It planned to convert those subsidiaries under state law into disregarded limited liability companies and then revoke its S election. The entities, assets, liabilities, vessel titles, ownership, and construction fund would remain in place through the changes. The maritime agency administering the fund stated that the conversions and revocation would not constitute a fund withdrawal or vessel disposition under the governing maritime rules. Based on those representations, the IRS ruled that neither transaction would be treated as a withdrawal under section 7518.

Ruling snapshot

• Question: Will converting the QSubs to disregarded LLCs and revoking the parent's S election trigger a capital construction fund withdrawal?
• Outcome: No, neither transaction will be treated as a section 7518 withdrawal.
• Key authorities: IRC § 7518; Merchant Marine Act § 607

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201923005                                              Third Party Communication: None
Release Date: 6/7/2019                                         Date of Communication: Not Applicable
Index Number: 7518.00-00
                                                               Person To Contact:
----------------------------------                             ------------------------, ID No. ------------------
-----------------------------                                  ----------------------------------------------------
---------------------------------------                        Telephone Number:
--------------------------------                               ----------------------
                                                               Refer Reply To:
                                                               CC:PSI:03
                                                               PLR-120540-18
                                                               Date:
                                                               December 14, 2018


Legend

Taxpayer                   =         ----------------------------------
-------------------------------------------------------------

Sub 1                      =        ----------------------------------

Sub 1A                     =        ---------------------------------

Sub 1B                     =        ---------------------------------------

Sub 2                      =        ----------------

Sub 2A                     =        --------------------------------------

Sub 2B                     =        ----------------------------------

Administrator              =        ----------------------------------------------------------------------------

Agency                     =        ----------------------------------------------------

State 1                    =        -----------------

State 2                    =        ----------

State 3                    =        ----------

Date 1                     =        -----------------------

Date 2                     =        ------------------------
PLR-120540-18                                 2


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

This letter responds to a letter dated June 27, 2018, and subsequent correspondence,
submitted on behalf of Taxpayer by its authorized representative requesting a ruling
under section 7518 of the Internal Revenue Code (Code).

                                           Facts

Taxpayer was organized as an S corporation that owns 100 percent of Sub 1 and Sub
2, each organized under the laws of State 1. Sub 1 owns 100 percent of Sub 1A,
organized under the laws of State 2, and Sub 1B, organized under the laws of State 3.
Sub 2 owns 100 percent of Sub 2A, organized under the laws of State 3, and Sub 2B,
organized under the laws of State 1. Sub 1, Sub 1A, Sub 1B, Sub 2, Sub 2A, and Sub
2B (Taxpayer’s Subsidiaries) are qualified subchapter S subsidiaries (QSubs).

Taxpayer maintains a capital construction fund (CCF) pursuant to a capital construction
fund agreement (CCF Agreement) entered into with Administrator.

Taxpayer plans to execute the following:

    1. Prior to Date 1, convert under state law Taxpayer’s Subsidiaries into limited
       liability companies (LLCs) that will be disregarded entities for federal income tax
       purposes (the Conversion); and

    2. Effective Date 1 revoke its S election pursuant to section 1362(d)(1) and section
       1.1362-2(a) of the Income Tax Regulations (the Revocation).

A letter from Agency dated Date 2 states that for purposes of 46 USC Chapter 535 and
the regulations promulgated under 46 CFR Part 390, and based on Taxpayer’s
representations that (i) for applicable state law purposes, each of the converted entities
are deemed to be the same entity that existed prior to the conversion and (ii) title to all
of the assets, including the vessels, will remain vested in the Taxpayer’s Subsidiaries
that currently own them, neither the Conversion nor the Revocation will be deemed to
constitute a withdrawal from the CCF or a disposition of any of the vessels.

Taxpayer represents the following:

    1. Each of Taxpayer’s Subsidiaries will have a valid QSub election in place at the
       time of the Conversion.

    2. Taxpayer has no plan or intention to file a Check-the-Box Election to treat
       Taxpayer’s Subsidiaries as associations for federal income tax purposes.
PLR-120540-18                               3

    3. Following the Conversion, Taxpayer, Sub 1, and Sub 2 will each: (i) possess the
      same powers, (ii) hold the same rights; (iii) be subject to the same duties and
      responsibilities with respect to each of Taxpayer’s Subsidiaries, as they did prior
      to the Conversion.

    4. Following the Conversion, each of Taxpayer’s Subsidiaries will remain organized
      in the same state.

    5. All assets and liabilities of each of Taxpayer’s Subsidiaries before the Conversion
      will remain the assets and liabilities of each of Taxpayer’s Subsidiaries
      respectively following the Conversion.

    6. None of the assets owned by Taxpayer’s Subsidiaries will require transfer of
      legal title as a result of the Conversion.

    7. The state conversion statutes provide that, for state law purposes, Taxpayer’s
      Subsidiary that exists after the Conversion is deemed to be the same Taxpayer’s
      Subsidiary that existed before the Conversion, and that the assets and liabilities
      owned by Taxpayer’s Subsidiaries (as QSubs) before the Conversion are
      considered to be automatically owned by Taxpayer’s Subsidiaries respectively
      (as LLCs) after the Conversion.

    8. Before, during, and after the Revocation, the CCF and its funds remain with
      Taxpayer.

    9. There is no plan or intention to change the ownership of any of Taxpayer’s
      Subsidiaries after the Conversion.

                                   Law and Analysis

Section 607(a) of the Merchant Marine Act (the MMA) provides that any citizen of the
United States owning or leasing one or more eligible vessels may enter into an
agreement (CCF Agreement) with the Secretary of Commerce to establish a capital
construction fund (CCF) with respect to any or all of the vessels. Any CCF Agreement
entered into shall be for the purpose of providing replacement vessels, additional
vessels, or reconstructed vessels, built in the United States and documented under the
laws of the United States for operation in the United States foreign, Great Lakes, or
noncontiguous domestic trade or in the fisheries of the United States and shall provide
for the deposit in the CCF of the amounts agreed upon as necessary or appropriate to
provide for qualified withdrawals under section 607(f) of the MMA. The deposits in the
CCF, and all withdrawals from the CCF, whether qualified or nonqualified, shall be
subject to the conditions and requirements as the Secretary of Commerce may by
regulations prescribe or are set forth in the CCF Agreement.
PLR-120540-18                                 4

Section 607(f)(1) of the MMA and section 7518(e)(1) of the Code provide that a qualified
withdrawal from the CCF is one made in accordance with the terms of the CCF
Agreement but only if it is for (A) the acquisition, construction, or reconstruction of a
qualified vessel, (B) the acquisition, construction, or reconstruction of barges and
containers that are part of the complement of a qualified vessel, or (C) the payment of
the principal on indebtedness incurred in connection with the acquisition, construction,
or reconstruction of a qualified vessel or a barge or container that is part of the
complement of a qualified vessel.

Section 607(h)(1) of the MMA and section 7518(g)(1) of the Code provide that any
withdrawal from a CCF that is not a qualified withdrawal shall be treated as a
nonqualified withdrawal.

Section 607(f)(2) of the MMA and section 7518(e)(2) provide that if the Secretary of
Commerce determines that any substantial obligation under any CCF Agreement is not
being fulfilled, the Secretary of Commerce may, after notice and opportunity for hearing
to the person maintaining the CCF, treat the entire CCF or any portion thereof as an
amount withdrawn from the CCF in a nonqualified withdrawal.

                                        Conclusion

Based on Taxpayer’s representations and the letter from Administrator, we conclude
that the Revocation and Conversion will not be treated as a withdrawal under section
7518 of the Code.

Except as specifically ruled upon above, we express or imply no opinion concerning the
Federal tax consequences of the facts described above under any other provision of the
Code.

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

The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.
PLR-120540-18                                5


Pursuant to a power of attorney on file with this office, we are sending a copy of this
letter to your authorized representative.


                                      Sincerely,


                                      ______________________________
                                      Richard T. Probst
                                      Senior Technician Reviewer, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)


Enclosures (2):
Copy of this letter
Copy for section 6110 purposes



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