S corporation split-off qualifies as a tax-free reorganization and distribution

Plain-English summary

An S corporation proposed transferring a business and other assets to a qualified subchapter S subsidiary, then distributing all of that subsidiary's stock to one shareholder group in exchange for its stock in the parent. The IRS ruled that the subsidiary's QSub election would terminate and that the transfer followed by the split-off would qualify as a reorganization under section 368(a)(1)(D) and a distribution under section 355. The parent, subsidiary, and exchanging shareholders would recognize no gain or loss under the cited provisions, and the transferred assets and distributed shares would generally carry over their bases and holding periods. The parent could allocate earnings and profits and its accumulated adjustments account between the two corporations. The new corporation could elect S corporation status for its first taxable year if it otherwise qualified and made the election effective immediately after the QSub termination. The IRS did not determine whether the transaction met section 355's business-purpose, nondevice, or acquisition-plan requirements.

Ruling snapshot

• Question: What are the federal tax consequences of transferring assets to a QSub and splitting it off to one shareholder group?
• Outcome: approved, subject to the stated representations and unresolved section 355 requirements
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368(a)(1)(D), 1032, 1223, 1361, and 1362; Treas. Reg. §§ 1.1361-5 and 1.1368-2

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201945016                                              Third Party Communication: None
Release Date: 11/8/2019                                        Date of Communication: Not Applicable
Index Numbers: 368.04-00, 355.01-01,
              1361.05-00                                       Person To Contact:
                                                               ------------------, ID No. ------------------
----------------------------                                   Telephone Number:
--------------                                                 ----------------------
--------------------------------                               Refer Reply To:
---------------------                                          CC:CORP:1
------------------------------                                 PLR-104037-19
                                                               Date:
                                                               August 12, 2019




Legend

Distributing               =         --------------------------------
---------------------------------------------------------------------
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Controlled                 =         ---------------------------
---------------------------------------------------------------------
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Sub 1                      =         --------------------------
---------------------------------------------------------------------
-------------------------------------------------------------

Sub 2                      =         ----------------------------
---------------------------------------------------------------------
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Sub 3                      =         ---------------------------------------
-------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
-----------------------------------------------------------------
-------------------------------------------------------------

X                          =        -------------------------------

Y                          =        -------------------------------------

Business 1                 =        ------------------
PLR-104037-19                                                2



Business 2                 =         ----------------------------------------
------------------------------------------------------------------------------
-------------------------------------------------------------

Business 3                 =        ----------------------------------------------------------

Other Assets               =        --------------------------------------------------------------------------------

Retained Assets            =        ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------
                                    ----------------------------------------------

A                          =        ---------------------------------

B                          =        -----------------------------

C                          =        ----------------------

D                          =        ----------------------

E                          =        ------------------------

F                          =        -----------------

G                          =        ----------------------

H                          =        ----------------------------

State A                    =        --------------

a                          =        ------

b                          =        ------

c                          =        ------

d                          =        ------

e                          =        ------
PLR-104037-19                                     3

f                          =   ------

g                          =   ------

h                          =   ------

i                          =   ------

j                          =   ------

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

This letter responds to your letter dated March 1, 2019, as supplemented by
subsequent submissions, requesting Transactional Rulings with respect to a Covered
Transaction (described below) pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283.
The information submitted in that letter and in subsequent correspondence is
summarized below.

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.

This office has made no determination regarding whether the Distribution (as defined
below): (i) satisfies the business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) is
used principally as a device for the distribution of the earnings and profits of the
distributing corporation or the controlled corporation or both (see section 355(a)(1)(B)
and Treas. Reg. § 1.355-2(d)); or (iii) is part of a plan (or series of related transactions)
pursuant to which one or more persons will acquire directly or indirectly stock
representing a 50-percent or greater interest in the distributing corporation or the
controlled corporation, or any predecessor or successor of the distributing corporation
or any successor of the controlled corporation, within the meaning of Treas. Reg.
§ 1.355-8T (see section 355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

                                        Summary of the Facts

Distributing is a subchapter S corporation. Individuals A, B, C and D collectively own
50% of the stock of Distributing. B, C and D are the children of A (hereinafter, A, B, C
and D will be collectively referred to as the “Split-Off Shareholders”). Individuals E, F, G
and H collectively own the remaining 50% of the stock of Distributing. F, G and H are
the children of E (hereinafter, E, F, G and H will be collectively referred to as the
“Remaining Shareholders”).
PLR-104037-19                                 4

Distributing owns all of the stock of Controlled and Sub 1, each of which is a qualified
subchapter S subsidiary (“QSub”). Controlled owns all of the stock of Sub 2, also a
QSub. Sub 1 owns approximately a% [at least 33⅓%] of the capital and profits in Sub
3, a State A limited liability company treated as a partnership for Federal income tax
purposes. X, a holding company, owns approximately b% of Sub 3. The balance of the
capital and profits of Sub 3, c%, is owned by other parties.

The Split-Off Shareholders have an economic interest in X of approximately d%, which
includes a voting interest of approximately e%. The Remaining Shareholders have an
economic interest in X of approximately f%, which includes a voting interest of
approximately g%. The remaining interest in X (approximately h% of economic interest
and approximately i% of voting interest) is owned by other parties.

The Split-Off Shareholders will have no ability to influence or control X, Sub 3, or the
other shareholders of X or Sub 3.

Controlled operates Business 1. Sub 3 operates Business 2. Finally, Sub 1, as an
investment, owns approximately j% of Y, which operates Business 3.

                               The Proposed Transaction

   1) Distributing will transfer to Controlled the assets described in Steps 1a through
      1c (collectively, the “Transferred Assets”):
         a. The assets comprising Business 1;
         b. 50% of Sub 1’s interest in Y; and
         c. The Other Assets.
         d. Distributing will retain the Retained Assets. The transfer of the Transferred
             Assets and retention of the Retained Assets are intended to equalize the
             value of Controlled and Distributing immediately after the distribution of
             Controlled stock (as described in Step 3 below).

   2) Controlled will assume the liabilities associated with the Transferred Assets (the
      transfer of the Transferred Assets described in Step 1 and the assumption of
      liabilities described in this Step 2 are collectively described as the “Contribution”).
      None of these liabilities is evidenced by a debt instrument. Controlled therefore
      will not assume liability for any Distributing Debt within the meaning of Rev. Proc.
      2018-53, § 3.01, 2018-43 I.R.B. 667 ; and

   3) Distributing will distribute all of the Controlled stock proportionately to each of the
      Split-Off Shareholders in exchange for all of their Distributing stock (this Step 3 is
      described as the “Distribution” – the Contribution and the Distribution collectively
      are described as a “Covered Transaction” within the meaning of § 2.03(1)(a) of
      Rev. Proc. 2017-52).
PLR-104037-19                                5

                                   Representations

Except as otherwise set forth in the next sentence, Distributing makes all the
representations in Section 3 of the Appendix to Rev. Proc. 2017-52. Representations 6,
36, 37, 38, 39, 40, 42, 43, 44, 45 and 46 in Section 3 of the Appendix to Rev. Proc.
2017-52 do not apply.

With respect to representations 3, 8, 11, 15, 22, 31, and 41 in Section 3 of the Appendix
to Rev. Proc. 2017-52, Distributing makes the following alternative representations:
3(a); 8(b); 11(a); 15(a); 22(a); 31(a); and 41(b).

                                Transactional Rulings

   1) The Distribution will cause a termination of Controlled’s QSub election because
      Controlled will cease to be a wholly owned subsidiary of an S corporation. For
      Federal tax purposes, Controlled will be treated as a new corporation acquiring
      all of its assets and assuming all of its liabilities from Distributing immediately
      before the termination of Controlled’s QSub election in exchange for the stock of
      Controlled, pursuant to Treas. Reg. § 1.1361-5(b)(1)(i) (§ 1361(b)(3)(B) and (C)).

   2) The Contribution followed by the Distribution will qualify as a reorganization
      under section 368(a)(1)(D). Distributing and Controlled will each be “a party to a
      reorganization” within the meaning of section 368(b).

   3) No gain or loss will be recognized by Distributing on the Contribution (sections
      361(a) and 357(a)).

   4) No gain or loss will be recognized by Controlled on the Contribution (section
      1032(a)).

   5) Controlled’s basis in each asset received from Distributing in the Contribution will
      be the same as the basis of such asset in the hands of Distributing immediately
      before the Contribution (section 362(b)).

   6) Controlled’s holding period for each asset received from Distributing in the
      Contribution will include the period during which Distributing held that asset
      (section 1223(2)).

   7) No gain or loss will be recognized by Distributing on the Distribution of Controlled
      (section 361(c)(1)).

   8) No gain or loss will be recognized by (and no amount will be included in the
      income of) each of the Split-Off Shareholders upon the receipt of Controlled
PLR-104037-19                                 6

       stock (in exchange for all of that Shareholder’s Distributing stock) in the
       Distribution (section 355(a)(1)).

   9) The basis of the shares of Controlled in the hands of each of the Split-Off
      Shareholders immediately after the Distribution will be the same as the basis of
      the Distributing shares surrendered in exchange therefor (section 358(a)(1)).

   10) The holding period of the Controlled shares received by each of the Split-Off
      Shareholders in the Distribution will include the holding period of the Distributing
      shares surrendered in exchange therefor, provided that the Distributing shares
      were held as a capital asset in that Shareholder’s hands on the date of the
      Distribution (section 1223(1)).

   11) Earnings and profits, if any, will be allocated between Distributing and Controlled
      in accordance with section 312(h) and Treas. Reg. § 1.312-10(a).

   12) Distributing’s accumulated adjustments account will be allocated between
      Distributing and Controlled in a manner similar to the manner in which earnings
      and profits of Distributing will be allocated under section 312(h) in accordance
      with Treas. Reg.§ 1.1368-2(d)(3).

   13) Distributing’s momentary ownership of the stock of Controlled, as part of the
      reorganization under section 368(a)(1)(D), will not cause Controlled to have an
      ineligible shareholder for any portion of its first taxable year under section
      1361(b)(1)(B), and will not, in itself, render Controlled ineligible to elect to be an
      S corporation for its first taxable year. If Controlled otherwise meets the
      requirements of a small business corporation under section 1361, Controlled will
      be permitted to make a subchapter S election under section 1362(a) for its first
      taxable year, provided that such election is made effective immediately following
      the termination of the original QSub election.

                                          Caveat

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the proposed transactions under any provision of the Code and
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the proposed transactions that is not specifically addressed by this letter.

                                 Procedural Statements

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.
PLR-104037-19                                 7

In accordance with the Power of Attorney on file with this office, copies of this letter are
being sent to your authorized representatives.

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.

                                       Sincerely,



                                       Susan E. Massey
                                       Branch Chief, Branch 3
                                       (Corporate)




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