S corporation split-off qualifies as Type D reorganization

Plain-English summary

An S corporation operating three businesses proposed separating one business to resolve shareholder disagreements. It would place specified assets and an LLC interest into a controlled QSub, shift part of bank debt to that entity, and distribute all controlled stock to one trust in exchange for the trust's distributing-corporation shares. Controlled would then elect S status and its trust owner would elect ESBT treatment. The IRS ruled that the contribution and split-off qualified as a Type D reorganization and section 355 distribution, with specified nonrecognition, basis, holding-period, earnings-and-profits, S corporation, and post-closing payment treatment.

Ruling snapshot

• Question: Would the proposed S corporation business split-off receive Type D reorganization and section 355 nonrecognition treatment?
• Outcome: Approved on the fifteen specified rulings.
• Key authorities: IRC §§ 312, 355, 357, 358, 361, 362, 368, 1032, 1223, 1361, and 1368; Rev. Proc. 2017-52; Rev. Proc. 2018-53.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201949013 Third Party Communication: None
Release Date: 12/6/2019 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-01,
368.00-00, 368.04-00, Person To Contact:
361.00-00 --------------------, ID No. ------------------
Telephone Number:
-------------------- --------------------
------------------------------------ Refer Reply To:
---------------------------- CC:CORP:5
--------------------------------- PLR-106081-19
------------------------------ Date:
September 10, 2019

Legend

Distributing = ----------------------------

Controlled = ------------------

Business A = ----------------------------------------------------------

Business B = ---------------------------------

Business C = -----------------------------

QSub 1 = -----------------------------

QSub 2 = ----------------------------------------------

QSub 3 = ------------------------------------

LLC 1 = ----------------

Grantor Trust 1 = -----------------------

Grantor Trust 2 = ------------------------

Irrevocable Trust 1 = ------------------
PLR-106081-19 2

Irrevocable Trust 2 = -------------------

Irrevocable Trust 3 = --------------------

Irrevocable Trust 4 = ---------------------

Irrevocable Trust 5 = -------------------------

Irrevocable Trust 6 = ---------------------

Irrevocable Trust 7 = ------------------------

Beneficiary 1 = ----------------------

Beneficiary 2 = --------------------------

Beneficiary 3 = ----------------------

Beneficiary 4 = --------------------------

Bank = --------------------------------

Continuing Relationships = -----------------------------------------------------

-----------------------------------------------------------------------------------------------

--------------------------------------------------------------

-------------------------------------------------------------

Tax Cover Price = ------------------------------------------------------------------------------
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
-------------------------------------------------------------------------------

Date 1 = -------

Date 2 = -----------------------

Date 3 = -----------------------

Date 4 = --------------------
PLR-106081-19 3

Date 5 = --------------------

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

Asset A = ----------------------------------------------

Asset B = ----------------------------------------------

Asset C = ---------------------------

Asset D = ----------------------------------------------------------

a = -----

b = ----

c = --

d = ------

e = ----

f = ----

g = ----

h = ----

i = ----

j = --

k = ------------------

l = --------

m = ------------------

n = ------------

o = --

p = ----
PLR-106081-19 4

q = ----------------

r = ----------------

s = ------------

t = --------

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

This letter responds to your letter dated March 20, 2019, as supplemented on May 28,
2019 and August 1, 2019, requesting rulings under § 355 and related provisions of the
Internal Revenue Code and related regulations with respect to the proposed transaction
described below (the “Proposed Transaction”). The material information submitted is
summarized below.

The rulings contained in this letter are based upon information submitted by the
taxpayer and accompanied by a penalties 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 letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, as amplified
and modified by Rev. Proc. 2018-53, 2018-43 I.R.B. 667, regarding one or more
“Covered Transactions” under § 355 and § 368 of the Internal Revenue Code (the
“Code”). This Office expresses no opinion as to the overall tax consequences of the
transactions described in this letter or as to any issue not specifically addressed by the
rulings below.

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 § 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 the controlled corporation, within the meaning of Treas. Reg. § 1.355-8T (see
§ 355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).
PLR-106081-19 5

                                Summary of Facts

Distributing was formed on Date 1 as a State A corporation. On Date 2, Distributing
elected under § 1362(a) of the Code to be treated as a subchapter S corporation for
Federal income tax purposes. Distributing is engaged in Business A, Business B, and
Business C. Business A is operated by QSub 1, a State A corporation which has
elected under § 1361(b)(3)(B) of the Code to be treated as a qualified subchapter S
subsidiary for federal income tax purposes. Business B is operated by QSub 2, a State
A limited liability corporation which has elected under § 1361(b)(3)(B) of the Code to be
treated as a qualified subchapter S subsidiary for federal income tax purposes.
Business C is operated by QSub 3, a State A limited liability corporation which has
elected under § 1361(b)(3)(B) of the Code to be treated as a qualified subchapter S
subsidiary for federal income tax purposes. Business C consists of assets including
Asset A, Asset B, and Asset C. Distributing also owns a percent of LLC 1, a State A
limited liability company which has elected to be disregarded for federal income tax
purposes.

Distributing has both voting and non-voting shares of stock outstanding. Distributing’s
Series A stock represents a percent of the vote and b percent of the value. Distributing’s
Series B stock represents c percent of the vote and d percent of the value. Grantor
Trust 1 owns e percent of the outstanding Series A stock. Grantor Trust 2 owns f
percent of the outstanding Series A stock. Irrevocable Trust 1 owns g percent of the
outstanding Series B stock. Irrevocable Trust 2 owns h percent of the outstanding
Series B stock. Irrevocable Trust 3 owns i percent of the outstanding Series B stock.
Distributing is managed and operated by the beneficiaries of Grantor Trust 1, Grantor
Trust 2, Irrevocable Trust 1, Irrevocable Trust 2, and Irrevocable Trust 3.

On Date 3, Irrevocable Trust 1 elected to be treated as an electing small business trust
under § 1361(e) of the Code. Irrevocable Trust 1 was created for the benefit of
Beneficiary 1, Beneficiary 2, Beneficiary 3, and Beneficiary 4. Beneficiary 1, Beneficiary
2, Beneficiary 3, and Beneficiary 4 are siblings.

Beneficiary 1 is the beneficiary of Irrevocable Trust 4. Beneficiary 2 is the beneficiary of
Irrevocable Trust 5. Beneficiary 3 is the beneficiary of Irrevocable Trust 6. Beneficiary 4
is the beneficiary of Irrevocable Trust 7.

Financial information has been submitted indicating that each of Business A and
Business C have had gross receipts and operating expenses representing the active
conduct of a trade or business for each of the past five years.
PLR-106081-19 6

To resolve differences of opinion among the shareholders as to how Business C should
be operated, Distributing proposes the following transaction (the “Proposed
Transaction”):

                             Proposed Transaction

To achieve the business purposes described above, the following series of steps are
proposed:

1. The assets of Irrevocable Trust 1 will be divided into j equal shares and be
   contributed to Irrevocable Trust 4, Irrevocable Trust 5, Irrevocable Trust 6, and
   Irrevocable Trust 7. Irrevocable Trust 4 will receive k Series B shares of Distributing
   representing l percent of the outstanding Series B Shares. Irrevocable Trust 5,
   Irrevocable Trust 6, and Irrevocable Trust 7 will receive m Series B shares of
   Distributing representing n percent of the outstanding Series B Shares.

2. On Date 4, Controlled was formed as a subsidiary of Distributing. Distributing will file
   an election to treat Controlled as a qualified subchapter S subsidiary for federal
   income tax purposes under § 1361(b)(3)(B) of the Code. On Date 5, Controlled
   formed o State A single member limited liability companies (each a “Controlled
   SPE”).

3. Distributing will contribute Asset A, Asset B, and Asset C (the “Contribution” and
   collectively, the “Controlled Business”), Asset D, and p percent of LLC 1 to
   Controlled in exchange for Controlled common stock and the assumption of liabilities
   described in Step 4. Each asset of the Controlled Business and Asset D will be
   transferred to a separate Controlled SPE.

4. Distributing will cause Controlled to enter into a credit agreement with Bank, which
   will establish a line of credit with a maximum aggregate principal amount of $q prior
   to the Split-off and $r after the Split-off (the “Controlled Credit Line”). Prior to the
   Split-off, Controlled will draw down $q on the Controlled Credit Line, which will be
   evidenced by a promissory note (the “Controlled Loan”) and the outstanding
   principal of Distributing’s loan with Bank (the “Bank Loan”) will be reduced by a
   corresponding amount.

5. Any obligations (not otherwise settled or resolved in other steps) that would result in
   obligations between Distributing immediately following the Split-off (defined below)
   will be settled in cash, other than obligations under the Continuing Relationships
   (defined below).

6. Distributing will distribute all of the Controlled common stock to Irrevocable Trust 4 in
   exchange for all of the shares of Series B stock of Distributing owned by Irrevocable
   Trust 4 (the “Split-off” or the “Distribution”). Irrevocable Trust 4 may receive a cash
   PLR-106081-19 7

distribution from Distributing equal to the Tax Cover Price, if that amount is positive,
and Irrevocable Trust 4 will be required to pay the Negative Tax Cover to
Distributing, if that amount is negative.

7. Contemporaneous with Step 6, Distributing will redeem for cash s shares of its
   Series A stock held by Grantor Trust 1 to reduce the percentage of Series A stock
   owned by Grantor Trust 1 to t percent of the outstanding Series A stock.

8. After the Split-off, Controlled will elect under § 1362(a) of the Code to be treated as
   an S corporation on the first available date, effective as of the date of the Split-off.
   Controlled’s sole owner, Irrevocable Trust 4, will file a timely election to be treated as
   an electing small business trust under § 1361(e) of the Code.

9. Following the Proposed Transaction, Distributing will engage in certain continuing
   business relationships with Controlled, Irrevocable Trust, and Beneficiary 1
   (collectively, the “Continuing Relationships”). All such relationships will be based on
   arm’s length terms and conditions and will not be inconsistent with the overall
   separation of Business A and the Controlled Business.

                                Representations
   

With respect to the Distribution, except as set forth below, Distributing has made all of
the representations in Section 3 of the Appendix to Rev. Proc. 2017-53, 2017-41 I.R.B.
283 in the form set forth therein .

Distributing has made the following alternative representations set forth in Section 3 of
the Appendix to Rev. Proc. 2017-53:

   Representations 3(a), 8(a), 11(a), 15(a), 22(a), 31(a), and 41(b)

Distributing has not made the following representations, which do not apply to the
Proposed Transaction:

   Representations 5, 6, 19, 20, 24, 25, 35, 36, 37, 38, 39, and 40.

In addition, except as set forth below, Distributing has made all of the representations in
Section 3.04 of Rev. Proc. 2018-53, 2018-43 I.R.B. 667.

Distributing has made the following modified representation:

Representation 4: The Controlled Loan was obtained to substitute for an equivalent
amount of Distributing Debt (the Bank Loan). Distributing incurred the Distributing Debt
that will be satisfied with the Controlled Loan (a) before the request for any relevant
ruling is submitted and (b) no later than 60 days before the earliest of the following
PLR-106081-19 8

dates: (i) the date of the first public announcement (as defined in § 1.355-7(h)(10)) of
the Divisive Reorganization or a similar transaction, (ii) the date of the entry by
Distributing into a binding agreement to engage in the Divisive Reorganization or a
similar transaction, and (iii) the date of approval of the Divisive Reorganization or a
similar transaction by the board of directors of Distributing.

                                      Rulings

Based solely on the information submitted and representations made, we rule as
follows:

1. The Split-off 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 income 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 (the Contribution), pursuant to Treas. Reg. § 1.1361-5(b)(1)(i)
   (§ 1361(b)(3)(B) and (C)).

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

3. Distributing will recognize no gain or loss on the Contribution. Sections 357 and
   361(a).

4. Controlled will recognize no gain or loss on the Contribution. Section 1032(a).

5. Controlled’s basis in each asset received in the Contribution will be the same as the
   basis of that asset in the hands of Distributing immediately prior to the Contribution.
   Section 362(b).

6. Controlled’s holding period in each asset received in the Contribution will include the
   period during which Distributing held such asset. Section 1223(2).

7. Distributing will recognize no gain or loss on the Split-off. Section 361(c)(1).

8. Irrevocable Trust 4 will recognize no gain or loss (and no amount will be includable
   in its income) on the receipt of the stock of Controlled in the Split-off. Section 355(a).

9. The basis of the Controlled stock in the hands of Irrevocable Trust 4 immediately
   after the Split-off will be the same as the basis of the Distributing stock held by
   Irrevocable Trust 4 immediately before the Split-off. Section 358(a)(1).
   PLR-106081-19 9

10. Irrevocable Trust 4’s holding period of the Controlled stock received in the Split-off
    will include the holding period of Irrevocable Trust 4’s Distributing stock exchanged,
    provided that Irrevocable Trust 4 holds such Distributing stock as a capital asset on
    the date of the Split-off. Section 1223(1).

11. As provided in section 312(h), proper allocation of earnings and profits among
    Distributing and Controlled will be made in accordance with Treas. Reg. § 1.312-
    10(a).

12. Distributing’s accumulated adjustments account immediately before the transaction
    will be allocated between Distributing and Controlled in a manner similar to the
    manner in which earnings and profits are allocated under § 312(h) in accordance
    with Treas. Reg. § 1.1368-2(d)(3) (§§ 1.312-10(a) and 1.1368-2(d)(3)).

13. Momentary ownership by Distributing of the stock of Controlled, as part of the
    reorganization, will not cause Controlled to have an ineligible shareholder for any
    portion of its first taxable year under section 1361(b)(1)(B). Controlled may, without
    requesting the Commissioner’s consent, make a valid S corporation election before
    the expiration of the five-year period described in section 1361(b)(3)(D) and Treas.
    Reg. § 1.1361-5(c)(1), provided that (i) immediately following the distribution of the
    Controlled stock, Controlled is otherwise eligible to make an S corporation election,
    and (ii) the election is made effective on the date of the Split-off.

14. Payments made by and between Distributing and Controlled under the Continuing
    Relationships regarding liabilities, indemnities, or other obligations that (i) relate to
    periods ending on or before the Split-off, and (ii) do not become fixed and
    ascertainable until after the Split-off, will be treated as occurring immediately before
    the Split-off. See Arrowsmith v. Commissioner, 344 U.S. 6, 8 (1952); Rev. Rul. 83-
    73, 1983-1 C.B. 84.

15. Payments of Tax Cover Price made by Distributing to Irrevocable Trust 4 and
    payments of Negative Tax Cover Price made by Irrevocable Trust 4 to Distributing
    that do not become fixed and ascertainable until after the Split-off, will be treated as
    occurring immediately before the Split-off. See Arrowsmith v. Commissioner, 344
    U.S. 6, 8 (1952); Rev. Rul. 83-73, 1983-1 C.B. 84.

                                      Caveats
    

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 Transaction that is not specifically addressed by this letter.

                              Procedural Statements

PLR-106081-19 10

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.

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.

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

                                   Sincerely,



                                   Mark S. Jennings
                                   Senior Technician Reviewer, Branch 1
                                   Office of Associate Chief Counsel (Corporate)

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