Family-owned S corporation may complete two tax-free split-offs

Plain-English summary

Three family shareholder groups disagreed about management of an S corporation's business. The corporation proposed transferring portions of the business to two newly formed corporations, then exchanging each of two families' stock in the original company for stock in one new company. The IRS ruled that each contribution and split-off would qualify as a Type D reorganization under IRC § 368(a)(1)(D) and a tax-free distribution under § 355. The rulings also preserved carryover asset basis and holding periods, allocated shareholder stock basis and holding periods, and addressed earnings, profits, and accumulated adjustment accounts. The original corporation's momentary ownership of each new corporation would not itself make the new corporations ineligible to elect S status immediately after the transaction, but the IRS did not rule on business purpose, device, or acquisition-plan requirements.

Ruling snapshot

• Question: Will the two business contributions and family split-offs qualify for tax-free Type D reorganization and § 355 treatment?
• Outcome: Approved
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368, 1032, 1223, 1361, and 1362

Full text (IRS public release)

 Internal Revenue Service                                    Department of the Treasury
                                                             Washington, DC 20224

 Number: 202108010                                           Third Party Communication: None
 Release Date: 2/26/2021                                     Date of Communication: Not Applicable
 Index Number: 355.01-01, 368.04-00
                                                             Person To Contact:
 -------------------------                                   ------------------------, ID No. -----------------
 -------------                                               Telephone Number:
 ---------------------------                                 --------------------
 -------------------------                                   Refer Reply To:
 -----------------------                                     CC:CORP:B3
                                                             PLR-120326-20
                                                             Date:
                                                             December 03, 2020




Legend

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

Business X                =    --------------------------------

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

State Y                   =    --------

Shareholder A             =    --------------

Shareholder B             =    -------------------------

Shareholder C             =    -----------------


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

This letter responds to your letter dated September 10, 2020. In that letter, you
requested that this office reconsider its response to your original letter dated December
21, 2018, as supplemented by subsequent submissions, requesting rulings on certain
federal income tax consequences of the Proposed Transaction (as defined below). The
information provided in that letter and in subsequent correspondence is summarized
below.

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” (as defined in section 2.03(1)(a) of Rev. Proc. 2017-52) under
PLR-120326-20                                 2

section 355 and section 368 of the Internal Revenue Code (the “Code”). This Office
expresses no opinion as to any issue not specifically addressed by the rulings below.

The rulings contained in this letter are based on facts and representations submitted by
the taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. This office has not verified any of the materials submitted in support
of the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.

This office has made no determination regarding whether the Distributions (defined
below): (i) satisfy the business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) are
used principally as devices for the distribution of the earnings and profits of the
distributing corporation or of either of the controlled corporations or of more than one of
the three corporations (see section 355(a)(1)(B) and Treas. Reg. § 1.355-2(d)); or (iii)
are 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 either of the controlled corporations, or any
predecessor or successor of the distributing corporation or either of the controlled
corporations, within the meaning of Treas. Reg. § 1.355-8T (see section 355(e)(2)(A)(ii)
and Treas. Reg. § 1.355-7).

                                    Summary of Facts

Distributing, a State Y corporation, is engaged in Business X. Distributing made an
election under section 1362(a) to be treated under subchapter S with an effective date
of Date 1. Distributing has Class A voting stock and Class B nonvoting stock (The Class
A and Class B Distributing stock are collectively referred to as the “Distributing Stock”.)
The classes of stock differ only with respect to voting rights.

All of the Distributing Stock is owned directly or indirectly by Shareholder A,
Shareholder B, and Shareholder C, and their respective children. Each parent, together
with their respective children, owns one-third of the Class A stock and one-third of the
Class B stock, individually or through revocable and irrevocable trusts. There are
various disagreements among the shareholder families as to how the business should
be operated and managed.

                               The Proposed Transaction

For what are represented to be valid business purposes, Distributing proposes to
engage in the following transaction (“Proposed Transaction”):

1.     Distributing will form Controlled A as a State Y corporation. Controlled A will have
       Class A voting stock and Class B nonvoting stock. The classes of stock will differ
       only with respect to voting rights. Distributing will contribute a portion of the
       assets of Business X to Controlled A in exchange for all of the stock of Controlled
PLR-120326-20                                 3

       A and the assumption by Controlled A of a portion of Distributing’s liabilities
       (“Contribution A”).

2.     Distributing will form Controlled B as a State Y corporation. Controlled B will have
       Class A voting stock and Class B nonvoting stock. The classes of stock will differ
       only with respect to voting rights. Distributing will contribute a portion of the
       assets of Business X to Controlled B in exchange for all of the stock of Controlled
       B and the assumption by Controlled B of a portion of Distributing’s liabilities
       (“Contribution B”). (Contribution A and Contribution B are collectively referred to
       as the “Contributions”.) Immediately after the Contributions, Controlled A and
       Controlled B will each have a fair market value (assets less assumed liabilities)
       that is equal to one-third of Distributing’s fair market value immediately prior to
       the Contributions.

3.     Shareholder A, Shareholder A’s children, and any of their respective trusts
       (“Group A”) will exchange all of their Class A stock in Distributing for all of the
       Class A stock of Controlled A and all of their Class B stock in Distributing for all
       of the Class B stock of Controlled A (“Distribution A”).

4.     Shareholder B, Shareholder B’s children and any of their respective trusts
       (“Group B”) will exchange all of their Class A stock in Distributing for all of the
       Class A stock of Controlled B and all of their Class B stock in Distributing for all
       of the Class B stock of Controlled B (“Distribution B”). (Distribution A and
       Distribution B are collectively referred to as the “Distributions”.)

                                     Representations

With respect to the each of the Distributions, except as otherwise set forth below,
Distributing has made all of the representations in § 3 of the Appendix to Rev. Proc.
2017-52.

(1) Distributing has made the following alternative representations for each of the
Distributions:

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

(2) Distributing has not made the following representations for each of the Distributions,
which do not apply to the Proposed Transaction:

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

(3) Distributing cannot make Representation 23 due to the nature of the business.
However, Distributing represents that any mismatch will not result in a material
distortion of income and the Distributing shareholders agree to elect to terminate the tax
year on the date of the Proposed Transaction pursuant to § 1377(a)(2).
PLR-120326-20                                4


(4) Distributing cannot make Representation 42, but has represented that all of its
shareholders are U.S. persons.

Distributing has additionally made the representations set forth in section 3.04 of Rev.
Proc. 2018-53 for each of the Distributions.

                                         Rulings

Based solely on the information submitted and the representations set forth above, we
rule as follows:

Contribution A and Distribution A

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

2.    No gain or loss will be recognized by Distributing on Contribution A (§§ 357(a)
      and 361(a)).

3.    No gain or loss will be recognized by Controlled A on Contribution A (§ 1032(a)).

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

5.    Controlled A’s holding period for each asset received in Contribution A will
      include the period during which Distributing held such asset (§ 1223(2)).

6.    No gain or loss will be recognized by Distributing on Distribution A (§ 361(c)(1)).

7.    No gain or loss will be recognized by (and no amount will otherwise be included
      in the income of) each member of Group A upon receipt of Controlled A stock in
      Distribution A (§ 355(a)(1)).

8.    The aggregate basis of the Controlled A stock received by each Group A
      member in Distribution A will equal such Group A member’s aggregate basis in
      the Distributing Stock surrendered in Distribution A and will be allocated among
      the shares received in the manner described in Treas. Reg. § 1.358-2 (§ 358(a)
      and (b)).

9.    The holding period of the Controlled A stock received by each member of Group
      A in Distribution A will include the holding period of the Distributing Stock
      surrendered in exchange therefor in Distribution A, provided that the Distributing
PLR-120326-20                                 5

      Stock was held by the shareholder as a capital asset on the date of Distribution A
      (§ 1223(1)).

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

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

12.   The momentary ownership by Distributing of the stock of Controlled A as part of
      the reorganization under section 368(a)(1)(D) will not cause Controlled A 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 A ineligible to elect to be an
      S Corporation for its first taxable year. If Controlled A otherwise meets the
      requirements of a small business corporation under § 1361, Controlled A will be
      eligible to make a subchapter S election under § 1362(a) for its first taxable year,
      provided that such election is made effective immediately following the Proposed
      Transaction.

Contribution B and Distribution B

13.   Contribution B, followed by Distribution B, will qualify as a reorganization within
      the meaning of § 368(a)(1)(D). Distributing and Controlled B will each be “a party
      to a reorganization” within the meaning of § 368(b).

14.   No gain or loss will be recognized by Distributing on Contribution B (§§ 357(a)
      and 361(a)).

15.   No gain or loss will be recognized by Controlled B on Contribution B (§ 1032(a)).

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

17.   Controlled B’s holding period for each asset received in Contribution B will
      include the period during which Distributing held such asset (§ 1223(2)).

18.   No gain or loss will be recognized by Distributing on Distribution B (§ 361(c)(1)).

19.   No gain or loss will be recognized by (and no amount will otherwise be included
      in the income of) each member of Group B upon receipt of Controlled B stock in
      Distribution B (§ 355(a)(1)).
PLR-120326-20                                  6

20.    The aggregate basis of the Controlled B stock received by each Group B
       member in Distribution B will equal such Group B member’s aggregate basis in
       the Distributing Stock surrendered in Distribution B and will be allocated among
       the shares received in the manner described in Treas. Reg. § 1.358-2 (§ 358(a)
       and (b)).

21.    The holding period of the Controlled B stock received by each member of Group
       B in Distribution B will include the holding period of the Distributing Stock
       surrendered in exchange therefor in Distribution B, provided that the Distributing
       Stock was held by the shareholder as a capital asset on the date of Distribution B
       (§ 1223(1)).

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

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

24.    The momentary ownership by Distributing of the stock of Controlled B as part of
       the reorganization under section 368(a)(1)(D) will not cause Controlled B 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 B ineligible to elect to be an
       S Corporation for its first taxable year. If Controlled B otherwise meets the
       requirements of a small business corporation under § 1361, Controlled B will be
       eligible to make a subchapter S election under § 1362(a) for its first taxable year,
       provided that such election is made effective immediately following the Proposed
       Transaction.

                                          Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the Proposed Transaction 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

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

A copy of this letter should be attached to the federal income tax return of each
taxpayer involved for the taxable year in which the transaction covered by this ruling
letter is consummated. Alternatively, taxpayers filing their returns electronically may
PLR-120326-20                                  7

satisfy this requirement by attaching a statement to their return that provides the date
and control number of this letter ruling.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.


                                        Sincerely,



                                        Susan E. Massey
                                        Chief, Branch 3
                                        Office of Associate Chief Counsel (Corporate)




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