Bankruptcy claims trusts are qualified settlement funds; operating subsidiary deducts settlement funding and recognizes no gain on transferring parent stock

Plain-English summary

A regulated operating company and its holding-company parent went through Chapter 11 bankruptcy because of massive damage claims tied to their failure to maintain their property. Under the confirmed plan, the claims were channeled into two court-supervised trusts, which the companies funded with cash, parent stock, and a multi-year payment agreement. The consolidated group asked the IRS to confirm the tax treatment of that funding, and the IRS ruled favorably on every question it addressed. The trusts qualify as "qualified settlement funds" under Treas. Reg. § 1.468B-1, so funding them (rather than paying each claimant) fixes the timing and character of the tax results. The operating subsidiary, not the parent holding company, is the right party to deduct the settlement funding under § 162 as ordinary business expenses (because the claims arose from the subsidiary's operations), to the extent the amounts go to non-governmental claimants. Under § 1032 and the special stock-through-subsidiary rules, neither the subsidiary nor any group member recognizes gain or loss on issuing or transferring the parent's stock to a trust. And because the underlying liabilities were genuinely disputed, settling them produces no cancellation-of-debt income. The IRS expressly declined to rule on whether amounts paid to governments or governmental entities are deductible under § 162(f), leaving that open.

Ruling snapshot

• Question: How are the claims trusts taxed, may the operating subsidiary deduct the settlement funding, and does transferring parent stock or settling the disputed claims trigger gain or discharge-of-indebtedness income?
• Outcome: Approved (favorable rulings on qualified-settlement-fund status, § 162 deductibility for non-governmental claims, § 1032 non-recognition, and no cancellation-of-debt income; § 162(f) government-payment question not ruled on)
• Key authorities: IRC §§ 468B, 162, 461, 1001, 1032, 61; Treas. Reg. §§ 1.468B-1, 1.468B-3, 1.1032-3, 1.461-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202203009 Third Party Communication: None
Release Date: 1/21/2022 Date of Communication: Not Applicable
Index Number: 61.22-00, 162.05-03, 461.01-
00, 468B.02-00, 468B.06-00, Person To Contact:
1001.00-00, 1032.00-00, -------------------, ID No. ----------
1502.13-01 Telephone Number:
--------------------
------------------------ Refer Reply To:
-------------------------- CC:ITA:B06
------------------------- PLR-112376-20
--------------------- Date:
----------------------- January 22, 2021

                                                LEGEND

Parent = -------------------------
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Subsidiary = ---------------------------------------------
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State = -------------

Business = -------------------------------------------------------
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Commissions = ------------------------------------------------------------------------
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Events = -------------------------------------------------------------------
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PLR-112376-20 2

Property A = ----------------------

Property B = --------------

Bankruptcy Court = -------------------------------------------
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Date 1 = -----------------------

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

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

Date 4 = -------------------

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

Effective Date = ----------------

Chapter 11 Plan = ----------------------------------------------------------
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Bar Date Order = --------------------------------------------------------------------
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Confirmation Order = ------------------------------------------------------------------------
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Payment Agreement = ------------------------------------------------------------------------
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Class A Claims = ------------------------------------------------------------------------

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PLR-112376-20 3

Class B Claims = -------------------------------------------------------------
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Class C Claims = -----------------------------------------------------------------------

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Agreement X = ------------------------------------------------------------------------
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Agreement Y = -----------------------------------------------------------
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Class B Claims Trust = ------------------------------------------------------------------------
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Class C Claims Trust = ------------------------------------------------------------------------
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a = -------------

b = -------------------

c = -----------------

d = ---------------------

e = ---

f = -------------------

g = -----------------
PLR-112376-20 4

h = -------------------

i = --

j = -----------

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

This letter responds to your letter dated May 26, 2020, and supplemental
correspondence, submitted on behalf of Parent and Subsidiary, regarding the
application of various sections of the Internal Revenue Code (the Code) and the Income
Tax Regulations to certain transactions. More specifically, Parent and Subsidiary
requested several rulings related to the qualification of certain trusts as qualified
settlement funds under § 1.468B-1 of the Income Tax Regulations and the tax treatment
to Parent and Subsidiary of the transfer of cash, stock, and other property to the trusts.

                                              FACTS

Parent, a State corporation, is a holding company and the common parent of an
affiliated group of corporations that includes Subsidiary (the “Parent Group”). The
Parent Group files a consolidated return on a calendar year basis using the accrual
method of accounting. Subsidiary, a State corporation, is primarily engaged in Business
in State, is the primary operating subsidiary of Parent, and is regulated by the
Commissions. Parent has none of the operations, nor is directly involved in the
management of Business.
Subsidiary and Parent are subject to numerous claims for damages relating to the
Events, based on the premise that Subsidiary failed to repair and maintain its Property
A and surrounding Property B. Under the laws of State, Subsidiary is subject to strict
liability for damages resulting from the Events. The claimants include private parties,
governments, and governmental entities.1
Parent and Subsidiary (the "Debtors'') commenced voluntary cases under Chapter 11 of
the Bankruptcy Code in Bankruptcy Court on Date 1 due to the substantial potential
liabilities relating to the Events. The Bankruptcy Court is jointly administering the
Chapter 11 cases of the Debtors. Pursuant to the Bar Date Order, all claims related to
the Events were deemed to be filed against both Parent and Subsidiary for the
convenience of the holders of such claims and to avoid unnecessary confusion.
Both prior to and during the Chapter 11 cases, the Debtors entered into certain
settlement agreements and restructuring support agreements with various claimants
and committees representing such claimants. On Date 3, the Bankruptcy Court
confirmed the Chapter 11 Plan. Under the Chapter 11 Plan, the claims related to the
1 For purposes of this ruling letter, the terms, “government” and “governmental entity” refer to any

“government”, “governmental entity”, or “non-governmental entity treated as governmental entity” under
sections 162(f)(1) and (f)(5) of the Code.
PLR-112376-20 5

Events generally comprised three categories of claims: Class A Claims, Class B
Claims,2 and Class C Claims (collectively, "Events Claims"). The treatment of Events
Claims under the Chapter 11 Plan reflects the settlements and restructuring support
agreements reached with or on behalf of holders of Events Claims. The Events Claims
were in dispute prior to reaching such agreements.
The Debtors represent that the Events Claims settled under the Chapter 11 Plan solely
or primarily relate to Subsidiary's conduct of Business. Accordingly, Parent and
Subsidiary entered Agreement X and Agreement Y confirming that any substantive
liability with respect to the Events Claims (to the extent ultimately allowed) is the sole or
primary liability of Subsidiary.
On Date 3, pursuant to the terms of the Chapter 11 Plan and related agreements,
representatives of holders of the Class B Claims and Class C Claims established two
trusts, the Class B Claims Trust and the Class C Claims Trust (collectively, “the
Trusts”). The Class B Claims Trust was established under state law to administer,
process, settle, resolve, liquidate, satisfy, and pay all Class B Claims as allowed in
accordance with the Class B Claims Trust agreement and the procedures established
for the resolution, liquidation, and payment of the Class B Claims. Pursuant to a
channeling injunction, Class B Claims were permanently channeled to the Class B
Claims Trust. Holders of Class B Claims must assert such claims exclusively against
the Class B Claims Trust in accordance with its terms, with no recourse to the Debtors
or their assets and properties. The Debtors have no residual interest in the assets of
the Class B Claims Trust. In addition, pursuant to the Class B Claims Trust agreement,
the Class B Claims Trust is subject to the continuing jurisdiction of the Bankruptcy
Court.
Similarly, the Class C Claims Trust was established under state law to administer,
process, settle, resolve, liquidate, satisfy, and pay all Class C Claims as allowed in
accordance with the Class C Claims Trust agreement and the procedures established
for the resolution, liquidation, and payment of the Class C Claims. Pursuant to a
channeling injunction, Class C Claims were permanently channeled to the Class C
Claims Trust. Holders of Class C Claims must assert such claims exclusively against
the Class C Claims Trust in accordance with its terms, with no recourse to the Debtors
or their assets and properties. The Debtors have no residual interest in the assets of the
Class C Claims Trust and the Debtors have no legal rights in, and no control over, the
disposition of the Parent stock transferred to the Class C Claims Trust. In addition,
pursuant to the Class C Claims Trust agreement, the Class C Claims Trust is subject to
the continuing jurisdiction of the Bankruptcy Court.
The Chapter 11 Plan became effective on Effective Date. Shortly before Effective Date
and immediately thereafter, the Debtors took several steps to fulfill their responsibilities
under the Chapter 11 Plan, the associated Confirmation Order, and the various

2 Holders of Class B Claims do not include any claim holders that are a government or a governmental

entity.
PLR-112376-20 6

settlement agreements and restructuring support agreements underlying the Chapter 11
Plan.
On Date 4, Subsidiary advanced $a to the counsel for Class B Claim holders, which
was used to fund the pre-Effective Date fees and expenses of the future trustee of the
Class B Claims Trust.
On Effective Date, Subsidiary transferred $b to Class A Claims holders in full and final
satisfaction, settlement, release and discharge of all allowed Class A Claims.
On Effective Date, Subsidiary funded the Class B Claims Trust by transferring $c
directly to the Class B Claims Trust and $d to an interest-bearing escrow account
owned by the Class B Claims Trust, in full and final satisfaction, release, and discharge
of the Class B Claims. The escrowed amount was held for e days to generate earnings
to satisfy certain other claims not included in the Class B Claims or any other claims
addressed in this letter ruling request. After e days, the escrow agent transferred $d,
the principal amount initially transferred to the escrow account, to the Class B Claims
Trust.
Also, on Effective Date, and pursuant to the Chapter 11 Plan and Agreement Y, Parent
made a capital contribution to Subsidiary consisting of Parent common stock and the
proceeds of certain stock and debt offerings. On the same day, Subsidiary funded, or
agreed to fund, the Class C Claims Trust with the following consideration in full and final
satisfaction, release and discharge of all allowed Class C Claims:
(i) $f of cash;

   (ii) g shares of Parent stock;

   (iii) additional cash payments pursuant to Payment Agreement, under which
   Subsidiary agreed to pay an aggregate amount $h, to the Class C Claims Trust,
   without interest, over i years;

   (iv) any proceeds payable from certain rights and potential causes of action
   against third parties; and

   (v) the assignment of rights under certain insurance policies.

On Date 5, Subsidiary funded the Class C Claims Trust with an additional j shares of
Parent stock.

In accordance with Agreement X and Agreement Y, all cash, Parent stock, and other
property transferred, or to be transferred, to the Trusts have been, and will be treated,
by Parent and Subsidiary as being received and then contributed by or on behalf of
Subsidiary. In addition, under Agreement X and Agreement Y, Parent treated and will
treat all stock, cash, and other property transferred to Subsidiary under the Chapter 11
Plan, as a contribution to the capital of Subsidiary.
PLR-112376-20 7

Subsidiary is considering making an election under § 1.468B-1(k) (a “Grantor Trust
Election”) with respect to either the Class B Claims Trust or the Class C Claims Trust, or
both Trusts. In the event Subsidiary decides to make a Grantor Trust Election with
respect to the Class C Claims Trust, Parent and Subsidiary intend to enter into a
supplemental agreement with the Class C Claims Trust pursuant to which, among other
things, Parent would agree to transfer on behalf of Subsidiary substitute shares of
Parent stock (either newly issued or treasury shares) to the Class C Claims Trust (the
“New Parent Shares”) as and when the Class C Claims Trust decides to dispose of a
number of shares of Parent stock to a third party, and concurrently therewith the Class
C Claims Trust would retransfer to Subsidiary the same number of shares of Parent
stock received by the Class C Claims Trust pursuant to the Chapter 11 Plan. The Class
C Claims Trust would promptly, within a commercially reasonable time thereafter, sell or
exchange the New Parent Shares for cash or other property in a transaction in which
the acquiror does not receive a substituted basis in such shares within the meaning of
section 7701(a)(42). The shares of Parent stock retransferred to Subsidiary would be
held as an additional asset of Subsidiary (with no current intent to dispose of such
shares).

                             REPRESENTATIONS

The following representations are made with respect to the Chapter 11 Plan:

1. Subsidiary will not deduct under section 162 any amounts representing insurance
   policy proceeds that the Debtors recovered but excluded from gross income.

2. Because Subsidiary has not yet determined whether to make a Grantor Trust
   Election with respect to the Class B Claims Trust or the Class C Claims Trust,
   the following representations assume, as applicable, that a Grantor Trust
   Election is not made:

   a. The Parent stock is "publicly traded" within the meaning of § 1.170A-
   13(c)(7)(xi)

   b. In accordance with § 1.468B-3(e), the Parent Group will provide the Internal
   Revenue Service (IRS) and each administrator of the Trusts with a Ҥ 1.468B-
   3 Statement" and will include such statement in its tax return for the taxable
   year in which a funding of the Trusts occurs.

   c. Following the funding of the Trusts, neither the Debtors nor any "related
   person" to the Debtors within the meaning of section 468B(d)(3) own or will
   own at any time, directly or indirectly, any beneficial interest in the corpus or
   income or the Trusts.
   PLR-112376-20 8

                           RULINGS REQUESTED
   

3. Each of the Trusts constitutes a qualified settlement fund under § 1.468B-1(c).

4. Subsidiary is eligible to make a Grantor Trust Election with respect to each of the
   Trusts.

5. (a) Provided that Subsidiary does not make a Grantor Trust Election for the Class C
   Claims Trust, neither Subsidiary nor any other member of the Parent Group recognized
   or will recognize any gain or loss on the issuance or transfer of Parent stock to the
   Class C Claims Trust pursuant to the Chapter 11 Plan.

(b) If Subsidiary makes a Grantor Trust Election for the Class C Claims Trust, neither
Subsidiary nor any other member of the Parent Group will recognize gain or loss on the
issuance or transfer of the New Parent Shares to the Class C Claims Trust, or on the
disposition of the New Parent Shares by the Class C Claims Trust.

4. No member of the Parent Group recognized any gain or loss upon the transfer of the
   Payment Agreement to the Class C Claims Trust.

5. If Subsidiary does not make a Grantor Trust Election with respect to either Trust:

(a) Subsidiary may deduct under section 162 the amounts of cash transferred by
Subsidiary to the Class B Claims Trust and the Class C Claims Trust to the extent such
amounts are allocable to claims by parties that are not a government or a governmental
entity.

(b) Subsidiary may deduct under section 162 the principal payments (as determined

for Federal income tax purposes) to be made to the Class C Claims Trust as required
under Payment Agreement to the extent such payments are allocable to claims by
parties that are not a government or a governmental entity.

(c) Subsidiary may deduct under section 162 an amount equal to the fair market

value of Parent stock and other property transferred by Subsidiary or by Parent on
behalf of Subsidiary to fund the Class C Claims Trust to the extent that these amounts
are allocable to claims by parties that are not a government or a governmental entity.

(d) However, if Subsidiary makes a Grantor Trust Election with respect to the Class

B Claims Trust or the Class C Claims Trust, Subsidiary may deduct under section 162
only amounts paid by the applicable Trust to the Class B or Class C claimants to
resolve their claims to the extent that such amounts are paid to resolve the claims of
parties that are not a government or a governmental entity.

6. If Subsidiary does not make a Grantor Trust Election with respect to either Trust, in
   accordance with sections 461 and 468B, Subsidiary may deduct amounts described in
   rulings 5(a), 5(b), and 5(c) in the taxable year in which such amounts are transferred to
   the Class B Claims Trust and the Class C Claims Trust, as applicable. However, if
   PLR-112376-20 9

Subsidiary makes a Grantor Trust Election with respect to the Class B Claims Trust or
the Class C Claims Trust, in accordance with section 461, Subsidiary must deduct the
amounts described in ruling 5(d) in the taxable year that, and only to the extent that,
such amounts are paid by the Trusts to the Class B or Class C claimants, as applicable.

7. No member of the Parent Group realized discharge of indebtedness income from the
   settlement and discharge of Class A Claims, Class B Claims and Class C Claims.

                               LAW AND ANALYSIS
   

   Ruling 1. Treatment as Qualified Settlement Funds under § 1.468B-1(c).

Section 468B(g)(1) provides that “[n]othing in any provision of law shall be construed as
providing that an escrow account, settlement fund, or similar fund is not subject to
current income tax.” Section 468B(g)(1) authorizes the issuance of regulations
providing for the taxation of any such account or fund whether as a grantor trust or
otherwise. Sections 1.468B-1 through 1.468B-5 regarding qualified settlement funds
were issued pursuant to section 468B(g).

Section 1.468B-1(a) provides that a qualified settlement fund is a fund, account, or trust
that satisfies the three requirements of § 1.468B-1(c). First, § 1.468B-1(c)(1) requires
that the fund, account, or trust is established pursuant to an order of, or it is approved
by, the United States, any state (including the District of Columbia), territory,
possession, or political subdivision thereof, or any agency or instrumentality (including a
court of law) of any of the foregoing and is subject to the continued jurisdiction of that
governmental authority. Second, § 1.468B-1(c)(2) requires that the fund, account, or
trust is established to resolve or satisfy one or more contested or uncontested claims
that have resulted or may result from an event (or related series of events) that has
occurred and that has given rise to at least one claim asserting liability (i) under the
Comprehensive Environmental Response, Compensation and Liability Act of 1980; (ii)
arising out of a tort, breach of contract, or violation of law; or (iii) designated by the
Commissioner in a revenue ruling or revenue procedure. Third, § 1.468B-1(c)(3)
provides that the fund, account, or trust must be a trust under applicable state law, or its
assets must be otherwise segregated from other assets of the transferor (and related
persons).

Section 1.468B-1(j)(1) provides that if a fund, account, or trust is established to resolve
or satisfy claims described in § 1.468B-1(c)(2), the assets of the fund, account, or trust
are treated as owned by the transferor of those assets until the fund, account, or trust
also meets the requirements of § 1.468B-1(c)(1) and (c)(3). On the date the fund,
account, or trust satisfies all the requirements of § 1.468B-1(c), the transferor is treated
as transferring the assets to a qualified settlement fund.

Based on the facts presented and the representations provided herein, we conclude
that the three requirements of § 1.468B-1(c) are satisfied and that each of the Trusts is
PLR-112376-20 10

a qualified settlement fund as of the Effective Date. First, each of the Trusts was
established in accordance with the Chapter 11 Plan pursuant to a confirmation order
entered and approved by the Bankruptcy Court and is subject to the Bankruptcy Court’s
continuing jurisdiction. See § 1.468B-1(c)(1). Second, each of the Trusts was
established to resolve or satisfy claims brought against Debtors for damages allegedly
sustained as a result of Events. See § 1.468B-1(c)(2). Third, each of the Trusts was
organized under the applicable state law. See § 1.468B-1(c)(3).

    Ruling 2.        Subsidiary’s Eligibility to Make a Grantor Trust Election.

Section 1.468B-1(k)(1) provides that, if a qualified settlement fund has only one
transferor (as defined in § 1.468B-1(d)(1)), the transferor may make an election to treat
the qualified settlement fund as a trust all of which is owned by the transferor under §
671 and the regulations thereunder.

Section 1.468B-1(d)(1) provides that a “transferor” is a person that transfers (or on
behalf of whom an insurer or other person transfers) money or property to a qualified
settlement fund to resolve or satisfy claims described in § 1.468B-1(c)(2) against that
person.

Section 1.468B-1(k)(2)(i) states the manner by which the transferor makes the Grantor
Trust Election, and provides that the transferor must make the election for the taxable
year in which the qualified settlement fund is established.

Section 1.468B-1(k)(3) governs the effect of making the Grantor Trust Election,
providing that if the election is made: (i) Paragraph (b) of this section, and §§ 1.468B-2,
1.468B-3, and 1.468B-5(a) and (b) do not apply to the qualified settlement fund;
however, this section (except for paragraph (b) of this section) and § 1.468B-4 apply to
the qualified settlement fund; (ii) the qualified settlement fund is treated, for Federal
income tax purposes, as a trust all of which is treated as owned by the transferor under
section 671 and the regulations thereunder; (iii) the transferor must take into account in
computing the transferor's income tax liability all items of income, deduction, and credit
(including capital gains and losses) of the qualified settlement fund in accordance with §
1.671-3(a)(1); and (iv) the reporting obligations imposed by §1.671-4 on the trustee of a
trust apply to the administrator.

Based on the facts presented and representations made, we conclude that Subsidiary is
eligible to make a Grantor Trust Election with respect to each of the Trusts.3 First, each

3 Because Subsidiary is a member of a consolidated group in which Parent is the common parent, the

election must be made by Parent as agent for Subsidiary. Section 1.1502-77(a)(1) provides that
generally one entity (the agent) is the sole agent that is authorized to act in its own name regarding all
matters relating to the Federal income tax liability for the consolidated return year for each member of the
group. Under § 1.1502-77(c)(1), that agent is generally the common parent. Under § 1.1502-77(d)(1),
the agent makes any election available to a subsidiary. Although Parent must make a grantor trust
election for Subsidiary, the election will affect Subsidiary’s separate taxable income as if Subsidiary made
PLR-112376-20 11

Trust constitutes a qualified settlement fund as of the Effective Date pursuant to ruling

1. Second, Subsidiary is the sole transferor as defined in § 1.468B-1(d)(1) with respect
   to all property transferred (and to be transferred) to the Trusts, with such transfers made
   in satisfaction and discharge of claims which relate to, and arise out of, the business
   and operations of Subsidiary.

In this regard and in accordance with Agreement X and Agreement Y, all cash, Parent
stock, and other property transferred, or to be transferred, to the Trusts have been, and
will be treated, by Parent and Subsidiary as being received and then contributed by or
on behalf of Subsidiary. In addition, under Agreement X and Agreement Y, Parent
treated and will treat all stock, cash, and other property transferred to Subsidiary under
the Chapter 11 Plan, as a contribution to the capital of Subsidiary.

If Subsidiary makes a Grantor Trust Election with respect to a particular Trust as
contemplated in some of the rulings that follow, Subsidiary as the transferor must
comply with the effect of the election as specified in § 1.468B-1(k)(3). Where a Grantor
Trust election is made, the qualified settlement fund is not treated as a separate taxable
entity. Section 1.468B-1(k)(3) requires Subsidiary (A) to treat the qualified settlement
fund, for Federal income tax purposes, as a trust all the assets of which are treated as
owned by the transferor under section 671 and the regulations thereunder, and (B) to
take into account in computing its income tax liability, all items of income, deduction,
and credit (including capital gains and losses) of the qualified settlement fund in
accordance with § 1.671-3(a)(1). See §§ 1.468B-1(k)(3)(ii) and (iii). Section 1.468B-
1(k)(3)(i) also provides that the requirements of § 1.468B-2 and § 1.468B-3 do not apply
to the post-election qualified settlement fund.

   Ruling 3(a). Tax Treatment Under Section 1032 of Issuance or Transfer of

Parent Stock to Class C Claims Trust if Subsidiary Does Not Make Grantor Trust
Election.

Section 1001(a) provides generally that gain or loss from the sale or other disposition of
property is the difference between the amount realized and the basis of the property, as
determined under section 1011.
Section 1001(c) states that, except as otherwise provided in Subtitle A, the entire
amount of gain or loss determined under section 1001 on the sale or exchange of
property shall be recognized.
Section 1.468B-3(a)(1) provides that a transferor must treat a transfer of property to a
qualified settlement fund as a sale or exchange for purposes of section 1001(a), with

the election and thus does not affect our conclusion that Subsidiary is eligible to make the § 1.468B-1(k)
election.
PLR-112376-20 12

the amount realized by the transferor being the fair market value of the property on the
date the transfer is made.
Section 1032(a) provides that no gain or loss will be recognized to a corporation on the
receipt of money or other property in exchange for stock of such corporation.
Section 1.1032-3(b)(1) provides that no gain or loss is recognized on the disposition of a
corporation’s stock (the “issuing corporation”) by an acquiring entity in exchange for
money or other property if the four requirements of § 1.1032-3(c) are met. If such
requirements are met, the transaction is treated as if, immediately before the acquiring
entity disposes of the stock of the issuing corporation, the acquiring entity purchased
the issuing corporation’s stock from the issuing corporation for fair market value with
cash contributed to the acquiring entity by the issuing corporation (or, if necessary,
through intermediate corporations or partnerships).
Section 1.1032-3(c) requires that, pursuant to a plan to acquire money or other
property: (i) the acquiring entity acquires stock of the issuing corporation directly or
indirectly from the issuing corporation in a transaction in which the tax basis of the stock
of the issuing corporation in the hands of the acquiring entity would be determined, in
whole or in part, with respect to the issuing corporation’s basis in the issuing
corporation’s stock under section 362(a) or 723; (ii) the acquiring entity immediately
transfers the stock of the issuing corporation to acquire money or other property (from a
person other than an entity from which the stock was directly or indirectly acquired); (iii)
the party receiving stock of the issuing corporation in the exchange from the acquiring
entity does not receive a substituted basis in the stock of the issuing corporation within
the meaning of section 7701(a)(42); and (iv) the issuing corporation stock is not
exchanged for stock of the issuing corporation.
Section 1.1502-13(f)(6) provides, in general, that any loss realized by a member of a
consolidated group with respect to stock of the common parent is permanently
disallowed, but as to any gain realized, refers over to § 1.1032-3.
Based on the facts presented and the representations provided herein, the
requirements of § 1.1032-3(c) are satisfied and we conclude that, provided that
Subsidiary does not make a Grantor Trust Election for the Class C Claims Trust, neither
Subsidiary nor any other member of the Parent Group recognized any gain or loss on
the issuance or transfer of Parent stock to the Class C Claims Trust pursuant to the
Chapter 11 Plan where the trust constitutes a qualified settlement fund as concluded
under Ruling 1.

First, all amounts funded to the Trusts were funded by and on behalf of Subsidiary. The
Parent stock transferred to the Class C Claims Trust was first contributed by Parent to
Subsidiary pursuant to a transaction to which section 362 would apply to determine
Subsidiary’s basis in such stock, in the absence of § 1.1032-3(b)(1).

Second, Subsidiary immediately transferred (or was treated as transferring) the Parent
stock to the Class C Claims Trust in consideration for the Class C Claims Trust’s
assumption of liability for the Class C Claims (in discharge of any and all liability of
PLR-112376-20 13

Subsidiary for such claims from the holders of Class C Claims) and thus is treated as
the transfer of such stock by Subsidiary to acquire property.

Third, the Class C Claims Trust took a new fair market value basis in the Parent stock
received from Subsidiary, i.e., not a substituted basis under section 7701(a)(42).
Fourth, the Parent stock transferred to the Class C Claims Trust was not exchanged for
other stock of Parent.

  Ruling 3(b). Tax Treatment Under Section 1032 of Issuance or Transfer of New

Parent Stock to Class C Claims Trust if Subsidiary Makes Grantor Trust Election.

If Subsidiary makes a Grantor Trust Election with respect to the Class C Claims Trust,
pursuant to § 1.468B-1(k)(3) the incidence of taxation changes from the Trust as a
separate taxable entity to the Subsidiary by operation of § 1.468B-1(k)(3)(i). Section
1.468B-1(k)(3)(ii) requires that the qualified settlement fund (i.e., the applicable Trust for
which the election is made) be treated by Subsidiary (the transferor), for Federal income
tax purposes, as a trust all of which is treated as owned by Subsidiary under section
671 and the regulations thereunder. Additionally, § 1.468B-1(k)(3)(iii) provides that
Subsidiary must take into account in computing it’s income tax liability all items of
income, deduction, and credit (including capital gains and losses) of the qualified
settlement fund (the Trust) in accordance with § 1.671-3(a)(1).

Accordingly, we conclude that, if Subsidiary makes a Grantor Trust Election with respect
to the Class C Claims Trust and New Parent Shares are transferred to the Class C
Claims Trust and disposed of by the Class C Claims Trust under the circumstances
represented, the requirements of § 1.1032-3(c) will be satisfied with respect to the New
Parent Shares. Therefore, neither Subsidiary nor any other member of the Parent
Group will recognize any gain or loss on the disposition of the New Parent Shares by
the Class C Claims Trust.

First, the New Parent Shares will be transferred to the Class C Claims Trust from Parent
on behalf of Subsidiary in a transaction deemed to be a transfer from Parent to
Subsidiary in which section 362 applies to determine Subsidiary’s basis in such New
Parent Shares, in the absence of § 1.1032-3(b)(1).

Second, the Class C Claims Trust will immediately sell the New Parent Shares to
acquire money or other property (from a person other than an entity from which the
stock was directly or indirectly acquired).

Third, the purchaser of such New Parent Shares from the Class C Claims Trust will take
a fair market value basis in the Parent stock, i.e., not a substituted basis under section
7701(a)(42).

Fourth, the New Parent Shares will not be exchanged, or treated as exchanged, for
other stock of Parent, in that Subsidiary (the regarded owner of the Parent stock held by
PLR-112376-20 14

the Class C Claims Trust, being a grantor trust) would continue to own the Parent stock
(now directly rather than in the trust) and the New Parent Shares will be exchanged for
money or other property.

   Ruling 4.   No Gain or Loss upon the Transfer of the Payment Agreement to

the Class C Claims Trust.

Section 1.468B-3(a)(1) provides that because the issuance of a transferor’s debt,
obligation to provide services or property in the future, or obligation to make a payment
described in § 1.461-4(g), is generally not a transfer of property by the transferor, the
transfer of such property generally does not result in gain or loss to the transferor.

Based on the facts presented and the representations provided herein, we conclude
that no member of the Parent Group recognized any gain or loss upon the transfer of
the Payment Agreement to the Class C Claims Trust. More specifically, because the
Payment Agreement is an obligation of Subsidiary to pay an amount of cash over i
years, the transfer of such instrument does not result in gain or loss to Parent,
Subsidiary or another member of the Parent Group.

   Ruling 5.     Treatment of Settlement Amounts under Section 162

Section 162(a) of the Code provides generally that there shall be allowed as a
deduction all the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business. See also § 1.162-1(a).

Section 162(f)(1) disallows a deduction for any amount paid or incurred (by suit,
agreement, or otherwise) to, or at the direction of, a government or governmental entity
in relation to the violation of any law or the investigation or inquiry by such government
or governmental entity into the potential violation of any law. Section 162(f)(2) provides
an exception to the general disallowance rule in section 162(f)(1) for certain amounts
paid or incurred for restitution, remediation, or to come into compliance with a law.

Section 6.02 of Rev. Proc. 2020-1, 2020-1 I.R.B. 1, provides that the IRS ordinarily does
not issue letter rulings or determination letters in certain areas because of the factual
nature of the matter involved or for other reasons. This section also provides that the
IRS may decline to issue a letter ruling or a determination letter when appropriate in the
interest of sound tax administration, including due to resource constraints, or on other
grounds whenever warranted by the facts or circumstances of a particular case.

Although Parent Group had initially requested rulings that included the application of
section 162(f) to the portion of the Debtors’ settlement amounts paid and property
transferred to certain governments or governmental entities, this office has notified
Parent Group of its determination that the provision of such ruling on this question at
this time is not in the interests of sound tax administration. Accordingly, for purposes of
this private letter ruling, no opinion is expressed or implied concerning the deductibility
PLR-112376-20 15

under section 162 of any amounts paid or property transferred, or to be paid or
transferred, under the Chapter 11 Plan, to any claim holder that is a “government”, a
“governmental entity” or a “non-governmental entity treated as a governmental entity”
under sections 162(f)(1) and (f)(5) of the Code. In addition, no opinion is expressed or
implied concerning the proper allocation of amounts paid or property transferred, or to
be paid or transferred, to such claim holders.

Notwithstanding the prohibition on the deduction of certain amounts under section
162(f), in order to be deductible under section 162, an expenditure must be (i) paid or
incurred during the taxable year; (ii) sustained in carrying on a trade or business; (iii) an
expense; (iv) a necessary expense; and (v) an ordinary expense. Commissioner v.
Lincoln Savings and Loan Association, 403 U.S. 345, 352 (1971).

Whether payments in settlement of a claim are deductible under section 162 is based
on the “origin of the claim.” Under this analysis, the characterization of costs depends
upon the nature of the activities giving rise to the claim and does not depend on the
consequence or result. See United States v. Gilmore, 372 U.S. 39 (1963) (establishing
the origin of the claim test for determining whether a settlement expense was a
nondeductible personal or deductible business expense); Woodward v. Commissioner,
397 U.S. 572 (1970) (stating that to determine if a business expense is ordinary and
necessary or capital and nondeductible, the inquiry turns on whether the origin of the
claim litigated is in the process of acquisition itself).

Consequently, amounts paid in settlement of a lawsuit are generally deductible if the
acts which gave rise to the litigation were performed in the ordinary conduct of the
taxpayer's business. See, e.g., Federation Bank & Trust Co. v. Commissioner, 27 T.C.
960 (1957) (allowing petitioner to deduct amounts paid in settlement of legal
proceedings charging petitioner with mismanagement in the liquidation of assets); Rev.
Rul. 80-211, 1980-2 C.B. 57 (allowing corporation to deduct amounts paid as punitive
damages that arose from a civil lawsuit against the corporation for breach of contract
and fraud in connection with the ordinary conduct of its business activities); Rev. Rul.
79-208, 1979-2 C.B. 79 (permitting taxpayer to deduct payments to settle lawsuit and
obtain a release from claims under a franchise agreement).

Where both Parent and Subsidiary were named as Debtors under the Chapter 11 Plan
and Confirmation Order, an initial determination must be made to determine whether
Subsidiary is the appropriate party to claim a business expense deduction under section

162. Generally, a corporation may not deduct expenses paid on behalf of a related
     corporation. See Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943);
     Deputy v. Dupont, 308 U.S. 488 (1940). However, there is a limited exception to this
     rule. Under this exception, a corporation may deduct such expenses if they are directly
     and proximately related to the corporation’s own trade or business. See Young &
     Rubicam v. U.S., 410 F.2d 410 F.2d 1233, 1238–1239 (Ct. Cl. 1969); Austin Co. v.
     Comm’r, 71 T.C. 955, 967 (1979), acq., 1979-2 C.B. 1; Columbian Rope Co. v.
     Commissioner, 42 T.C. 800, 815-16 (1964).
     PLR-112376-20 16

Under the facts of this case, we believe that Subsidiary is the appropriate party to claim
deduction for the cash and property transferred, or to be transferred, to the Trusts. As
noted in the facts, Bankruptcy Court is jointly administering Parent and Subsidiary’s
bankruptcy cases. The Bar Date Order deemed all Class B Claims and Class C Claims
to be filed against both Parent and Subsidiary for the convenience of the claimants and
to avoid confusion to individual claimants. Nevertheless, these claims related to, and
arose from, damages caused by Subsidiary’s failure to repair and maintain Property A,
property owned by Subsidiary and used to carry on its Business. Further, Subsidiary’s
payment of these claims was necessary to protect and preserve those business
operations. In contrast, Parent operated solely as a holding company and did not
directly own or operate the property related to the damage claims. Moreover, Parent
was not involved in the management of Subsidiary’s operations that gave rise to the
Events Claims.

In addition, Agreement X and Agreement Y address the proper allocation of liabilities
amongst the parties. These agreements provide that Parent will treat all cash, Parent
stock and other property that it transfers to Subsidiary to fund the Trusts as capital
contributions to Subsidiary. By agreeing to these terms, Parent and Subsidiary properly
acknowledge that the Class B and Class C Claims are directly and proximately related
to the operation of the Subsidiary’s trade or business, rather than Parent’s, and that the
parties will treat these claims accordingly. Thus, based on the submitted information
and representations made, Subsidiary is the appropriate party to claim a business
expense deduction for amounts incurred for such claims under section 162.

Finally, the Class B Claims and the Class C Claims clearly arose in the ordinary course
of Subsidiary’s business. As discussed above, these claims resulted from damages
allegedly caused by the failure of Subsidiary to repair and maintain Property A, property
used in Subsidiary’s business, and surrounding Property B. Accordingly, to the extent
that Subsidiary’s transfers of cash and Parent stock are allocable to claims held by
parties that are not a government or a governmental entity, Subsidiary may deduct
these amounts as ordinary and necessary business expenses under section 162.

Consequently, based on the foregoing facts and representations, and provided that
Subsidiary does not make a Grantor Trust Election with respect to either Trust, it is held
that:

(a) Subsidiary may deduct under section 162 the amounts of cash transferred by
Subsidiary to the Class B and Class C Claims Trusts to the extent such amounts
are allocable to claims by parties that are not a government or a governmental
entity;

(b) Subsidiary may deduct under section 162 the principal payments (as determined
for Federal income tax purposes) to be made by Subsidiary to the Class C
Claims Trust pursuant to the Payment Agreement to the extent such payments
PLR-112376-20 17

   are allocable to claims by parties that are not a government or governmental
   entity; and

(c) Subsidiary may deduct under section 162 an amount equal to the fair market
value of Parent stock and other property transferred by the Debtors to fund the
Class C Claims Trust to the extent that these amounts are allocable to claims by
parties that are not a government or a governmental entity.

(d) However, if Subsidiary makes a Grantor Trust Election with respect to the Class
B Claims Trust or the Class C Claims Trust, Subsidiary may deduct under
section 162 only amounts paid by the applicable Trust to the Class B or Class C
claimants to resolve their claims to the extent that such amounts are paid to
resolve the claims of parties that are not a government or a governmental entity.

   Ruling 6. Accrual of Deductions under Sections 461 and 468B

Section 461(a) provides that a deduction shall be taken for the taxable year that is the
proper taxable year under the method of accounting used in computing taxable income.

Section 1.461-1(a)(2) provides that under an accrual method of accounting a liability is
incurred, and generally is taken into account for Federal income tax purposes, in the
taxable year in which all the events have occurred that establish the fact of the liability,
the amount of the liability can be determined with reasonable accuracy, and economic
performance has occurred with respect to the liability.

Section 461(h)(1) provides that in determining whether an amount has been incurred
with respect to any item during any taxable year, the all events test shall not he treated
as met any earlier than when economic performance with respect to the item occurs.

Section 461(h)(4) provides that the all events test is met with respect to any item if all
events have occurred which determine the fact of the liability and the amount of such
liability can be determined with reasonable accuracy.

Section 1.461-4(g)(2) provides that if the liability of a taxpayer requires a payment or
series of payments to another person and arises under any workers compensation act
or out of any tort, breach of contract, or violation of law, economic performance occurs
as payment is made to the person to which the liability is owed.

Section 1.468B-3(a)(1) provides that a transferor must treat a transfer of property to a
qualified settlement fund as a sale or exchange of that properly for purposes of section
1001. In computing the gain or loss, the amount realized by the transferor is the fair
market value of the property on the dale the transferor is made to the qualified
settlement fund. Because the issuance of a transferor's debt, obligation to provide
services or property in the future, or obligation to make a payment described in § 1.461-
4(g), is generally not a transfer of property by the transferor, it generally does not result
in gain or loss to the transferor.
PLR-112376-20 18

Section 1.468B-3(c)(1) provides that, except as otherwise provided in that section, for
purposes of section 461(h), economic performance occurs with respect to a liability
described § 1.468B-1(c)(2) (determined with regard to § 1.468B-1(f) and (g)) to the
extent the transferor makes a transfer to a qualified settlement fund to resolve or satisfy
the liability.

Section 1.468B-3(c)(2)(i)(A) and (B) provide that economic performance does not occur
to the extent the transferor (or related person) has a right to a refund or reversion of a
transferor that right is exercisable currently and without the agreement or an unrelated
person that is independent or has an adverse interest (e.g., the court or agency that
approved the fond or the fund claimants), or money or property is transferred under
conditions that allow its refund or reversion by reason of the occurrence of an event that
is certain to occur, such as the passage of time, or if restrictions on its refund or
reversion are illusory.

Section 1.468B-1(h)(2) provides that economic performance does not occur with
respect to transfers to a qualified settlement fund for non-allowable claims.

Section 1.468B-3(c)(3) provides that economic performance does not occur when a
transferor transfers to a qualified settlement fund its debt (or the debt of a related
person). Instead, economic performance occurs as the transferor (or related person)
makes principal payments on the debt. Similarly, economic performance does not
occur when a transferor transfers to a qualified settlement fund its obligation (or the
obligation of a related person) to provide services or property in the future, or to make a
payment described in § 1.461-4(g). Instead, economic performance with respect to
such an obligation occurs as services, property or payments are provided or made to
the qualified settlement fund or a claimant.

Section 1.468B-3(d) provides that no deduction is allowed to a transferor for a transfer
to a qualified settlement fund to the extent the transferred amounts represent amounts
received from the settlement of an insurance claim and are excludable from gross
income.

Under the facts of this case, all events will have occurred to establish the fact of
Subsidiary’s liabilities for Class B and Class C Claims no later than the taxable year in
which Subsidiary makes transfers to the Trusts. The amounts of Subsidiary’s liabilities
under these claims will also be determinable with reasonable accuracy no later than
such taxable year. In addition, to the extent that these claims comprise liabilities
described in § 1.468B-1(c)(2), and Subsidiary does not make a Grantor Trust Election
with respect to either of the Trusts, economic performance with respect to these
liabilities will occur as Subsidiary makes transfers to the Trusts. As to transfers made
under the Payment Agreement, if Subsidiary does not make a Grantor Trust Election
with respect to the Class C Claims Trust, economic performance will occur as
Subsidiary pays principal amounts to the Class C Claims Trust.
PLR-112376-20 19

However, if Subsidiary makes a Grantor Trust Election with respect to either of the
Trusts, as discussed in Ruling 2, then pursuant to § 1.468B-1(k)(3)(i), all of § 1.468B-3
is rendered inapplicable with regard to the applicable Trust. Specifically, the economic
performance rule of § 1.468B-3(c)(1) will not apply to that Trust, and the general
economic performance provisions of section 461 apply instead. Pursuant to section 461
and § 1.461-4(g)(2), economic performance will therefore not occur until the applicable
Trust makes payments to the holders of the Class B Claims or the holders of the Class
C Claims, as applicable.

Further regarding the effects of the Grantor Trust Election, § 1.468B-1(k)(3)(ii) provides
that the qualified settlement fund (i.e., the applicable Trust for which the election is
made) is treated, for Federal income tax purposes, as a trust all of which is treated as
owned by Subsidiary (the transferor) under section 671 and the regulations thereunder.
Additionally, § 1.468B-1(k)(3)(iii) provides that Subsidiary must take into account in
computing its income tax liability all items of income, deduction, and credit (including
capital gains and losses) of the qualified settlement fund (the applicable Trust) in
accordance with § 1.671-3(a)(1).

Consequently, based on the foregoing facts and representations, it is held that:

   If Subsidiary does not make a Grantor Trust Election with respect to either Trust,
   in accordance with sections 461 and 468B, Subsidiary may deduct amounts
   described in rulings 5(a), 5(b), and 5(c) in the taxable year in which such
   amounts are transferred to the Class B Claims Trust and the Class C Claims
   Trust, as applicable. However, if Subsidiary makes a Grantor Trust Election with
   respect to the Class B Claims Trust or the Class C Claims Trust, in accordance
   with section 461, Subsidiary must deduct the amounts described in ruling 5(d), in
   the taxable year that, and only to the extent that, such amounts are paid by the
   Trusts to the Class B or Class C claimants, as applicable.

   Ruling 7.     Income from Discharge of Indebtedness under Section 61.

Section 61(a)(11) provides that gross income includes income from the discharge of
indebtedness. Such income (also known as discharge of indebtedness income) is
ordinary in nature and equals the difference between what is owed and what is actually
paid to satisfy the liability.

Generally, no discharge of indebtedness income is realized upon the discharge or
settlement of a contested liability. See Sobel v. Commissioner, 40 B.T.A. 1263 (1939);
Zarin v. Commissioner, 916 F.2d 110 (3rd Cir. 1990); Preslar v. Commissioner, 167
F.3d 1323 (10th Cir. 1999).

Based on the facts presented and representations made, we conclude that no member
of the Parent Group realized (or will realize) discharge of indebtedness income from the
settlement and discharge of Class A Claims, Class B Claims and Class C Claims.
Specifically, the amount of indebtedness on account of the Class A Claims, the Class B
PLR-112376-20 20

Claims and the Class C Claims that was satisfied pursuant to the Chapter 11 Plan is
equal to the amount of liability established pursuant to the relevant settlements entered
into by Parent, Subsidiary and the relevant holders of such claims. Because prior to
entering into each of the relevant settlements, the extent of the Debtors’ liability with
respect to each of the Class A Claims, the Class B Claims and the Class C Claims was
in dispute, no discharge of indebtedness income is or will be realized.

                            PROCEDURAL MATTERS

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. Further, no opinion is expressed or implied concerning the deductibility under
section 162 of any amounts paid or property transferred, or to be paid or transferred,
under the Chapter 11 Plan, to any claim holder that is a government, a governmental
entity or a non-governmental entity treated as a governmental entity under sections
162(f)(1) and (f)(5). In addition, no opinion is expressed or implied concerning the
proper allocation of amounts paid or property transferred, or to be paid or transferred, to
such claim holders.

Additionally, no opinion is expressed or implied concerning any transfers or payments
not specifically mentioned herein, including any made by Parent or any person related
to Parent.

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.

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

A copy of this letter must be attached to any Federal 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
PLR-112376-20 21

in support of the request for rulings, it is subject to verification on examination.

                                       Sincerely,



                                       Roy A. Hirschhorn
                                       Branch Chief, Branch 6
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)

Enclosures (2)
A copy of this letter
A copy for § 6110 purposes

cc: