Tax-free split-off of a family-owned S corporation's business into a new company distributed to one family branch
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This page covers one taxpayer's ruling from 2022, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.
Plain-English summary
A closely held S corporation owned by two family branches wanted to separate its businesses so one branch could go its own way. It proposed a "split-off": the company would drop part of its assets into a new subsidiary (Controlled), then hand all of the subsidiary's stock to one family branch in exchange for (and complete redemption of) that branch's shares in the parent. The company asked the IRS to confirm the deal qualifies as a tax-free divisive reorganization under §§ 368(a)(1)(D) and 355. The IRS issued 12 rulings confirming the favorable treatment: no gain or loss to the parent on the contribution or the distribution, none to the new subsidiary, none to the shareholders receiving the new stock, with carryover basis and holding periods, plus mechanics for the S corporation and qualified subchapter S subsidiary (QSub) elections. As is standard for these letters, the IRS did not rule on whether the deal has a valid business purpose, is not a device to distribute earnings, or is not part of a disqualifying acquisition plan. This matters because a proper § 355 split-off lets owners divide a business without triggering corporate or shareholder tax.
Ruling snapshot
- Question: Does the proposed contribution and split-off distribution of a new subsidiary's stock qualify as a tax-free reorganization under §§ 368(a)(1)(D) and 355?
- Outcome: approved (12 rulings granted; standard § 355 business-purpose/device/plan issues not ruled on)
- Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 357, 358, 362, 1032; IRC §§ 1361-1362 (S corporation / QSub)
Full text (IRS public release)
Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 202220003 Third Party Communication: None
Release Date: 5/20/2022 Date of Communication: Not Applicable
Index Number: 355.00-00, 361.00-00,
368.00-00, 368.04-00, Person To Contact:
355.01-01 ----------------------------, ID No. -------------
Telephone Number:
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------------- Refer Reply To:
----------------------------------- CC:CORP:4
----------------- PLR-117174-21
------------------------------- Date:
February 18, 2022
Legend
Distributing = --------------------------------------------------
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Controlled = ------------------
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Business A = -------------------------------------------------------------
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Distributing Business = -------------------------------------------------------------
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Controlled Business = -------------------------------------------------------------
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Transferred Assets = -------------------------------------------------------------
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Retained Assets = -------------------------------------------------------------
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Family A = ---------------------------------
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PLR-117174-21 4
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Family B = ---------------------
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a = ---
b = ----
Dear -----------------:
PLR-117174-21 5
This letter responds to your letter dated August 2, 2021, as supplemented by additional
letters dated February 15, 2022 and February 17, 2022, requesting rulings on certain
federal income tax consequences of a series of transactions (the “Proposed
Transaction,” as defined below). The material information submitted in that request and
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” under section 355 and/or 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 Proposed Transaction:
(i) satisfies the business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) is used
principally as a device for the distribution of the earnings and profits of the distributing
corporation or the controlled corporation or both (see section 355(a)(1)(B) and Treas.
Reg. § 1.355-2(d)); or (iii) is part of a plan (or series of related transactions) pursuant to
which one or more persons will acquire directly or indirectly stock representing a 50-
percent or greater interest in the distributing corporation or the controlled corporation, or
any predecessor or successor of the distributing corporation or the controlled
corporation, within the meaning of Treas. Reg. § 1.355-8 (see section 355(e)(2)(A)(ii)
and Treas. Reg. § 1.355-7).
Summary of Facts
Distributing is a closely held corporation that operates Business A. Distributing has
made an election under section 1362(a) to be treated as a subchapter S corporation
(within the meaning of section 1361(a)). Distributing has a single class of common stock
outstanding. Family A directly owns a percent of the issued and outstanding stock of
Distributing. Family B indirectly owns b percent of the issued and outstanding stock of
Distributing through various domestic eligible entities (within the meaning of Treas. Reg.
§ 301.7701-3(a)) that are disregarded as entities separate from their owner for U.S.
federal income tax purposes.
For purposes of satisfying the active trade or business requirements of section 355(b)
with respect to the Proposed Transaction (as defined below), Distributing will rely on the
Distributing Business, and Controlled will rely on the Controlled Business. Distributing
has submitted financial information in accordance with Rev. Proc. 2017-52 indicating
PLR-117174-21 6
that the Distributing Business and Controlled Business have had gross receipts and
operating expenses representing the active conduct of a trade or business for each of
the past five years.
Proposed Transaction
For what are represented to be valid business reasons, Distributing proposes to engage
in the following transactions (collectively, the “Proposed Transaction”):
-
Distributing will form a new limited liability company, Controlled, and elect to treat
Controlled as a qualified subchapter S subsidiary (a “QSub”) as of the date of formation.
Controlled will have a single class of stock outstanding, all of which will be directly
owned by Distributing. -
Distributing will transfer the Transferred Assets to Controlled solely in exchange for
stock of Controlled and the assumption by Controlled of liabilities associated with the
Transferred Assets (the “Contribution”). -
Distributing will distribute all of the stock of Controlled to the Family A shareholders in
complete redemption of the Family A shareholders’ respective shares of Distributing
(the “Distribution”). -
Effective immediately after the Distribution, Controlled will elect to be classified as a
subchapter S corporation for U.S. federal income tax purposes.
In connection with the Proposed Transaction, Distributing and Controlled may enter into
a separation and distribution agreement, and a tax matters agreement, that will continue
after the completion of the Proposed Transaction in order to effectively transition to
separate operations.
Representations
Except as set forth below, Distributing has made all of the representations in section 3
of the Appendix to Rev. Proc. 2017-52 with respect to the Proposed Transaction:
-
Distributing has made the following alternative 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: 5, 6, 20, 24, 25, 35, 36, 37, 38, 39, and 40. -
Distributing cannot make Representation 42 but has represented that: “All of the
shareholders of Distributing are U.S. persons.”
Distributing has made all of the representations in section 3.04 of Rev. Proc. 2018-53
PLR-117174-21 7
with respect to the Proposed Transaction, except Representation 6, which does not
apply to the Proposed Transaction.
Rulings
-
The Contribution, together with the Distribution, will qualify as a reorganization and
distribution pursuant to sections 368(a)(1)(D) and 355. Distributing and Controlled will
each be a “party to the reorganization” within the meaning of section 368(b). -
No gain or loss will be recognized by Distributing on the Contribution. Sections 357(a)
and 361(a). -
No gain or loss will be recognized by Controlled on the Contribution. Section 1032(a).
-
The basis in each asset received by Controlled from Distributing in the Contribution
will equal the basis of the asset in the hands of Distributing immediately before the
Contribution. Section 362(b). -
The holding period in each asset received by Controlled from Distributing in the
Contribution will include the period during which such asset was held by Distributing.
Section 1223(2). -
No gain or loss will be recognized by Distributing upon its distribution of the stock of
Controlled on the Distribution. Section 361(c). -
No gain or loss will be recognized by (and no amount otherwise will be included in the
income of) the shareholders of Distributing upon the receipt of Controlled stock in
exchange for their Distributing stock. Section 355(a)(1). -
Each participating shareholder’s aggregate basis in its Controlled stock immediately
after the Distribution will equal such shareholder’s aggregate basis in the Distributing
stock surrendered in the Distribution and will be allocated among the shares received in
the manner described in Treas. Reg. § 1.358-2(a). Section 358(a)(1) and (b)(1). -
Each participating shareholder’s holding period in its Controlled stock received in the
Distribution will include the holding period of the Distributing stock held by such
shareholder, provided that such Distributing stock was held as a capital asset on the
date of the Distribution. Section 1223(1). -
Distributing’s accumulated adjustment account immediately before the transaction
will be allocated between Distributing and Controlled in a manner similar to the manner
in which Distributing’s earnings and profits will be allocated under section 312(h) in
accordance with Treas. Reg. § 1.1368-2(d)(3). Treas. Reg. §§ 1.312-10(a) and 1.1368-
2(d)(3).
PLR-117174-21 8 -
The Distribution will cause a termination of Controlled’s QSub election because
Controlled will cease to be a wholly owned subsidiary of a subchapter S corporation.
For all U.S. 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 pursuant to Treas. Reg. § 1.1361-5(b)(1)(i) and section 1361(b)(3)(B) and
(C). -
Distributing’s momentary ownership of the stock of Controlled, as part of the
reorganization under section 368(a)(1)(D), will not cause Controlled to have an ineligible
shareholder for any portion of its first taxable year under section 1361(b)(1)(B), and will
not, in itself, render Controlled ineligible to elect to be a subchapter S corporation for its
first taxable year. If Controlled otherwise meets the requirements of a small business
corporation under section 1361, Controlled will be eligible to make a subchapter S
election under section 1362(a) for its first taxable year, provided that such election is
made effective immediately upon the Distribution.Caveats
Except as expressly provided herein, no opinion is expressed or implied about the tax
treatment of the Proposed Transaction under any other provisions of the Code or
regulations, or the tax treatment of any conditions existing at the time of, or effects
resulting from, the Proposed Transaction that are not specifically covered by the above
rulings.
Procedural Statements
This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.
A copy of this letter should be attached to the federal income tax return to which it is
relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
PLR-117174-21 9
requirement by attaching a statement to their return that provides the date on and
control number (PLR-117174-21) of this letter ruling.
Sincerely,
____________________________________
Brian R. Loss
Senior Technician Reviewer, Branch 4
Office of Associate Chief Counsel (Corporate)
cc:
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