IRS blesses a tax-free split-up of a feuding family's S corporation into two new corporations, one for each sibling's branch

Plain-English summary

A family-owned S corporation was jointly owned, through trusts and family members, by two siblings' branches. The siblings could no longer get along, and the disputes made it impossible to keep running the business as a single company. To split it up, the corporation formed two new subsidiaries (each initially a "qualified subchapter S subsidiary," or QSub), moved half of the business assets into each, then distributed one subsidiary's stock to each sibling's group and dissolved the original company. This is the classic "split-up," a tax-free reorganization under §§ 355 and 368(a)(1)(D). The company asked the IRS to confirm the tax consequences, and the IRS issued a series of favorable rulings: the asset transfers and stock distributions trigger no gain or loss to the company, the subsidiaries, or the shareholders (§§ 355(a)(1), 361, 357, 1032); the subsidiaries carry over the company's asset bases and holding periods; the shareholders carry over their old stock bases and holding periods; and earnings and profits and the accumulated adjustments account are split between the two new corporations. The IRS also ruled the momentary ownership during the reorganization will not block the new corporations from making their own S elections. As is standard for these letters, the IRS did not rule on the business-purpose, device, or § 355(e) anti-abuse tests, or on whether the entities validly qualify as S corporations.

Ruling snapshot

• Question: Do the tax-free reorganization rules of §§ 355 and 368(a)(1)(D) apply to splitting a family S corporation into two new corporations, one for each sibling group?
• Outcome: Approved (13 favorable rulings; standard business-purpose/device/§ 355(e) caveats reserved)
• Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 357, 1032, 362(b), 1223, 358, 312(h), 1361, 1362; Treas. Reg. §§ 1.1361-5(b)(1)(i), 1.312-10(a), 1.1368-2(d)(3); Rev. Procs. 2017-52, 2018-53

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202225006                                              Third Party Communication: None
 Release Date: 6/24/2022                                        Date of Communication: Not Applicable
 Index Number: 355.00-00, 355.01-00,
               355.01-02, 368.00-00,                            Person To Contact:
               368.04-00                                        -------------------------,
                                                                ID No. -----------------
 --------------------                                           Telephone Number:
 ---------------------------------------------                  --------------------
 ---------------------                                          Refer Reply To:
 --------------------------------------                         CC:CORP:BO2
                                                                PLR-120541-21
                                                                Date:
                                                                March 30, 2022




Legend

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

Controlled Co 1                     =        -----------------------------------

Controlled Co 2                     =        ------------------------------

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

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

Sibling A                           =        ---------------------------------

Sibling A Group                     =         -----------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             -----------------------

Sibling B                           =        --------------------
PLR-120541-21                                                2


Sibling B Group                     =         -----------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
----
                                             ------------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             ----------------------------------------------------

Daughter E                          =        ---------------------

Daughter F                          =        ------------------------

Trust A                             =         -----------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------

Trust B                             =         -----------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------

Trust C                             =         -----------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
----
--------------------------------------------------------------------------------------

Trust D                             =         ---------------------------------------------------------------
-----------------------------------------------------------------------

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

Year 1                              =        -------

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

a                                   =        -----------

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

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

d                                   =        --------

e                                   =        --------

f                                   =        -------------
PLR-120541-21                                   3


g                           =       -----------------

h                           =       --------

i                           =       --------

j                           =       --------

k                           =       ------


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

This letter responds to your letter dated September 20, 2021, as supplemented by
subsequent information and documentation, requesting rulings on certain federal
income tax consequences of the proposed transaction steps described below (such
steps comprise the "Proposed Transaction"). The material information 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 the revenue procedure)
under section 355 and/or section 368 of the Internal Revenue Code (the "Code").

The rulings contained in this letter are based upon facts and representations submitted
by 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 expresses no opinion as to any
issue not specifically addressed by the rulings below.

This Office has made no determination regarding whether any of the Distributions (as
defined below): (i) satisfies the business purpose requirement of § 1.355-2(b) of the
Income Tax Regulations ("Treas. Reg."); (ii) is used principally as a device for the
distribution of the earnings and profits of the distributing corporation or the controlled
corporations 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 corporations (see section 355(e) and Treas.
Reg. § 1.355-7).
PLR-120541-21                                4


                                   Summary of Facts

Distributing (also, the "Taxpayer") is an accrual method taxpayer that was formed in
Year 1 as a State A corporation and elected to be treated as a subchapter S corporation
as of Date 1.

Distributing manages and operates Business A using the Business A Assets.

Distributing has one class of common voting stock and has a shares of common voting
stock outstanding.

Sibling A is a trustee in Trust A and Trust B, which own b and c shares of common
voting stock representing d percent and e percent of Distributing stock outstanding,
respectively. Trust A and Trust B are known as the "Sibling A Group."

Sibling B is a trustee in Trust C and Trust D, which own f and g shares of common
voting stock representing h and i percent of Distributing stock outstanding, respectively.
Daughter E and Daughter F, daughters of Sibling B, own j shares of common voting
stock in the aggregate which collectively represents k percent of Distributing stock
outstanding. Trust C, Trust D, Daughter E, and Daughter F are known as the "Sibling B
Group."

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

Sibling A and Sibling B disagree with each other, and intense conflict exists among
them. Due to the personal conflicts, serious disputes have arisen regarding the
operation of Distributing's Business A that have made it impossible to continue
operating the entire business under a single entity. Therefore, Distributing proposes the
Proposed Transaction.

                                 Proposed Transaction

To achieve the business purpose described above, Distributing proposes the following
Proposed Transaction:

Step 1: Distributing has formed two new entities, Controlled 1 and Controlled 2 (each, a
"Controlled Co" and together, "Controlled Cos"), as State A corporations. Distributing
has elected to treat each Controlled Co as a qualified subchapter S subsidiary ("QSub")
as of the date of its organization.

Step 2: Distributing will transfer 50% of all the Business A assets to Controlled 1 and the
remaining 50% to Controlled 2 (together, the "Contributions").
PLR-120541-21                                 5


Step 3: Distributing will make the following distributions in the process of dissolving and
terminating Distributing (together, the "Distributions").

        1. All of the stock of Controlled 1 will be distributed to the Sibling A Group; and

        2. All of the stock of Controlled 2 will be distributed to the Sibling B Group.

Step 4: Each of Controlled 1 and Controlled 2 will file a Form 2553, Election by a Small
Business Corporation, electing to be treated as a subchapter S corporation as of the
day of the Distributions.

Step 5: As soon as practically possible under State A corporate law, Distributing will be
terminated and dissolved.

                                    Representations

With respect to the Proposed Transaction, except as set forth below, Distributing has
made the representations in section 3 of the Appendix to Rev. Proc. 2017-52.

        1. Distributing has made the following alternative representations:

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

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

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

        3. Distributing has not made Representation 42 but has provided the required
      explanation.

Additionally with respect the Proposed Transaction, except as set forth below,
Distributing has made the representations under section 3.04 of Rev. Proc. 2018-53.

        1. Distributing has not made Representation 6, which does not apply to the
      Proposed Transaction.

                                         Rulings

        1. The Distributions will cause a termination of the Controlled Cos' QSub elections
      because the Controlled Cos will cease to be wholly-owned subsidiaries of a
      subchapter S corporation. For federal income tax purposes, the Controlled Cos
      will be treated as new corporations acquiring all of their assets and assuming all
      of their liabilities from Distributing immediately before the termination of the
PLR-120541-21                               6

     Controlled Cos' QSub elections in exchange for the stock of the Controlled Cos
     pursuant to Treas. Reg. § 1.1361-5(b)(1)(i) (sections 1361(b)(3)(B) and (C)).

    2. The Contributions followed by the Distributions will qualify as a reorganization
     under section 368(a)(1)(D). Distributing and each Controlled Co will be "a party to
     a reorganization" within the meaning of section 368(b).

    3. No gain or loss will be recognized by Distributing on the Contributions to each
     Controlled Co (sections 361(a) and 357(a)).

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

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

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

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

    8. No gain or loss will be recognized by (and no amount will be included in income
     of) any of Distributing's shareholders upon the receipt of the stock of the
     Controlled Cos in the Distributions (section 355(a)(1)).

    9. The basis of the shares of the Controlled Cos in the hands of the Sibling A Group
     and Sibling B Group, respectively, immediately after the Distributions will be the
     same as the basis of their Distributing shares deemed surrendered in exchange
     therefor (section 358(a)(1)).

    10. The holding period of the shares of the Controlled Cos received by each of the
      Sibling A Group and Sibling B Group, respectively, in the Distributions will include
      the holding period of the Distributing shares deemed surrendered in exchange
      therefor, provided that the Distributing shares were held as a capital asset in the
      hands of the Sibling A Group and Sibling B Group on the date of the Distributions
      (section 1223(1)).

    11. Earnings and profits of Distributing will be allocated among the Controlled Cos in
      accordance with section 312(h) and Treas. Reg. § 1.312-10(a).

    12. Distributing's accumulated adjustments account will be allocated among the
      Controlled Cos in a manner similar to the manner in which earnings and profits of
PLR-120541-21                                 7

       Distributing will be allocated under section 312(h) in accordance with Treas. Reg.
       § 1.1368-2(d)(3).

        13. Distributing's momentary ownership of the stock of the Controlled Cos, as part of
       the reorganization under section 368(a)(1)(D), will not cause either Controlled Co
       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 either Controlled Co ineligible
       to elect to be a subchapter S corporation for their first taxable year. If the
       Controlled Cos otherwise meet the requirements of a small business corporation
       under section 1361, the Controlled Cos will be eligible to make a subchapter S
       election under section 1362(a) for their first taxable year, provided that such
       election is made effective immediately following the termination of the original
       QSub elections.

                                          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 transactions that are not specifically addressed by this
letter. In particular, no opinion is expressed regarding whether: i) Distributing is a valid
subchapter S corporation; and ii) the Controlled Cos are otherwise eligible to be treated
as subchapter S corporations.

                                 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 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.
PLR-120541-21                                        8

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,


                                                               _              _
                                              Robert M. Rhyne
                                              Assistant to the Branch Chief, Branch 2
                                              Office of Associate Chief Counsel
                                              (Corporate)




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