Tax-free split-off lets two family branches divide a closely held S corporation

Plain-English summary

A closely held S corporation is owned by two branches of a family that disagree about how to run the business. To separate, the corporation (Distributing) will form a new subsidiary (Controlled), move part of the business into it, and then hand all of the subsidiary's stock to one family branch in exchange for that branch's stock in the parent. This kind of divisive exchange is called a "split-off." The IRS issued 13 rulings confirming the split-off qualifies as a tax-free reorganization under sections 355 and 368(a)(1)(D), so neither the corporations nor the departing family branch recognize gain on the exchange, and it addressed the S corporation and QSub election mechanics that follow. The IRS did not rule on the business-purpose, device, or plan requirements (it left those open). This matters because it lets feuding owners divide a single company into two independently run businesses without triggering an immediate corporate or shareholder tax bill.

Ruling snapshot

• Question: Does the proposed split-off of part of the business to one family branch qualify as a tax-free section 355 distribution and section 368(a)(1)(D) reorganization?
• Outcome: Approved (13 favorable rulings; business purpose, device, and section 355(e) plan questions expressly not addressed)
• Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 357, 1032, 362, 358, 1223, 312(h), 1361(b)(3), 1362(a); Rev. Proc. 2017-52; Rev. Proc. 2018-53

Full text (IRS public release)

Internal Revenue Service                      Department of the Treasury
                                              Washington, DC 20224

Number: 202235002                             Third Party Communication: None
Release Date: 9/2/2022                        Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-01,
              368.00-00, 368.04-00            Person To Contact:
                                              ------------------, ID No. -----------------
------------------                            Telephone Number:
-------------                                 --------------------
-------------------------                     Refer Reply To:
------------------                            CC:CORP:1
--------------------------------              PLR-104805-22
                                              Date:
                                              June 06, 2022




Legend

Distributing                       =   -------------------------
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Controlled                         =   -------------------------------
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Activity                           =   ----------------------

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

Family Branch A                    =   -------------------------------------------------------------
                                       -------------------------------------------------------------
                                       --------------------

Family Branch B                    =   -------------------------------------------------------------
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                                       -------------------------------------------------------------
                                       --------------------

State A                            =   -------------
PLR-104805-22                                2



 Continuing Transactions             =     -------------------------------------------------------------
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 a                                   =     ---

 b                                   =     ---


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

This letter responds to a letter dated March 1, 2022, submitted on behalf of the
taxpayer, requesting rulings under section 355 and related provisions of the Internal
Revenue Code of 1986 (the “Code”), as amended, and related regulations, with respect
to the proposed transactions described below (the "Proposed Transaction").

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalties of perjury statement
executed by an appropriate party. While this office has not verified any of the material
submitted in support of the request for rulings, it is subject to verification on
examination.

This letter is issued pursuant to Rev. Proc. 2022-1, 2022-1 I.R.B. 1, Rev. Proc. 2022-10,
2022-6 I.R.B. 473, and Rev. Proc. 2017-52, 2017-41 I.R.B. 283, as amplified and
PLR-104805-22                                  3


modified by Rev. Proc. 2018-53, 2018-43 I.R.B. 667, regarding a Transactional Ruling
for a Covered Transaction, and section 6.03(2) of Rev. Proc. 2022-1, regarding rulings
on one or more significant issues that are presented in a transaction intended to qualify
under section 355 or section 368 of the Code. This office expresses no opinion as to
any issue not specifically addressed by the rulings below.

This office has made no determination regarding whether the Distribution (as defined
below) in each case: (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.
All of Distributing’s issued and outstanding stock is owned, directly and indirectly, by
members of Family Branch A and Family Branch B. Family Branch A owns, directly and
indirectly, a percent of the issued and outstanding stock of Distributing. Family Branch B
owns, directly and indirectly, b percent of the issued and outstanding stock of Distributing.

Distributing is engaged in the conduct of Business A. Distributing has submitted financial
information in accordance with Rev. Proc. 2017-52 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.

                               The Proposed Transaction

Family Branch A and Family Branch B have differences of opinion as to the
management and operation of Business A and desire to split the assets and operate
separate portions of Business A independently. Accordingly, Distributing proposes to
engage in the following transactions (collectively, the “Proposed Transaction”).

1.      Distributing will incorporate Controlled, a State A corporation, and timely elect to
        treat Controlled as a qualified subchapter S subsidiary within the meaning of
        section 1361(b)(3) (a “QSub”) as of the date of its incorporation.

2.      Distributing will contribute certain Business A assets to Controlled in exchange
        for: (i) all the stock of Controlled; and (ii) potentially the assumption of certain
PLR-104805-22                                  4


         Business A liabilities to the extent necessary to equalize values (the
         “Contribution”).

3.       Distributing will distribute all the stock of Controlled to Family Branch B in
         complete exchange for all of Family Branch B’s Distributing stock (the
         “Distribution”).

4.       Controlled will timely elect under section 1362(a) to be treated as a subchapter
         S corporation for U.S. federal income tax purposes, effective immediately after
         the Distribution.

After the Distribution, Family Branch B will have no involvement in the management of
Distributing, and Family Branch A will have no involvement in the management of
Controlled. However, it is expected that Distributing and Controlled may engage in the
Continuing Transactions.

                                     Representations

Except with respect to Representations 6, 20, 25, 35, 36, 37, 38, 39, and 40 of section 3
of the Appendix to Rev. Proc. 2017-52, which are inapplicable to the Proposed
Transaction, and Representations 8(b), 11(b), 23, and 32, which Distributing has
modified below, Distributing makes all the representations in section 3 of the Appendix
to Rev. Proc. 2017-52. With respect to representations that allow for alternative
representations to be made and are not otherwise modified below, Distributing makes
Representations 3(a), 15(a), 22(a), 31(a), and 41(b).

(8(b))   Distributing may have securities outstanding, but it will not distribute Controlled
         stock, Controlled securities, or Other Property to any holder of such securities
         in the Distribution, in satisfaction thereof.

(11(b)) Following the Distribution, and except with respect to the Continuing
        Transactions, Distributing and Controlled each will continue, independently and
        with its separate employees, the active conduct of its share of all the integrated
        activities of Business A, the business relied on by each of Distributing and
        Controlled to meet the active trade or business requirement of section 355(b),
        as conducted by Distributing prior to the consummation of the transaction. The
        Continuing Transactions will be subject to arm’s-length terms between
        Distributing and Controlled.

(23)     With the exception of (i) the Continuing Transactions, (ii) certain receivables
         that are disproportionately allocated to equalize values, and (iii) income and
         deductions taken in connection with Activity that occur after the Distribution, the
         transaction does not involve and will not result in a situation in which one party
         owns Property, but another party recognizes the income associated with such
         Property.
PLR-104805-22                                5



(32)    No intercorporate debt will exist between Distributing and Controlled at the time
        of the Distribution, and no intercorporate debt will exist between Distributing
        and Controlled subsequent to the Distribution except with respect to the
        Continuing Transactions.

In addition, except as set forth below, Distributing has made all the representations
in section 3.04 of Rev. Proc. 2018-53.

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

Distributing has modified Representation 4 as follows:

(4)     Except with respect to debt incurred in the ordinary course of its business,
        Distributing incurred the Distributing Debt that will be assumed or satisfied
        (a) before the request for any relevant ruling is submitted and (b) no later than
        60 days before the earliest of the following dates: (i) the date of the entry by
        Distributing into a binding agreement to engage in the Divisive Reorganization
        (as defined in section 1 of Rev. Proc. 2018-53) or a similar transaction, and (ii)
        the date of approval of the Divisive Reorganization or a similar transaction by
        the board of directors of Distributing.

                                         Rulings

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

(1)     The Contribution and the Distribution, together, will be a “reorganization” within
        the meaning of section 368(a)(1)(D). Distributing and Controlled will each be “a
        party to the reorganization” within the meaning of section 368(b).

(2)     Distributing will not recognize gain or loss on the Contribution. Sections 361(a)
        and 357(a).

(3)     Controlled will not recognize gain or loss on the Contribution. Section 1032(a).

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

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

(6)     No gain or loss will be recognized by Distributing on the Distribution. Section
PLR-104805-22                                6


       361(c).

(7)    No gain or loss will be recognized by (and no amount will otherwise be included
       in the income of) Family Branch B upon its receipt of stock of Controlled in the
       Distribution in exchange for all their stock of Distributing. Section 355(a)(1).

(8)    In applying section 355(e) to the Distribution, any increase in ownership of
       Distributing stock, by vote or value, by a Distributing shareholder that occurs
       solely as a result of the exchange of Distributing stock for Controlled stock in
       the Distribution will be disregarded (and not treated as an acquisition for
       purposes of section 355(e)(2)(A)(ii)).

(9)    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).

(10)   Each participating shareholder’s holding period in its Controlled stock received
       in the Distribution will include the holding period of the Distributing stock
       received in exchange therefor, provided that such Distributing stock was held
       as a capital asset on the date of the Distribution. Section 1223(1).

(11)   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 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). Section 1361(b)(3)(B) and (C).

(12)   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).

(13)   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, by 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 permitted to make a subchapter S election under section
       1362(a) for its first taxable year, provided that such election is made effective
PLR-104805-22                                        7


          immediately following the termination of the QSub election.

                                                 Caveats

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.

                                           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.

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

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.

                                               Sincerely,


                                               Samuel G. Trammell
                                               Samuel G. Trammell
                                               Assistant to the Branch Chief, Branch 4
                                               Office of Associate Chief Counsel (Corporate)


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