PLR 200029053: Business split-off qualifies as a tax-free reorganization

Plain-English summary

Shareholders of an S corporation disagreed over management of its businesses and proposed separating one business into a new corporation. The original company would transfer that business's assets and liabilities for all of the new company's stock, then give the stock to one shareholder in exchange for that shareholder's original shares. The IRS ruled that the steps qualified as a section 368(a)(1)(D) reorganization and that the specified transfers and stock exchange generally produced no recognized gain or loss. It also ruled that the new corporation's brief ownership by the original company would not itself prevent an S election for its first tax year. The rulings depended on detailed representations about business continuity, valuation, liabilities, and the planned S election.

Ruling snapshot

• Question: Does the proposed business split-off qualify for nonrecognition and permit the new company's S election?
• Outcome: Approved on the submitted facts and representations.
• Key authorities: IRC §§ 355, 361, 368(a)(1)(D), 1361, 1362, and 1374.

Full text (IRS public release)

Internal Revenue Service                       Department of the Treasury

Index Number:        0368.04-00                Washington, DC 20224
                     0355.01-01
Number: 200029053                              Person to Contact:
Release Date: 7/21/2000                        Telephone Number:

                                               Refer Reply To:
                                               CC:DOM:CORP:5 - PLR-118623-99
                                               Date:
                                               April 27, 2000


Re:

Distributing               =


Controlled                 =


State X                    =

State Y

State Z                    =

Business A                 =

Business B                 =

Business C                 =


       A                   =

       B                   =

       C                   =

       D                   =

       E                   =

Dear             :

      This is in reply to a letter dated November 17, 1999, in which rulings were
requested as to the federal income tax consequences of a proposed transaction.

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Addition information has been submitted in and with a letter dated April 20, 2000. The
information submitted for consideration is substantially as set forth below.

       Distributing is an accrual basis State Y corporation actively engaged in Business
A, Business B, and Business C. Distributing is an S corporation. Business A is located
in State X. Business B is located in State Y. Business C is located in State Z. As of
November 17, 1999, Distributing has outstanding 34,087 shares of no par value voting
common stock that were owned by A (10,701 shares; about 31.4%), B (11,073 shares;
about 32.5%), C (9,313 shares; about 27.3%), D (1,500 shares; about 4.4%), and E
(1,500 shares; about 4.4%).

      Controlled is an accrual basis State X corporation formed to effectuate the
proposed transaction. Controlled will elect S corporation status. Controlled will have
issued and outstanding 100,000 shares of voting common stock, all of which initially will
be held by Distributing.

        Financial information has been received which indicates that Business A,
Business B, and Business C of Distributing each have had gross receipts and operating
expenses representative of the active conduct of a trade or business for each of the
past five years.

      A, B, C, D, and E have decided to split up the businesses of Distributing due to
ongoing and unreconcilable disputes on how the businesses of Distributing should be
conducted. Specifically, the Distributing shareholders disagree on the management,
acquisition, expansion and development of goals for Distributing. Accordingly, they
propose the following transaction:

      (i)     Distributing will transfer to the newly-formed Controlled all of the assets
              and liabilities pertaining to the operation of Business A. In exchange,
              Distributing will receive all of the 100,000 issued and outstanding shares
              of Controlled voting common stock.

      (ii)    Then, Distributing will distribute all 100,000 shares of Controlled stock to
              A solely in exchange for all of A’s shares of Distributing stock.

      (iii)   Controlled will elect to be an S corporation immediately after the proposed
              transaction effective for its first tax year.

      The taxpayer has made the following representations in connection with the
proposed transaction:

      (a)     The fair market value of the stock of Controlled received by A, described
              in step (ii) above, will approximately equal the fair market value of the
              Distributing stock surrendered by A in the exchange.

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     (b)   No part of the consideration to be distributed by Distributing is being
           received by a shareholder as a creditor, employee, or in any capacity
           other than as a shareholder of the corporation.

     (c)   The five years of financial information submitted on behalf of Distributing
           is representative of the corporation’s present operations, and there have
           been no substantial operational changes since the date of the last
           financial statements submitted.

     (d)   Following the proposed transaction, Distributing and Controlled will each
           continue, independently and with their separate employees, the active
           conduct of the businesses previously conducted solely by Distributing.

     (e)   The distribution of the stock of Controlled is carried out for the following
           corporate business purpose: management disagreements between
           shareholders which have an unfavorable effect on the operations of
           Distributing. The distribution of the stock of Controlled is motivated in
           whole by this corporate business purpose.

     (f)   There is no plan or intention by the shareholders of Distributing to sell,
           exchange, transfer by gift, or otherwise dispose of any of their stock in
           Distributing or Controlled subsequent to the transaction.

     (g)   There is no plan or intention by either Distributing or Controlled, directly or
           through any subsidiary, to purchase any of its outstanding stock after the
           transaction, other than through stock purchases meeting the requirements
           of §4.05(1)(b) of Rev. Proc. 96-30.

     (h)   There is no plan or intention to liquidate either Distributing or Controlled,
           to merge either corporation with any other corporation, or to sell or
           otherwise dispose of the assets of either corporation subsequent to the
           transaction, except in the ordinary course of business.

     (i)   The income tax liability for the taxable year in which investment credit
           property (including any building to which §47(d) applies) is transferred will
           be adjusted pursuant to § 50(a)(1) or (a)(2) (or §47, as in effect before
           amendment by Public Law 101-508, Title 11, 104 Stat. 1388, 536 (1990),
           if applicable) to reflect an early disposition of the property.

     (j)   Distributing neither accumulated its receivables nor made extraordinary
           payment of its payables in anticipation of the transaction.

     (k)   No intercorporate debt will exist between Distributing and Controlled at the

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             time of or subsequent to the proposed distribution.

      (l)    Any payments made in connection with all continuing transactions, if any,
             between Distributing and Controlled will be for fair market value based on
             terms and conditions arrived at by the parties bargaining at arm’s length.

      (m)    No two parties to the transaction are “investment companies” as defined
             in § 368(a)(2)(F)(iii) and (iv).

      (n)    The total adjusted bases and the fair market value of the assets
             transferred to Controlled by Distributing each equals or exceeds the sum
             of the liabilities assumed by Controlled plus any liabilities to which the
             transferred assets are subject.

      (o)    The liabilities assumed in the transaction and the liabilities to which the
             transferred assets are subject were incurred in the ordinary course of
             business and are directly associated with the assets being transferred.

      (p)    Distributing is an S corporation within the meaning of §1361(a).
             Controlled will elect to be an S corporation pursuant to § 1362(a) on the
             first available date after the distribution and there is no plan or intent to
             revoke or otherwise terminate the S election of either Distributing or
             Controlled.

      (q)    The distribution of the Controlled stock is not part of a plan or series of
             related transactions (within the meaning of § 355(e)) pursuant to which
             one or more persons will acquire directly or indirectly stock possessing 50
             percent or more of the total combined voting power of all classes of stock
             of either Distributing or Controlled, or stock possessing 50 percent or
             more of the total value of all classes of stock of either Distributing or
             Controlled.

      Based solely on the information submitted and on the representatives set forth
above, we hold as follows:

      (1)    The transfer by Distributing to Controlled of the assets and liabilities of
             Business A as described in step (i) above, solely in exchange for all of the
             outstanding stock of Controlled, followed by the distribution of the
             Controlled stock by Distributing to A in exchange for all of their Distributing
             stock will be a reorganization within the meaning of §368(a)(1)(D).
             Distributing and Controlled each will be a “party to a reorganization” within
             the meaning of §368(b).

      (2)    Distributing will recognize no gain or loss upon the transfer of assets and

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            liabilities to Controlled in exchange for Controlled stock (§361(a) and
            357(a)).

     (3)    Controlled will recognize no gain or loss on the receipt of assets and
            liabilities in exchange for the Controlled stock (§ 1032(a)).

     (4)    Controlled’s basis in the assets received will be the same as the basis of
            such assets in the hands of Distributing immediately prior to the
            transaction (§362(b)).

     (5)    Controlled’s holding period for the assets received from Distributing will
            include the period during which such assets were held by Distributing
            (§1223(2)).

     (6)    Distributing will recognize no gain or loss upon the distribution of all of its
            Controlled stock in exchange for their Distributing stock (§361(c)(1)).

     (7)    No gain or loss will be recognized to(and no amount will be included in the
            income of A) upon the receipt of the Controlled stock in exchange for all of
            their shares of Distributing stock (§355(a)(1)).

     (8)    A’s basis in the Controlled stock after the distribution will be the same as
            A’s basis in the Distributing stock surrendered in exchange therefor
            (§358(a)(1)).

     (9)    A’s holding period in the Controlled stock received will include the holding
            period of the Distributing stock surrendered in exchange therefor,
            provided that the Distributing stock is held as a capital asset by the
            shareholder on the date of the exchange (§1223(1)).

     (10)   As provided in §312(h), proper allocation of earnings and profits between
            Distributing and Controlled will be made under §1.312-10(a) of the income
            Tax Regulations.

     (11)   The provisions of Rev. Rul. 74-101, 1974-1C.B. 7, will be applied, where
            applicable, to any “§38 property” covered by this ruling letter.

     (12)   The momentary affiliation by Distributing of the stock of Controlled in
            connection with the reorganization will not, in and of itself, make
            Controlled ineligible to elect to be an S corporation for its first tax year,
            provided that Controlled otherwise meets the other requirements under
            §1361(b).

     (13)   The S election to be made by Controlled immediately following the

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            distribution of Controlled’s stock by Distributing will not subject
            Controlled’s assets to be taxed under §1374.

             We express no opinion about the tax treatment of the transaction under
    other provisions of the Code and regulations or about 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.

            This ruling is directed only to the taxpayer who requested if. 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 returns
    of the taxpayers involved for the taxable year in which the transaction covered by
    this ruling letter is consummated.

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           Pursuant to a power of attorney on file in this office, a copy of this letter
    has been sent to your authorized representative.

                                                Sincerely yours,
                                                Assistant Chief Counsel (Corporate)
                                                By:__                    ______
                                                Chief, Branch 5