PLR 200234061: Family business split qualifies for three corporate reorganizations

Plain-English summary

Shareholders of an S corporation disagreed about how to run its three businesses. The company planned to move business assets into three new corporations and distribute their shares to different family shareholder groups in exchange for shares of the original company. The IRS ruled that each transfer and distribution would be a reorganization under IRC § 368(a)(1)(D). Under the specified provisions, the corporation and shareholders would recognize no gain or loss on the transfers and exchanges, and the new corporations would take carryover bases and holding periods in the assets. The ruling also addressed stock basis, stock holding periods, and allocation of earnings and profits. The IRS gave no opinion on the existing or proposed S corporation elections.

Ruling snapshot

• Question: Do the three transfers and stock exchanges qualify as tax deferred reorganizations?
• Outcome: Approved: each qualifies under § 368(a)(1)(D), with specified nonrecognition and carryover treatment
• Key authorities: IRC §§ 355(a)(1), 357(a), 358(a)(1), 361, 362(b), 368(a)(1)(D), 1032(a), 1223

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200234061
Washington, DC 20224
Release Date: 8/23/2002
Index Numbers: 355-00.00; 368-04-00 Person to Contact:

Telephone Number:

Refer Reply To:
CC:CORP:2-PLR-164359-01
Date:
May 22, 2002

Legend

Distributing =

Controlled #1 =

Controlled #2 =

Controlled #3 =

Estate
=

A
=

B
=

C
=

D
=

Business X
=

Business Y
=

Business Z
=

Date 1
=

2
PLR-164359-01

Date 2
=

a
=

b
=

c
=

d
=

e
=

State A
=

Dear

This is in response to a letter dated November 21, 2001, submitted on behalf of Distributing, requesting rulings under §§ 355 and 368 of the Internal Revenue Code (the “Code”) with respect to a proposed transaction. Additional information was received in letters dated January 15, 2002, January 25, 2002, March 8, 2002, and April 3, 2002.

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 in support of the request for rulings, it is subject to verification on examination. The material information submitted is summarized below.

Distributing is an S corporation that files federal income tax returns on a calendar-year basis and uses the cash method. Distributing is engaged in Business X, Business Y, and Business Z. Distributing first became engaged in Business Z on Date

1. Since Date 1, Distributing has expanded Business Z by acquiring other Business Z
   assets.

   The stock of Distributing is owned by Estate, individuals A, B, C, revocable trusts
   

   for the benefit of D and a member of D’s immediate family, and members of the immediate families of each of A, B, and D. A, B, C, and D have managed the business, with varying degrees of involvement. Of A, B, C, and D, only A and A’s family wish to continue in Business X. A and A’s family have no interest in pursuing Business Z. Although B, C, and D all wish to continue in Business Z, the level of animosity, distrust, and lack of communication among A, B, C, and D has reached the point that they can no longer successfully operate a business together. The following series of transactions (collectively, the “Distribution”) is therefore proposed:

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   Distributing will form three corporations, Controlled #1, Controlled #2, and
   

   Controlled #3 (collectively, the “Controlled Corporations”). Distributing will contribute to Controlled #1 the Business X operation. Controlled #1 will also assume or refinance, in the amount of $a, a debt now secured by certain Business Z assets that will be contributed to Controlled #2. Distributing will contribute to Controlled #2 certain Business Z assets, cash or notes in the amount $b, and certain equipment. Controlled

   2 will receive cash or notes in the amount $c from Controlled #1. Distributing will contribute to Controlled #3 the Business Y assets, certain Business Z assets, cash or notes in the amount $d, a note in the amount $e owed to Distributing by C, and certain equipment. Distributing will retain certain Business Z assets.

   Distributing will then distribute all of the stock of Controlled #1 to A, the members
   of the A family holding Distributing stock, and to Estate in exchange for the shares of Distributing held by such shareholders. Shares of Controlled #1 owned by Estate will be settled solely to A. Distributing will distribute all of the stock of Controlled #2 to B, the members of the B family holding Distributing stock, and Estate, in exchange for the shares of Distributing held by such shareholders. Shares of Controlled #2 held by Estate will be settled solely to B. Distributing will distribute all of the stock of Controlled

   3 to C and to Estate, in exchange for the shares of Distributing held by such shareholders. Shares of Controlled #3 held by Estate will be settled solely to C. Following the Distribution, Distributing will retain certain Business Z assets. The stock of Distributing will be owned by revocable trusts for the benefit of D and a member of D’s immediate family, and members of D’s immediate family. The Distribution will not be carried out prior to Date 2 (i.e., the day following the fifth anniversary of Date 1). Each of the Controlled Corporations will elect to be an S corporation on the first available date after the Distribution.

   Financial information has been received indicating that Business X has had
   gross receipts and operating expenses representing the active conduct of a trade or business for each of the past five years, and that Business Z has had gross receipts and operating expenses representing the active conduct of a trade or business for the period beginning Date 1.

   Distributing has made the following representations with respect to the
   Distribution:

   (a) The fair market value of the stock of each of the Controlled Corporations
   to be received by each shareholder of Distributing will be approximately
   equal to the fair market value of the stock of Distributing surrendered in
   the exchange.

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

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   (c) The five years of financial information submitted on behalf of Distributing
   is representative of Distributing’s present operation with respect to its
   Business X activities, and there have been no substantial operational
   changes since the date of the last financial statements submitted for such
   operations. The financial information submitted on behalf of Distributing is
   representative of Distributing’s present operation with respect to its
   Business Z activities since Date 1, and there have been no substantial
   operational changes since the date of the last financial statements
   submitted for such operations

   (d) Following the Distribution, Distributing and each of the Controlled
   Corporations will continue independently the active conduct of its share of
   all of the integrated activities of its business independently and with its
   separate employees, except that the services of one employee will be
   shared by Controlled #2 and Distributing.

   (e) The Distribution is being carried out for the following corporate business
   purpose: to eliminate disputes among A, B, C, and D regarding important
   business decisions, including decisions with respect to the types of
   business for the corporation to acquire, management styles, disclosure
   and sharing of information regarding management of assets, and the
   focus of the business.

   (f) Distributing is an S corporation within the meaning of § 1361(a) of the
   Code. Each of the Controlled Corporations will elect to be an S
   corporation pursuant to § 1362(a) on the first available date after the
   Distribution. There is no plan or intention to revoke or otherwise terminate
   the S corporation election of Distributing or of any of the Controlled
   Corporations, once made.

   (g) There is no plan or intention by the shareholders or security holders of
   Distributing to sell, exchange, transfer by gift, or otherwise dispose of any
   stock in, or securities of, either Distributing or any of the Controlled
   Corporations after the transaction, except for gifts by shareholders of
   Distributing or the Controlled Corporations to the immediate family of such
   shareholders.

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

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   (i) There is no plan or intention to liquidate any of the Controlled
   Corporations, to merge any of the Controlled Corporations with any other
   corporation, or to sell or otherwise dispose of the assets of any of the
   Controlled Corporations after the Distribution, except in the ordinary
   course of business.

   (j) The Distribution is not part of a plan or series of related transactions
   (within the meaning of Code § 355(e)) pursuant to which one or more
   persons will acquire directly or indirectly stock possessing 50% or more of
   the total combined voting power of all classes of stock of either
   Distributing or any of the Controlled Corporations entitled to vote or stock
   possessing 50% or more of the total value of all classes of stock of either
   Distributing or any of the Controlled Corporations.

   (k) The total adjusted basis and the fair market value of the assets
   transferred to each of the Controlled Corporations by Distributing each
   equals or exceeds the sum of the liabilities assumed by each of the
   Controlled Corporations plus any liabilities to which the transferred assets
   are subject. 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 associated with the assets being transferred,
   except that, as noted above, in order to equalize values, a debt now
   secured by an asset to be transferred to Controlled #2 will be assumed by
   Controlled #1 or refinanced, and the security interest will be assets of
   Controlled #1.

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

   (m) No intercorporate debt will exist between Distributing and any of the
   Controlled Corporations at the time of, or subsequent to, the Distribution,
   except for the following, made to equalize the values in the Distribution: a
   note in favor of Controlled #2 obligating Distributing in an amount not to
   exceed $b and a note in favor of Controlled #3 obligating Distributing in
   the amount not to exceed $d.

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

   (o) No two parties to the Distribution are investment companies as defined in
   Code § 368(a)(2)(F)(iii) and (iv).

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       Based solely on the information submitted and the representations made,
   

   we have concluded that:

   (1) The transfer by Distributing to each of the Controlled Corporations of
   property in exchange for all of the stock of each of the Controlled
   Corporations, as described above, followed by the distribution by
   Distributing of all of the shares of the common stock of each of the
   Controlled Corporations to certain of the Shareholders as described
   above, will in each case constitute a reorganization within the meaning of
   Code § 368(a)(1)(D). Distributing and each of the Controlled Corporations
   will each be a party to a reorganization within the meaning of Code
   § 368(b).

   (2) Distributing will not recognize any gain or loss upon the transfer of its
   assets to the Controlled Corporations in exchange for shares of 100% of
   the common stock of the Controlled Corporations and the assumption of
   certain liabilities by the Controlled Corporations. Code §§ 361(a) and
   357(a).

   (3) No gain or loss will be recognized to the Controlled Corporations upon the
   receipt of Distributing’s assets in exchange for 100% of the stock of the
   Controlled Corporations and the assumption of the liabilities of Distributing
   by the Controlled Corporations. Code § 1032(a).

   (4) The basis of the assets received by the Controlled Corporations from
   Distributing will be the same as the basis of such assets in the hands of
   Distributing immediately prior to the transfer. Code § 362(b).

   (5) The holding period of each asset received by the Controlled Corporations
   from Distributing will include the period during which Distributing held such
   asset. Code § 1223(2).

   (6) No gain or loss will be recognized to Distributing upon the distribution to
   the Shareholders of 100% of the shares of the common stock of the
   Controlled Corporations pursuant to the Distribution. Code § 361(c)(1).

   (7) No gain or loss will be recognized to, and no amount will be included in
   the income of, the Shareholders upon the exchange of their shares of
   Distributing common stock for shares of the common stock of the
   Controlled Corporations pursuant to the Distribution. Code § 355(a)(1).

   (8) The basis of the shares of the common stock of each of the Controlled
   Corporations will be the same as the basis of the Distributing common
   stock surrendered in exchange therefor. Code § 358(a)(1).

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   PLR-164359-01

   (9) The holding period of the shares of the stock of the each of the Controlled
   Corporations to be received by the Shareholders will include the period
   during which the Shareholders held the Distributing stock surrendered in
   exchange therefore, provided that such shareholder held the Distributing
   stock as a capital asset on the date of the Distribution. Code § 1223(1).

   (10) As provided in Code § 312(h), the earnings and profits of Distributing will
   be allocated among the Controlled Corporations under Treas. Reg.
   § 1.312-10(a).

   No opinion is expressed as to the tax treatment of the transactions under other
   provisions of the Code or regulations or about the tax treatment of any conditions existing at the time of, or effects resulting from, the transactions that are not specifically covered by the above ruling. Specifically, no opinion was requested and none is expressed as to the validity or effect of Distributing’s S corporation election or the proposed S corporation election of any of the Controlled Corporations.

   This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of
   the Code provides that it may not be used or cited as precedent.

                                      Sincerely yours,
                                      Gerald B. Fleming
                                      Senior Technician Reviewer, Branch 2
                                      Office of Associate Chief Counsel (Corporate)
   

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