PLR 200828036: Employer stock treatment continues for pension shares after a corporate spin off

Plain-English summary

A company spun off a subsidiary, leaving shares of both companies in their employee stock ownership plans. The IRS ruled that former parent shares held by the subsidiary's plan would continue to count as employer securities for the rule that can exclude net unrealized appreciation when shares are distributed. It also ruled that the original share basis would be divided between the two companies' shares according to their relative fair market values. When the subsidiary's plan sells former parent shares and promptly reinvests the proceeds in subsidiary shares, the transaction is disregarded in calculating that appreciation, and the replacement shares carry the sold shares' basis. The rulings assume the plans remain qualified and their trusts tax exempt.

Ruling snapshot

• Question: How do a spin off and reinvestment of plan shares affect employer security status, basis, and net unrealized appreciation?
• Outcome: Approved on the four requested treatments, subject to the stated plan qualification assumptions.
• Key authorities: IRC §§ 355, 358, 402(e)(4), 402(j); Treas. Reg. §§ 1.358-2(a)(2), 1.402(a)-1; Rev. Rul. 73-29, 80-138.

Full text (IRS public release)

200828036
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

APR 16 2008

Uniform Issue List: 402.07-00

Attn: ****

LEGEND:

Company A = ***
Company B = ***
Plan X = ***
Plan Y = ***
Fund S = ***
Fund H = ***
Date 1 = ***
Date 2 = ***
Date 3 = ***
Date 4 = ***
Date 5 = ***
Date 6 = ***
Date 7 = ***

Dear *

This letter responds to your representative's letter dated December 22, 2006, as supple- mented by correspondence dated November 29, 2007, requesting rulings regarding the tax consequences of the spin-off of a subsidiary by its parent corporation. Your authorized rep-

resentative has submitted the following facts and representations in support of this request.

On Date 1, in a corporate reorganization pursuant to section 355 of the Internal Revenue Code (“Code”), Company A spun off its branded apparel business into a stand-alone com- pany known as Company B, by issuing a stock dividend of shares of Company B common stock (the “Spin-Off’). In a private letter ruling issued on Date 2, the Office of Associate Chief

Counsel (Corporate) ruled that the Spin-Off will qualify for nonrecognition of gain or loss to

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the shareholders of Company A under section 355(a)(1) of the Code. In that same letter, the Office of Associate Chief Counsel (Corporate) also ruled that the aggregate basis of Com- pany A common stock and Company B common stock (including any fractional interest in Company B common stock) in the hands of shareholders of Company A common stock im- mediately after the Spin-Off will be the same as the aggregate basis of the Company A common stock held by such shareholders immediately before the Spin-Off, allocated in pro- portion to the fair market value of each in accordance with section 1.358-2(a)(2) of the In- come Tax Regulations (“Regulations”).

Following the Spin-Off, Company A and Company B will no longer be part of the same con- trolled group of corporations within the meaning of section 414(b), (c), (m) or (o) of the Code.

Company A established Plan X, effective Date 3, for the benefit of its employees and the employees of its participating subsidiaries. Plan X consists of a profit sharing plan with a cash or deferred arrangement intended to satisfy the requirements of Code section 401(a) and 401(k), and an employee stock ownership component (“Company A ESOP”) that is in- tended to satisfy the requirements of certain subsections of Code section 409 and Code sec- tion 4975(e)(7). Plan X also provides for employer matching contributions. The Company A ESOP is designed to be invested primarily in Company A shares, which are “employer secu- rities” within the meaning of Code section 409(l). The Company A ESOP consists primarily of the assets held in Fund S. The Company A ESOP is leveraged.

Under the terms of Plan X, Company A shares that are held in suspense under the Company A ESOP are released from the suspense account as contributions necessary to enable the Company A ESOP to make principal and interest payments on its outstanding loans are made to the Company A ESOP. Loan repayments are made semi-annually in June and De- cember of each year, and shares are released annually following the December loan repay- ment. The number of Company A shares released each year bears the same proportion to the number of Company A shares held immediately before the release as the semi-annual loan payments for the year bear to the total remaining loan payments required to be made under the loan.

Under the terms of Plan X, eligible employees may contribute from zero percent to 50 per- cent of compensation on a pre-tax basis, subject to the limitations of Code Section 402(g); however, highly compensated employees may not contribute more than five percent of com- pensation. Certain employees also may make after-tax contributions to Plan X.

Participants who make contributions to Plan X also are eligible for employer matching contri- butions. In addition, participants receive annual allocations based on the employers’ re- quired payments of loan principal and interest on the outstanding ESOP loan, with a mini- mum allocation to each participant of 1.75 percent to 2 percent of compensation.

Plan X is an individual account plan that is intended to comply with section 404(c) of the Em- ployee Retirement Income Security Act of 1974 (“ERISA”). Each Plan X participant is permit- ted to direct the investment of assets credited to his or her accounts under Plan X in accor- dance with the terms of Plan X. Annual employer contributions are invested initially in Fund S. Plan X participants are permitted to elect to invest all contributions to their accounts, and existing account balances, in a diversified array of investment choices, including Fund S, on

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any business day, subject to the trading restrictions of the particular investment fund. After the Spin-Off, an additional investment fund will hold participants’ interests in Company B shares for up to one year; however, participants will not be permitted to make new invest- ments in the fund.

Participants may elect to receive payment of their accounts in a lump sum, a partial distribu- tion, or installments over a period of up to five years. In the case of a former participant in a predecessor plan, certain forms of payment provided for under the predecessor plan also may be available. On termination of employment, participants may elect to receive an in- kind distribution of their interests in Fund S.

Effective Date 5, Company B established Plan Y. As of Date 5, the Plan X accounts of Com- pany B employees were transferred to Plan Y in a direct trustee-to-trustee transfer of assets that satisfied the requirements of Code section 414(l).

Plan Y consists of a profit sharing plan with a cash or deferred arrangement intended to sat- isfy the requirements of Code section 401(a) and 401(k), and an employee stock ownership component (“Company B ESOP”) that is intended to satisfy the requirements of certain sub- sections of Code section 409 and Code section 4975(e)(7). The Company B ESOP is nonleveraged and is designed to be invested primarily in employer securities within the meaning of Code section 409(l). Before the Spin-Off, the Company B ESOP was comprised of that portion of Plan Y invested in Company A shares; after the Spin-Off, it is comprised of the employer stock fund invested in Company B shares.

Under the terms of Plan Y, eligible employees may contribute from zero percent to 50 per- cent of compensation on a pre-tax basis, subject to the limitations of Code Section 402(g); however, highly compensated employees may not contribute more than five percent of com- pensation. With respect to periods after the Spin-Off, each participant's employer may make matching contributions and discretionary profit sharing contributions to Plan Y. All such con- tributions will be made in cash.

Plan Y is an individual account plan that is intended to meet the requirements of section 404(c) of ERISA. Each Plan Y participant is permitted to direct the investment of assets cred- ited to his or her accounts under Plan Y in accordance with the terms of Plan Y. Participants in Plan Y are permitted to elect to invest contributions to their accounts, and existing account balances, in a diversified array of investment choices, including Fund H, on any business day, subject to the trading restrictions of the particular investment fund. After the Spin-Off, an additional investment fund will hold participants’ interests in Company A shares for up to one year; however, participants will not be permitted to make new investments in the fund.

Plan Y participants may elect to receive payment of their accounts in a lump sum, a partial distribution, or installments over a period of up to five years. In the case of a former partici- pant in a predecessor plan, certain forms of payment provided for under the predecessor plan also may be available. Upon termination of employment, participants may elect to re- ceive distribution of amounts invested in Fund H in Company B shares.

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As a result of the Spin-Off, Plan X and Plan Y each hold both Company A and Company B Shares. The Plans each provide a one-year period during which participants may voluntarily elect to dispose of their interest in non-employer shares in accordance with ERISA section 404(c).

During Date 6, plan participants were permitted to affirmatively elect to retain their interests in the non-employer shares subsequent to the Spin-Off, ie., Plan X participants could elect to retain their interest in Company B shares, and Plan Y participants could elect to retain their interest in the Company A shares. If a participant did not elect to retain his or her inter- est in non-employer shares after the Spin-Off, then that interest was liquidated over the five business days immediately following the Spin-Off, with the proceeds invested immediately thereafter in accordance with the participant's then current investment election. If a partici- pant elected to retain his or her interest in non-employer shares after the Spin-Off, the par- ticipant could elect to transfer all or a portion of such interest to another investment fund maintained under the applicable plan at any time during the one-year period following the Spin-Off (Transition Period). If the participant retained an interest in the non-employer shares as of the end of the Transition Period, that interest would be immediately liquidated by the trustee and the proceeds invested in accordance with the participant's current investment election.

When the proceeds of the non-employer shares are reinvested in accordance with the par- ticipant’s current investment election, if a Plan X participant's current investment election in- cludes an investment in Fund S, the proceeds of the participant’s interest in Company B shares will be reinvested in Fund S. Similarly, if a Plan Y participant’s current investment election includes an investment in Fund H, the proceeds of the participant’s interest in Com- pany A shares will be reinvested in Fund H. In addition, if a participant elects to transfer his or her interest in the non-employer shares during the Transition Period, the participant may elect to invest all or a portion of such interest in the investment fund that constitutes em- ployer securities, i.e., a Plan X participant may elect to transfer all or a portion of his or her interest in Company B shares to Fund S in Plan X, and a Plan Y participant may elect to transfer all or a portion of his or her interest in Company A shares to Fund H in Plan Y.

Company A and Company B intend to provide the Transition Period to (a) give participants sufficient time to liquidate their interests in non-employer shares, (b) permit a smooth transi- tion, and (c) avoid adversely affecting the market for Company A or Company B shares by requiring the sale of a significant number of shares at one time. After the Spin-Off, Plan X will not acquire additional Company B Shares and Plan Y will not acquire additional Com- pany A shares.

Under subsection 5.06 of Plan X, eligible participants are entitled to a minimum allocation of the Company A shares released each calendar year as the Company A ESOP's loan is re- paid. This allocation is provided by the employers through a loan repayment contribution to

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Plan X and a release of Company A shares from the suspense account in Plan X. The em- ployer’s contribution under subsection 5.06 is determined and allocated in April of the year following the year to which the contribution applies.

For , it is proposed that Company B employees as of the Spin-Off participate in the allo- cation of the Company A ESOP release for based on their eligible compensation through the Spin-Off. Further, in lieu of releasing Company A shares with respect to the Company B employees, it is proposed that Company B Shares be released from the sus- pense account to eligible employees. Once the minimum allocation has been completed, in Date 7, the Company B Shares released to the Company B employees will be transferred to Plan Y in a subsequent trustee-to-trustee transfer intended to satisfy the requirements of Code section 414(l), and such shares will be invested as part of Fund H.

Once the allocation has been completed and the appropriate number of Company B Shares has been released from the suspense account with respect to Company B employ- ees in Plan X, then any remaining Company B Shares held in the suspense account will be liquidated and reinvested in Company A Shares.

Based on the foregoing facts and representations, your authorized representatives have re- quested the following rulings:

1. The Company A shares held by Plan Y as of the Spin-Off will be “securities of the
   employer corporation" for purposes of Code Section 402(e)(4), and the net unrealized appreciation in such shares may be excluded from gross income upon distribution by Plan Y to the extent provided in Code section 402(e)(4).

2. For purposes of determining net unrealized appreciation under Code section
   402(e)(4), the basis of Company A shares and Company B shares held by Plan Y will be determined by allocating the basis of the Company A shares immediately before the Spin-Off between the Company A shares and the Company B shares held immediately after the Spin-Off in proportion to their relative fair market values, in accordance with Code section 358.

3. With respect to a Plan Y participant whose interest in Company A shares was liqui-
   dated over the five business days beginning on the Spin-Off, to the extent the proceeds were invested in Fund H immediately after the end of the five-day period, such disposi- tion and reinvestment shall constitute an exchange of “securities of the employer corpo- ration” for purposes of Code section 402(j)(2), so that the determination of net unrealized appreciation shall be made without regard to such disposition. With respect to any other Plan Y participant, to the extent the participant's interest in Company A shares is dis- posed of and the proceeds immediately reinvested in Fund H, either at the participant's election during the Transition Period or pursuant to applicable Plan Y provisions at the end of the Transition Period, such disposition and reinvestment shall constitute an ex- change of “securities of the employer corporation” for purposes of Code section 402(j)(2), so that the determination of net unrealized appreciation shall be made without regard to such disposition.

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4. In the event that Plan Y disposes of Company A shares and reinvests the proceeds
   in Company B shares, for purposes of determining net unrealized appreciation under Code section 402(e)(4), the basis of the replacement Company B shares purchased with the proceeds of the Company A shares sold by Plan Y will be equal to the basis of the Company A shares sold.

Code section 402(e)(4)(A) states, in pertinent part that, for purposes of sections 402(a) and 72, in the case of a distribution other than a lump sum distribution, the amount actually dis- tributed to any distributee from a trust described in section 402(a) shall not include any net unrealized appreciation in securities of the employer corporation attributable to amounts con- tributed by the employee.

Code section 402(e)(4)(B) states, in pertinent part that, for purposes of sections 402(a) and 72, in the case of any lump sum distribution which includes securities of the employer corpo- ration, there shall be excluded from gross income the net unrealized appreciation attributable to that part of the distribution which consists of securities of the employer corporation.

Code section 402(e)(4)(E)(ii) provides in pertinent part that, for purposes of section 402(e), the term "securities of the employer corporation” includes securities of a parent or subsidiary corporation (as defined in subsections (e) and (f) of Code section 424) of the employer corpo- ration.

Code section 402(j) provides a special rule for certain transactions. Code section 402(j)(2) states, that for section 402(e)(4) purposes, the determination of net unrealized appreciation will not apply to any transaction where a plan trustee disposes of securities of the employer corporation and uses the proceeds of such disposition to acquire securities of the employer corporation within 90 days.

Section 1.402(a)-1(b)(2)(i) of the Regulations provides that the amount of net unrealized ap- preciation in securities of the employer corporation that are distributed by the trust is the ex- cess of the market value of such securities at the time of distribution over the cost or other basis of such securities to the trust.

Section 1.402(a)-1(b)(2)(ii) of the Regulations sets forth the manner in which the cost or other basis to the trust of a distributed security of the employer corporation is calculated for the purpose of determining the net unrealized appreciation on such security.

Under section 1.402(a)-1(d)(2) of the Regulations neither employee salary deferrals made pursuant to a cash or deferred arrangement nor matching contributions are treated as em- ployee contributions for purposes of Code section 402(e)(4).

In Revenue Ruling 73-29, 1973-1 C.B. 198, securities of an employer corporation held by its qualified plan were transferred to the qualified trust of an unrelated corporation when the first employer sold part of its business and transferred some of its employees to an unrelated corporation. It was held that shares of stock of the seller corporation distributed from the buyer's qualified trust to employees of the buyer corporation who are former employees of the seller corporation are securities of the employer corporation and will always be securities

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of the employer corporation even after those shares and the employees in whose accounts they were held were transferred to an unrelated corporation.

In Revenue Ruling 80-138, 1980-1 C.B. 87, the Service held that the transfer of employer securities from an exempt trust maintained by a parent corporation and its subsidiary to a newly established exempt trust of the subsidiary will not change the basis of the securities for purposes of computing net unrealized appreciation in the securities because the transfer is not a taxable event.

With respect to ruling request 1, Company B was a wholly-owned subsidiary of Company A before the Spin-Off. Therefore, before the Spin-Off, Company B shares constituted “securi- ties of the employer corporation” within the meaning of Code section 402(e)(4)(E). Pursuant to and simultaneously with the Spin-Off, Company B ceased to be a subsidiary of Company A. However, the Company B shares distributed to Plan X and Plan Y pursuant to the Spin- Off represent part of the pre-Spin-Off value of the Company A shares. Accordingly, we con- clude that the shares of Company A acquired by Plan Y as a result of the Spin-Off will con- tinue to be treated as "securities of the employer corporation" for purposes of Code section 402(e)(4) in accordance with Revenue Ruling 73-29, and the net unrealized appreciation in such shares may be excluded from gross income upon distribution to a participant or benefi- ciary to the extent provided in section 402(e)(4).

With respect to ruling request 2, Company A has received a private letter ruling from the Of- fice of Chief Counsel stating that the Spin-Off will be tax-free under section 355 of the Code. Section 1.358-2(a)(2) of the Regulations provides that if, as a result of a transaction under section 355, a shareholder who owned stock of only one class before the transaction owns stock of two or more classes after the transaction, then the basis of all the stock held before the transaction is allocated among the stock of all classes held immediately after the transac- tion in proportion to the fair market values of the stock of each class.

Accordingly, with respect to ruling request 2, we conclude that, for purposes of determining net unrealized appreciation under Code section 402(e)(4), to the extent that the Spin-Off is a tax-free spin-off under Code section 355, the basis of the Company A and Company B shares held by Plan Y for the benefit of Plan Y participants immediately after the Spin-Off will be determined by allocating the basis in the Company A shares held by Plan Y immediately before the Spin-Off between the Company A shares and the Company B shares in propor- tion to their relative fair market values in accordance with Code section 358.

With respect to ruling request 3, Code section 402(j) provides, generally, that for purposes of section 402(e)(4), in the case of any transaction in which either (A) the plan trustee ex- changes the plan's securities of the employer corporation for other such securities, or (B) the plan trustee disposes of securities of the employer corporation and uses the proceeds of such disposition to acquire securities of the employer corporation within 90 days (or such longer period as the Secretary may prescribe), the determination of net unrealized apprecia- tion shall be made without regard to such transaction. In this case to the extent there is an exchange of Company A shares for Company B shares or there is a disposition of Company A shares followed by the reinvestment of the proceeds in Company B shares, such ex- change or disposition will constitute an exchange of "securities of the employer corporation"

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for purposes of Code section 402(j)(2) so that the determination of net unrealized apprecia- tion shall be made without regard to such exchange or disposition.

In addition, Code section 402(j), by its terms alone, does not expressly prohibit participant- directed transactions. Further, the legislative history (see, Senate Report No. 99-313, at 1040 (1986)) indicates that section 402(j) applies to transactions that are in the exercise of . fiduciary duty or are required by ERISA and requires a participant-directed trustee to act in accordance with participant investment directions. Therefore, it is appropriate for participant- directed dispositions and acquisitions of employer securities to be covered by section 402(j), provided that the transactions are completed within the required time frame.

Accordingly, with respect to ruling request 3, with respect to a Plan Y participant whose in- terest in Company A shares was liquidated over the five business days beginning on the date of the Spin-Off, to the extent the proceeds were invested in Fund H immediately after the end of the five-day period, such disposition and reinvestment shall constitute an ex- change of “securities of the employer corporation” for purposes of Code section 402(j)(2), so that the determination of net unrealized appreciation shall be made without regard to such disposition.

Similarly, with respect to any other Plan Y participant, to the extent the participant's interest in Company B shares is disposed of and the proceeds immediately reinvested in Fund H, ei- ther at the participant’s election during the Transition Period or pursuant to applicable Plan Y provisions at the end of the Transition Period, such disposition and reinvestment shall consti- tute an exchange of “securities of the employer corporation” for purposes of Code section 402(j)(2), so that the determination of net unrealized appreciation shall be made without re- gard to such disposition.

With respect to ruling request 4, we have concluded with respect to ruling request 3 that to the extent Plan Y disposes of Company A shares and the trustee of Plan Y reinvests the proceeds of the disposition in Company B shares, such disposition and reinvestment will constitute an exchange of “securities of the employer corporation” for purposes of Code sec- tion 402(j)(2), so that the determination of net unrealized appreciation shall be made without regard to such disposition.

Accordingly, with respect to ruling 4, we conclude that, to the extent that Plan Y disposes of Company A shares and reinvests the proceeds in Company B shares, for purposes of de- termining net unrealized appreciation under Code section 402(e)(4), the basis of the re- placement Company B shares will be equal to the basis of the Company A shares.

This ruling letter is based on the assumption that Plan X and Plan Y are qualified under Code section 401(a), that they meet the requirements of Code section 4975(e)(7), and that their related trusts are tax exempt under Code section 501(a) at all relevant times.

No opinion is expressed or implied concerning the tax consequences of the proposed trans- actions under any other provision of the Code or Regulations or the tax treatment of any conditions existing at the time of, or effects resulting from, the proposed transactions that are not specifically covered by the above rulings.

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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, a copy of this letter is being sent to your authorized representative.

If you have any questions concerning this ruling, please contact ****,

Sincerely,

Donzell H. Littlejohn, Manager
Employee Plans Technical Group 4

Enclosures:
Deleted copy
Notice 437