PLR 1026007: IRS approved a divisive reorganization separating two businesses

Plain-English summary

The IRS approved a proposed split-off in which an S corporation would transfer one of its businesses to a newly formed corporation and distribute that corporation's stock to a group of shareholders in exchange for their stock in the original corporation. The IRS ruled that the contribution and distribution would qualify as a divisive reorganization under IRC § 368(a)(1)(D), with no gain or loss recognized in the specified transactions. The ruling also addressed the transferred assets' basis and holding period, the shareholders' basis and holding period in the new corporation's stock, allocation of earnings and profits, and the new corporation's eligibility to elect S corporation status. The IRS expressly did not rule on several business-purpose, device, acquisition-plan, and small-business-corporation questions.

Ruling snapshot

• Question: Could an S corporation separate one business into a new corporation and distribute its stock to one shareholder group in exchange for that group's stock in the original corporation?
• Outcome: approved
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368, 1032, 1223, 1361, 1362, 1374, and 312; Treas. Reg. §§ 1.355-2(b), 1.355-2(d), 1.355-7, and 1.358-2(a)(2); IRC § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201026007 Third Party Communication: None
Release Date: 7/2/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 355.00-00, 355.01-01, 368.00- ----------------------------
00, 368.04-00 ID No. -----------------
Telephone Number:
---------------------
---------------------- Refer Reply To:
------------- CC:CORP:02
---------------------------------- PLR-102480-10
---------------- Date:
--------------------------------- March 25, 2010

                                                 LEGEND

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

State X = -------------

Shareholder 1 = -----------------------

Shareholder 2 = --------------------------

Shareholder 3 = ----------------------

Shareholder 4 = ------------------------

Shareholder 5 = --------------------------

Shareholder 6 = -----------------------

Shareholder 7 = -------------------------
PLR-102480-10 2

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

Business B = ----------

a = --------

b = -----

c = --------

d = --------

e = ------

f = --------

g = -------

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

Date 2 = ----------------------

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

This letter responds to your January 15, 2010 request, submitted by your authorized
representative, for rulings on certain federal income tax consequences of the Proposed
Transaction (described below). The information provided in that request and in later
correspondence is summarized below.

The rulings contained in this letter are based upon facts and representations submitted
by the taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. This office has not verified any of the material 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.

In particular, this office has not reviewed any information pertaining to, and has made
no determination regarding, whether the Proposed Transaction: (i) satisfies the
business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) is being 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
PLR-102480-10 3

greater interest in the distributing corporation or the controlled corporation (see section
355(e) and Treas. Reg. § 1.355-7).

                             STATEMENT OF FACTS

Distributing is a State X corporation that was organized as a subchapter C corporation
on Date 1. On Date 2, which is within the last 10 years, Distributing elected to be
treated as a subchapter S corporation for federal income tax purposes. Distributing has
a shares of voting common stock issued and outstanding. Shareholders 1 through 5
(collectively, the “Group A Shareholders”) together own b shares of Distributing stock,
which equals approximately c%. Shareholders 6 and 7 (collectively, the “Group B
Shareholders”) own d and e shares, respectively, of Distributing stock, which collectively
equals approximately f%.

Distributing is engaged in Business A and Business B. Distributing has submitted
financial information indicating that Business A and Business B each have had gross
receipts and operating expenses representing the active conduct of a trade or business
for each of the past five years.

                           PROPOSED TRANSACTION

For what are represented to be valid business reasons, Distributing has proposed the
following transaction (the “Proposed Transaction”):

(i) Distributing will form Controlled, which will have one class of voting common
stock authorized.

(ii) Distributing will transfer all of the assets related to Business B to Controlled in
exchange for g shares of Controlled common stock, which will be 100 percent
of Controlled’s outstanding stock, and the assumption by Controlled of all
liabilities related to Business B (the “Contribution”).

(iii) Immediately after the Contribution, Distributing will distribute all of the
Controlled stock to the Group B Shareholders (d shares to Shareholder 6 and
e shares to Shareholder 7) in exchange for all of their Distributing stock
(the “Distribution”).

Immediately after the Distribution, Controlled will elect to be treated as a subchapter S
corporation for federal income tax purposes.
PLR-102480-10 4

                             REPRESENTATIONS

Distributing makes the following representations regarding the Proposed Transaction:

(a) The fair market value of the Controlled stock to be received by each Group B
Shareholder will be approximately equal to the fair market value of the
Distributing stock surrendered by each Group B Shareholder in the
Distribution.

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

(c) The five years of financial information submitted on behalf of Business A is
representative of the present operations of the business, and with regard to
such business, there have been no substantial operational changes since the
date of the last financial statements submitted.

(d) The five years of financial information submitted on behalf of Business B is
representative of the present operations of the business, and with regard to
such business, there have been no substantial operational changes since the
date of the last financial statements submitted.

(e) Distributing neither acquired Business A nor acquired control of an entity
conducting Business A during the five-year period ending on the date of the
Distribution in a transaction in which gain or loss was recognized (or treated
as recognized) in whole or in part. Throughout the five-year period ending on
the date of the Distribution, Distributing will have been the principal owner of
the goodwill and significant assets of Business A, and it will continue to be the
principal owner following the Distribution.

(f) Distributing neither acquired Business B nor acquired control of an entity
conducting Business B during the five-year period ending on the date of the
Distribution in a transaction in which gain or loss was recognized (or treated
as recognized) in whole or in part. Throughout the five-year period ending on
the date of the Distribution, Distributing will have been the principal owner of
the goodwill and significant assets of Business B, and Controlled will be the
principal owner following the Distribution.

(g) Following the Proposed Transaction, Distributing and Controlled will each
continue the active conduct of its business, independently and with its
separate employees.
PLR-102480-10 5

(h) The Distribution is carried out for the following corporate business purposes:
to allow each group of shareholders to own and manage its respective
business based upon its own specific interests, to restrict its investment and
devote its attention to its respective business, to operate its respective
business independently and as it sees fit, to devote its undivided attention to
its respective business, and to apply a consistent business strategy to its
respective business. The Distribution is motivated, in whole or substantial
part, by one or more of these corporate business purposes.

(i) The Proposed Transaction is not used principally as a device for the
distribution of earnings and profits of Distributing or Controlled or both.

(j) For purposes of section 355(d), immediately after the Distribution, no person
(determined after applying section 355(d)(7)) will hold stock possessing 50
percent or more of the total combined voting power of all classes of
Distributing stock entitled to vote, or 50 percent or more of the total value of
shares of all classes of Distributing stock, that was acquired by purchase (as
defined in section 355(d)(5) and (8)) during the five-year period (determined
after applying section 355(d)(6)) ending on the date of the Distribution.

(k) For purposes of section 355(d), immediately after the Distribution, no person
(determined after applying section 355(d)(7)) will hold stock possessing 50
percent or more of the total combined voting power of all classes of
Controlled stock entitled to vote, or 50 percent or more of the total value of
shares of all classes of Controlled stock, that was either (i) acquired by
purchase (as defined in section 355(d)(5) and (8)) during the five-year
period (determined after applying section 355(d)(6)) ending on the date of the
Distribution, or (ii) attributable to distributions on Distributing stock that were
acquired by purchase (as defined in section 355(d)(5) and (8)) during the five-
year period (determined after applying section 355(d)(6)) ending on the date of
the Distribution

(l) The total adjusted basis of the assets that will be transferred to Controlled in the
Contribution will equal or exceed the sum of (i) the total liabilities assumed
(within the meaning of section 357(d)) by Controlled and (ii) the total amount of
any money and the fair market value of any other property (within the
meaning of section 361(b)) received by Distributing from Controlled and
transferred to Distributing’s shareholders or creditors pursuant to the plan of
reorganization.

(m) The total fair market value of the assets transferred to Controlled in the
Contribution will exceed the sum of (i) the amount of any liabilities assumed
(within the meaning of section 357(d)) by Controlled in connection with the
exchange, (ii) the amount of any liabilities owed to Controlled by Distributing
PLR-102480-10 6

    that are discharged or extinguished in connection with the exchange, and (iii)
    the amount of any cash and the fair market value of any other property (other
    than stock and securities permitted to be received under section 361(a)
    without the recognition of gain) received by Distributing in connection with the
    exchange. The fair market value of the assets of Controlled will exceed the
    amount of its liabilities immediately after the exchange.

(n) The liabilities assumed (within the meaning of section 357(d)) by Controlled in
the Contribution were incurred in the ordinary course of business and are
associated with the assets being transferred.

(o) The income tax liability for the taxable year in which investment credit
property (including any building to which section 47(d) applies) is transferred
will be adjusted pursuant to section 50(a)(1) or (a)(2) (or section 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.

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

(q) No income items, including accounts receivable, or any item resulting from a
sale, exchange, or disposition of property that would have resulted in income
to Distributing and no items of expense will be transferred to Controlled if
Distributing has earned the right to receive the income or could claim a
deduction for the expense under the accrual or similar method of accounting.

(r) Distributing and Controlled and their respective shareholders will each pay
their own expenses, if any, incurred in connection with the transaction.

(s) No intercorporate debt will exist between Distributing and Controlled at the
time of, or subsequent to, the Distribution.

(t) 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.

(u) No two parties to the transaction are investment companies as defined in
section 368(a)(2)(F)(iii) and (iv).

(v) The Distribution is not part of a plan or series of related transactions (within
the meaning of Treas. Reg. § 1.355-7) pursuant to which one or more
persons will acquire, directly or indirectly, stock representing a 50-percent or
greater interest (within the meaning of section 355(d)(4)) in Distributing or
Controlled.
PLR-102480-10 7

(w) Immediately after the transaction either (1) no person will hold a 50-percent
or greater interest (within the meaning of section 355(g)(3)) in the stock of
Distributing or Controlled who did not hold such an investment immediately
before the transaction, or (2) neither Distributing nor Controlled will be a
disqualified investment corporation (within the meaning of section 355(g)(2)).

(x) Effective Date 2, Distributing made an election under section 1362(a) to be a
subchapter S corporation (within the meaning of section 1361(a)) and
Distributing has continued to be a subchapter S corporation since Date 2
(within the meaning of section 1361(a)).

(y) Controlled will elect to be treated as a subchapter S corporation, effective
immediately after the Distribution.

                                    RULINGS

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

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

(2) No gain or loss will be recognized by Distributing on the Contribution
(sections 357(a) and 361(a)).

(3) No gain or loss will be recognized by Controlled on the Contribution (section
1032(a)).

(4) Controlled’s basis in each asset received from Distributing in the Contribution
will equal 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 from Distributing in the
Contribution will include the period during which Distributing held such asset
(section 1223(2)).

(6) No gain or loss will be recognized by Distributing on the distribution of the
Controlled stock in the Distribution (section 361(c)(1)).
PLR-102480-10 8

(7) No gain or loss will be recognized by the Group B Shareholders (and they will
not otherwise include any amount in income) upon receipt of the Controlled
stock in exchange for shares of their Distributing stock in the Distribution
(section 355(a)(1)).

(8) The aggregate basis of the Controlled stock received by each Group B
Shareholder in the Distribution (including any fractional interest in Controlled
stock to which the shareholder may be entitled) will be the same as the
shareholder’s aggregate basis in the Distributing stock surrendered in
exchange therefor, allocated in the manner described in Treas. Reg.
§ 1.358-2(a)(2) (sections 358(a)(1) and (b)(2)).

(9) The holding period of the Controlled stock received by each Group B
Shareholder in the Distribution will include the holding period of the
Distributing stock surrendered in exchange therefor, provided that the
Distributing stock is held as a capital asset on the date of the Distribution
(section 1223(1)).

(10) The earnings and profits of Distributing, if any, will be allocated between
Distributing and Controlled in accordance with section 312(h) and Treas. Reg.
§ 1.312-10(a).

(11) Controlled will be subject to section 1374 with respect to any asset
transferred to Controlled from Distributing in the Contribution to the same
extent that Distributing was subject to section 1374 with respect to such
asset. For purposes of section 1374, Controlled’s recognition period will be
reduced by the portion of Distributing’s recognition period that expires prior to
the Contribution (section 1374(d)(8) and Ann. 86-128, 1986-51 I.R.B. 22).

(12) 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). If Controlled otherwise meets the requirements of a small
business corporation under section 1361, Controlled will be eligible to elect
to be a subchapter S corporation under section 1362(a) for its first taxable year.

                                    CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the Proposed Transaction under other provisions of the Code or the
regulations, or 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. In particular, no opinion is expressed regarding:
PLR-102480-10 9

  (i)     Whether the Distribution satisfies the business purpose requirement of Treas.
          Reg. § 1.355-2(b);
  (ii)    Whether the Distribution is used principally as a device for the distribution of
          the earnings and profits of Distributing or Controlled or both;
  (iii)   Whether the Proposed Transaction is part of a plan (or series of related
          transactions) under section 355(e)(2)(A)(ii); and
  (iv)    Whether Distributing or Controlled otherwise meets the requirements of a
          small business corporation under section 1361.

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

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,

                                      Frances L. Kelly
                                      Assistant to the Branch Chief, Branch 2
                                      Office of Associate Chief Counsel (Corporate)

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