PLR 1030017: S corporation split-up approved as tax-free reorganizations

Plain-English summary

The IRS approved a proposed transaction in which an S corporation would divide its business between two newly formed S corporations. The existing corporation would contribute one-half of its assets to each new corporation, distribute the two new corporations' stock to its two equal shareholders, and liquidate. The IRS ruled that the contributions and distributions would qualify as reorganizations under section 368(a)(1)(D), with nonrecognition of gain or loss and carryover basis and holding periods in the transferred assets and distributed stock. It also ruled that the shareholders would generally recognize no income and that the existing corporation's earnings and profits and accumulated adjustments account would be allocated between the new corporations. The ruling was subject to the stated representations and did not address the business-purpose, device, acquisition, or S-election issues reserved in the letter.

Ruling snapshot

• Question: Would the proposed split-up of an S corporation qualify for the requested tax treatment?
• Outcome: Approved
• Key authorities: IRC §§ 312, 355, 357, 358, 361, 362, 368, 1032, 1223, 1361, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201030017 Third Party Communication: None
Release Date: 7/30/2010 Date of Communication: Not Applicable
Person To Contact:
Index Numbers: 368.04-00, 355.01-02 ------------------, ID No. -----------------
Telephone Number:
--------------------------------------------- --------------------
------------- Refer Reply To:
------------------------------------ CC:CORP:B06
------------------------------------ PLR-148291-09
----------------------- Date:
April 20, 2010

Legend

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

----------------------------------------------------------------------------------------------

Controlled 1 = ---------------------------------------

Controlled 2 = ---------------------------------------

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

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

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

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

This letter responds to your October 26, 2009 letter from your authorized representative
requesting rulings on certain Federal income tax consequences of a proposed
transaction. Additional information was received in letters dated November 29, 2009,
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March 5, 2010, March 25, 2010 and March 30, 2010. The information provided in those
letters is summarized below.

The rulings contained in this letter are based on 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 Distribution (described below): (i) satisfies the
business purpose requirement of § 1.355-2(b) of the Income Tax Regulations, (ii) is
used principally as a device for the distribution of the earnings and profits of the
distributing corporation, the controlled corporations, or both (see § 355(a)(1)(B) of the
Internal Revenue Code and § 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
either of the controlled corporations (see § 355(e) and § 1.355-7).

Facts

Distributing is an S corporation engaged in Business A. The stock of Distributing is
owned equally by Shareholder 1 and Shareholder 2. Shareholder 1 and Shareholder 2
disagree on how to run Distributing. Accordingly, they have agreed to separate
Distributing into two corporations with each shareholder running its portion of Business
A through a newly-formed corporation.

Financial information submitted by Distributing indicates that Distributing’s Business A
business has had gross receipts and operating expenses representative of the active
conduct of a trade or business for each of the past five years.

Proposed Transaction

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

(i) Distributing will form Controlled 1 and Controlled 2 (collectively, the
“Controlled corporations”). Upon formation, each Controlled corporation will
be a cash method taxpayer, will file its tax returns on a calendar year and will
elect S status.

(ii) Distributing will transfer one-half of its assets to Controlled 1 in exchange for
all of the Controlled 1 stock and the assumption by Controlled 1 of the
liabilities associated with the transferred assets (“Contribution 1”).
PLR-148291-09 3

(iii) Distributing will transfer one-half of its assets to Controlled 2 in exchange for
all of the Controlled 2 stock and the assumption by Controlled 2 of the
liabilities associated with the transferred assets (“Contribution 2”)
(Contribution 1 and Contribution 2 are collectively known as the
“Contributions”).

(iv) Distributing will distribute all of the Controlled 1 stock to Shareholder 1 in
exchange for all of that shareholder’s Distributing stock.

(v) Distributing will distribute all of the Controlled 2 stock to Shareholder 2 in
exchange for all of that shareholder’s Distributing stock (steps (iv) and (v) are
collectively called the “Distribution”).

(vi) Distributing will liquidate.

Representations

The parties to the transaction have made the following representations:

(a) Distributing, Controlled 1, Controlled 2, and each of their respective shareholders will
pay their own expenses incurred in connection with the Proposed Transaction.

(b) There is no indebtedness owed by Controlled 1 or Controlled 2 to Distributing after
the Distribution.

(c) The fair market value of the Controlled 1 stock received by Shareholder 1 will be
approximately equal to the fair market value of the Distributing stock surrendered by
Shareholder 1 in the exchange, and the fair market value of the Controlled 2 stock
received by Shareholder 2 will be approximately equal to the fair market value of the
Distributing stock surrendered by Shareholder 2 in the exchange.

(d) 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 the corporation.

(e) The five years of financial information submitted on behalf of Distributing is
representative of its present operation, and with regard to such corporation, there have
been no substantial operational changes since the date of the last financial statements
submitted.

(f) The five years of financial information submitted on behalf of the assets and liabilities
to be contributed to Controlled 1 is representative of the business’s present operation,
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and with regard to such business, there have been no substantial operational changes
since the date of the last financial statements submitted.

(g) The five years of financial information submitted on behalf of the assets and
liabilities to be contributed to Controlled 2 is representative of the business’s present
operation, and with regard to such business, there have been no substantial operational
changes since the date of the last financial statements submitted.

(h) Following the transaction, Controlled 1 and Controlled 2 will each continue,
independently and with its separate employees, the active conduct of its share of all the
integrated activities of Business A conducted by Distributing prior to consummation of
the Proposed Transaction.

(i) The Distribution is carried out for the following corporate business purposes: (a) to
achieve each shareholder’s individual business objective in Business A; (b) to increase
the operating efficiency of each new S corporation; and (c) to strengthen the company’s
financial position of each new S corporation. The Distribution is motivated, in whole or
substantial part, by these corporate business purposes.

(j) The Distribution is not used principally as a device for the distribution of the earnings
and profits of Distributing, Controlled 1, Controlled 2, or collectively.

(k) The total adjusted basis and fair market value of the assets Distributing will transfer
to Controlled 1 in Contribution 1 will exceed the sum of (i) the amount of any liabilities
assumed (within the meaning of § 357(d)) by Controlled 1 in connection with the
exchange, (ii) the amount of any liabilities owed to Controlled 1 by Distributing 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 § 361(a) without the recognition of gain) received by
Distributing from Controlled 1 in connection with the exchange.

(l) The total adjusted basis and fair market value of the assets Distributing will transfer
to Controlled 2 in Contribution 2 will exceed the sum of (i) the amount of any liabilities
assumed (within the meaning of § 357(d)) by Controlled 2 in connection with the
exchange, (ii) the amount of any liabilities owed to Controlled 2 by Distributing 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 § 361(a) without the recognition of gain) received by
Distributing from Controlled 2 in connection with the exchange.

(k) The liabilities to be assumed (within the meaning of § 357(d)) by Controlled 1 and
Controlled 2 in the Contributions, if any, and the liabilities to which the transferred
assets are subject, if any, were incurred in the ordinary course of business and are
associated with the assets being transferred.
PLR-148291-09 5

(l) The aggregate fair market value of the assets Distributing transfers to each
Controlled corporation in the Contributions will equal or exceed the aggregate adjusted
basis of these assets.

(m) The fair market value of the assets of each Controlled corporation will exceed the
amount of its liabilities immediately after the exchange.

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

(o) No intercorporate debt will exist between Distributing and either Controlled
corporation or between Controlled 1 and Controlled 2 at the time of, or subsequent to,
the distribution of the stock of Controlled 1 and Controlled 2.

(p) Payments made in connection with all continuing transactions, if any, between
Controlled 1 and Controlled 2, will be for fair market value based on terms and
conditions arrived at by the parties bargaining at arm's length.

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

(r) For purposes of § 355(d), immediately after the Distribution, no person (determined
after applying § 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 § 355(d)(5) and (8)) during the five-year period (determined
after applying § 355(d)(6)) ending on the date of the Distribution.

(s) For purposes of § 355(d), immediately after the Distribution, no person (determined
after applying § 355(d)(7)) will hold stock possessing 50-percent or more of the total
combined voting power of all classes of either Controlled 1 or Controlled 2 stock entitled
to vote, or 50-percent or more of the total value of shares of all classes of either
Controlled 1 or Controlled 2 stock, that was either (i) acquired by purchase (as defined
in § 355(d)(5) and (8)) during the five-year period (determined after applying
§ 355(d)(6)) ending on the date of the Distribution or (ii) attributable to distributions on
Distributing stock or securities that were acquired by purchase (as defined in
§ 355(d)(5) and (8)) during the five-year period (determined after applying § 355(d)(6))
ending on the date of the Distribution.

(t) The Distribution is not part of a plan or series of related transactions (within the
meaning of § 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
PLR-148291-09 6

§ 355(d)(4)) in Distributing, Controlled 1, or Controlled 2 (including any predecessor or
successor of any such corporation).

(u) Immediately after the Distribution, neither Distributing, Controlled 1, nor Controlled 2
will be a disqualified investment corporation (within the meaning of § 355(g)(2)).

Rulings

Based on the information submitted and the representations provided, we rule as
follows with respect to the Proposed Transaction:

(1) Contribution 1 and Contribution 2, together, followed by each respective distribution,
will each qualify as a reorganization within the meaning of § 368(a)(1)(D). Distributing
and Controlled 1, and Distributing and Controlled 2 will each be "a party to a
reorganization" for each respective section 368(a)(1)(D) reorganization within the
meaning of § 368(b).

(2) No gain or loss will be recognized by Distributing on the Contributions to Controlled
1 and Controlled 2, respectively, in exchange for stock in Controlled 1 and Controlled 2
(§§ 361(a) and 357(a)).

(3) No gain or loss will be recognized by Controlled 1 or Controlled 2 on the
Contributions (§ 1032(a)).

(4) The basis of the assets received by Controlled 1 will be the same as the basis of
such assets in the hands of Distributing immediately prior to their transfer to Controlled
1 (§ 362(b)).

(5) The basis of the assets received by Controlled 2 will be the same as the basis of
such assets in the hands of Distributing immediately prior to their transfer to Controlled
2 (§ 362(b)).

(6) The holding period of each asset received by Controlled 1 and Controlled 2 in the
Contributions will include the period during which Distributing held that asset
(§ 1223(2)).

(7) No gain or loss will be recognized by Distributing on the Distribution (§ 361(c)(1)).

(8) No gain or loss will be recognized by (and no amount will be included in the income
of) Shareholder 1 or Shareholder 2 on the Distribution (§ 355(a)(1)).

(9) The aggregate basis of the Controlled 1 stock in the hands of Shareholder 1
immediately after the Distribution will equal Shareholder 1's aggregate basis in the
Distributing stock surrendered in the Distribution (§ 358(a)(1)).
PLR-148291-09 7

(10) The aggregate basis of the Controlled 2 stock in the hands of Shareholder 2
immediately after the Distribution will equal Shareholder 2's aggregate basis in the
Distributing stock surrendered in the Distribution (§ 358(a)(1)).

(11) The holding period of the Controlled 1 stock received by Shareholder 1 will include
the holding period of the Distributing stock surrendered by that shareholder in exchange
therefore, provided such stock is held as a capital asset on the date of the Distribution
(§ 1223(1)).

(12) The holding period of the Controlled 2 stock received by Shareholder 2 will include
the holding period of the Distributing stock surrendered by that shareholder in exchange
therefore, provided such stock is held as a capital asset on the date of the Distribution
(§ 1223(1)).

(13) Any earnings and profits of Distributing will be allocated between Controlled 1 and
Controlled 2 in accordance with § 312(h) and § 1.312-10(a).

(14) Any accumulated adjustments account of Distributing will be allocated between
Controlled 1 and Controlled 2 in a manner similar to the manner in which any earnings
and profits of Distributing will be allocated under section 312(h) between Controlled 1
and Controlled 2 (see Treas. Reg. §§ 1.312-10(a) and 1.1368-2(d)(3)).

(15) Distributing's momentary ownership of the stock of Controlled 1 and Controlled 2,
as part of the reorganization under § 368(a)(1)(D), will not cause Controlled 1 or
Controlled 2 to have an ineligible shareholder for any portion of its first taxable year
under § 1361(b)(2)(B) (Rev. Rul. 72-320, 1972-1 C.B. 270).

Caveats

No opinion is expressed about the tax treatment of the Proposed Transaction under
other provisions of the Code or regulations or the tax treatment of any condition existing
at the time of, or effects resulting from, the Proposed Transaction that is not specifically
covered by the above rulings. In particular, no opinion is expressed regarding:
(i) whether the Distribution satisfies the business purpose requirement of § 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 the Controlled corporations or both (see
§ 355(a)(1)(B) and § 1.355-2(d)), or (iii) whether the Distribution 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 Distributing or
either of the Controlled corporations (see § 355(e) and § 1.355-7).

Additionally, no opinion is expressed regarding issues relating to Distributing’s,
Controlled 1's or Controlled 2’s respective subchapter S election.
PLR-148291-09 8

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,


                                   Richard M. Heinecke
                                   Richard M. Heinecke
                                   Assistant to the Branch Chief, Branch 6
                                   Associate Chief Counsel (Corporate)

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