PLR 1033001: IRS approved tax treatment for separating businesses in an S corporation restructuring

Plain-English summary

A closely held S corporation planned to separate two active businesses by distributing the stock of a wholly owned qualified subchapter S subsidiary to its shareholders. The subsidiary would become a corporation, and the shareholders of the subsidiary and three other S corporations would form a new S corporation that would own the operating entities as qualified subchapter S subsidiaries. The IRS ruled that the contribution and distribution would qualify as a reorganization, and that the specified transfers would generally avoid immediate gain or loss recognition. It also ruled on stock basis, holding periods, earnings and profits, and the subsidiary's eligibility to make an S corporation election. The IRS expressly did not rule on several underlying qualification questions or on the federal tax consequences of the new corporation's formation steps.

Ruling snapshot

• Question: Would the proposed business separation receive the requested federal tax treatment under the reorganization and S corporation rules?
• Outcome: Approved
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368, 1032, 1223, 1361, and 1362; Treas. Reg. §§ 1.1361-5, 1.355-2, 1.355-7, 1.358-2, 1.312-10, and 1.1368-2.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201033001 Third Party Communication: None
Release Date: 8/20/2010 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
368.00-00, 368.04-00, Person To Contact:
1361.05-00 ---------------------, ID No. -------------
Telephone Number:
---------------- --------------------
------------- Refer Reply To:
---------------------------------- CC:CORP:B04
------------------------ PLR-100333-10
------------------------------ Date:
May 05, 2010

Legend:

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

Controlled = ----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------
-----------------------

Newco = ----------------------------------------------------------------------------------------------
-----------------------------------

Entity A = ----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------
------------------------

Entity B = ----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------
------------------------

Entity C = ----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------
------------------------
PLR-100333-10 2

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

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

a = ---

b = ---

c = ---

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

   This letter responds to your November 20, 2009 request for rulings regarding

certain federal income tax consequences of a proposed transaction (the “Proposed
Transaction”). The information submitted in that request and in later correspondence is
summarized below.

   The rulings contained in this letter are based on facts and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. This office has not verified any of the materials 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. Moreover, no information
provided by the taxpayer has been reviewed and no determination has been made
regarding whether the Proposed Transaction: (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 or controlled
corporation or both (see § 355(a)(1)(B) of the Internal Revenue Code (the “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 or controlled corporation (§ 355(e)(2)(A)(ii) and
§ 1.355- 7).

                                   Summary of Facts

   Distributing is a closely held subchapter S corporation that is engaged in

Business A. Distributing has one class of voting common stock outstanding that is
owned in varying percentages by a shareholders (the “Distributing Shareholders”).
Distributing wholly owns the stock of Controlled, a qualified subchapter S subsidiary
(“QSub”) that is engaged in Business B. Financial information submitted by Distributing
indicates that Business A and Business B have each had gross receipts and operating
expenses representing the active conduct of a trade or business for each of the past
five years.
PLR-100333-10 3

   Entity A, Entity B and Entity C are subchapter S corporations that are engaged in

Business B. Shareholders of Distributing own between b percent and c percent of the
voting stock of each of Entity A, Entity B and Entity C.

                              Proposed Transaction

  For what is represented to be a valid business purpose, Distributing has

proposed the following transaction to separate Business A from Business B (the
“Proposed Transaction”):

  (i)       Distributing will distribute all of the stock of Controlled to the Distributing
            Shareholders (the "Distribution").

  (ii)      Pursuant to § 1.1361-5(b)(i), the Distribution will result in a termination
            of Controlled’s QSub election with Controlled being treated as a new
            corporation acquiring all of its assets (and assuming all if its liabilities)
            immediately before the termination, from Distributing in exchange for
            stock of Controlled (the “Contribution”). Distributing will be deemed to
            have distributed the stock of Controlled to the Distributing Shareholders
            in the Distribution.

  (iii)     Controlled shareholders and the shareholders of each of Entity A, Entity
            B, and Entity C will form Newco. The shareholders of Controlled will
            each transfer to Newco, all of their shares in Controlled in exchange for
            Newco common stock. The shareholders of Entity A, Entity B, and
            Entity C will each transfer to Newco all of their shares in Entity A, Entity
            B, and Entity C in exchange for Newco common stock.

  (iv)      Newco will elect to be an S corporation pursuant to § 1362(a) and will
            also elect to treat Controlled, Entity A, Entity B, and Entity C as qualified
            subchapter S subsidiaries pursuant to § 1361(b)(3)(B). Controlled
            shareholders will own more than 50-percent of the Newco stock.

                                 Representations

  The taxpayer has made the following representations regarding the Contribution

and Distribution:

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

(b) The five years of financial information submitted on behalf of Distributing's
Business A and Business B represents the present operations of each business, and
PLR-100333-10 4

regarding each business, there have been no substantial operational changes since the
date of the last financial statements submitted.

(c) Neither Business A conducted by Distributing nor control of an entity conducting
this business will have been acquired 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 will continue to be the principal owner following the
distribution.

(d) Neither Business B that will be deemed contributed to Controlled nor control of
an entity conducting this business will have been acquired 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. Prior to the Contribution,
Distributing will have been the principal owner of the goodwill and significant assets of
Business B. Following the Contribution, Controlled will be the principal owner of the
goodwill and significant assets of Business B.

(e) 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.

(f) 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 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 §§ 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 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.

(g) Following the Distribution, Distributing and Controlled will each continue the
active conduct of its business, independently and with its separate employees.

(h) The Distribution is being carried out for the following business purposes: to
create synergy among the Business B entities, to allow Controlled to seek new capital
and to insulate Business A from the risk associated with Business B. The Distribution is
motivated, in whole or substantial part, by these corporate business purposes.
PLR-100333-10 5

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

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

(k) The total fair market value of the assets deemed transferred by Distributing to
Controlled in the Contribution will exceed the sum of (i) the amount of any liabilities
assumed (within the meaning of § 357(d)) by Controlled in connection with the
exchange, (ii) the amount of any liabilities owed to Controlled by Distributing that are
discharged or extinguished in connection with the exchange, and (iii) the amount of
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 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.

(l) The total adjusted basis of the assets deemed to be transferred to Controlled by
Distributing each will equal or exceed the sum of the liabilities deemed to be assumed
(as determined under § 357(d)) by Controlled and the liabilities deemed assumed (as
determined under § 357(d)) by Controlled in the Proposed 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 deemed to be transferred.

(m) No intercorporate debt will exist between Distributing and Controlled at the time
of, or after the Distribution, other than intercompany loans or obligations that have
arisen, or will arise, between the parties in the ordinary course of business.

(n) 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.

(o) Distributing is a subchapter S corporation (within the meaning of § 1361(a)).
Controlled is a qualified subchapter S subsidiary (within the meaning of
§ 1361(b)(3)(B)). There is no plan or intention to revoke or otherwise terminate the S
corporation election of Distributing.

(p) Controlled will elect to be a subchapter S corporation pursuant to § 1362(a) on
the first available date after the Distribution.

(q) No two parties to the transaction are investment companies as defined in
§ 368(a)(2)(F)(iii) and (iv).
PLR-100333-10 6

(r) No property deemed transferred between Distributing and Controlled has, or will,
claim investment credit under § 46.

                                     Rulings

  Based solely on the information submitted and the representations set forth

above, we rule as follows on the Contribution and Distribution:

(1) The Contribution, followed by the Distribution will qualify as a reorganization
within the meaning of § 368(a)(1)(D). Distributing and Controlled will each be "a party to
a reorganization" under § 368(b).

(2) Distributing will recognize no gain or loss on the Contribution (§ 357(a) and
§ 361(a)).

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

(4) The basis that Controlled has in each asset received from Distributing in the
Contribution will equal the basis of that asset in the hands of Distributing immediately
before its transfer (§ 362(b)).

(5) The holding period of each asset received by Controlled in the Contribution will
include the period Distributing held that asset (§ 1223(2)).

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

(7) No gain or loss will be recognized by (and no amount will be included in the
income of) the Distributing Shareholders upon the receipt of Controlled stock
(§ 355(a)(1)).

(8) The aggregate basis of the Distributing stock and the Controlled stock in the
hands of the Distributing Shareholders immediately after the Distribution will equal the
Distributing Shareholder's aggregate basis in the Distributing stock held immediately
before the Distribution. Such aggregate basis will be allocated between the Distributing
stock and the Controlled stock in proportion to the fair market value of each in
accordance with § 1.358-2(a)(2) (§ 358(b) and (c)).

(9) The holding period of the Controlled stock received by the Distributing
Shareholders will include the holding period of the Distributing stock on which the
Distribution is made, provided such stock is held as a capital asset on the date of the
Distribution (§ 1223(1)).

(10) A proper allocation of earnings and profits between Distributing and Controlled
will be made in accordance with § 312(h) and § 1.312-10(a).
PLR-100333-10 7

(11) Distributing’s momentary ownership of the stock of Controlled, as part of the
reorganization under § 368(a)(1)(D), will not cause Controlled to have an ineligible
shareholder for any portion of its first taxable year under § 1361(b)(1)(B). If Controlled
otherwise meets the requirements of a small business corporation under § 1361,
Controlled will be eligible to make a subchapter S election under § 1362(a) for its first
taxable year, provided such election is made effective immediately following the
termination of the original QSub election.

(12) The accumulated adjustments account of Distributing will be allocated between
Distributing and Controlled in a manner similar to the manner in which earnings and
profits of Distributing will be allocated under § 312(h) in accordance with Treas. Reg.
§ 1.1368-2(d)(3).

                                      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 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: (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 Controlled or both (see
§ 355(a)(1)(B) and § 1.355-2(d)); (iii) whether the Distribution and an acquisition or
acquisitions are part of a plan (or series of related transactions) under § 355(e)(2)(A)(ii);
(iv) whether Distributing is a valid S Corporation prior to the Distribution; (v) whether
Controlled will be a valid S corporation after the Distribution; (vi) whether Entity A, Entity
B and Entity C are valid S corporations prior to the Proposed Transaction; (vii) whether
Controlled, Entity A, Entity B and Entity C are valid QSubs after the Proposed
Transaction; and (viii) the federal income tax consequences of steps (iii) and (iv).

                              Procedural Statements

  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.

    Each taxpayer involved in the Proposed Transaction should attach a copy of this

ruling letter to the taxpayer's federal income tax return for the taxable year in which the
Proposed Transaction is completed. Alternatively, taxpayers filing their returns
electronically may satisfy this requirement by attaching a statement to their returns that
provides the date and control number of the letter ruling.
PLR-100333-10 8

     In accordance with the power of attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                    Sincerely,



                                    ____________________________________
                                    Richard K. Passales
                                    Senior Counsel, Branch 4
                                    Office of Associate Chief Counsel (Corporate)