PLR 1033019: IRS approved a tax-free reorganization and distribution of a controlled corporation

Plain-English summary

The IRS ruled favorably on a corporation's plan to convert a wholly owned limited liability company into a corporation, contribute additional business assets to it, and distribute the new corporation's stock to the shareholders. The IRS concluded that the steps together would qualify as a reorganization under IRC § 368(a)(1)(D), with nonrecognition of gain or loss and specified basis, holding-period, and earnings-and-profits results. The ruling was based on representations about the active businesses, business purposes, liabilities, and ownership structure. The IRS did not rule on several issues, including the business-purpose, device, acquisition-plan, and earlier restructuring questions.

Ruling snapshot

• Question: Would the proposed conversion, contribution, and distribution qualify for the specified tax-free reorganization and related basis and holding-period treatment?
• Outcome: Approved
• Key authorities: IRC §§ 312(h), 355, 357, 358, 361, 362, 368(a)(1)(D), 1032, and 1223; Treas. Reg. §§ 1.312-10, 1.1502-33, and 1.358-2

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201033019 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:
--------------------------, ID No. -------------
---------------- Telephone Number:
------------------------------ ---------------------
-------------------------------- Refer Reply To:
---------------------- CC:CORP:01
--------------------------------------------------- PLR-148975-09
Date:
May 20, 2010

LEGEND

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

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

a = ---------

b = ---------

Shareholder A = ---------------------------
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Shareholder B = ------------------------------------------------------------------------

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Shareholder C = ------------------
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Shareholder D = -------------------
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Shareholder E = ----------------

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Shareholder F = ------------------
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Member 1 = -------------------
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Member 2 = ------------------------------

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Member 3 = -------------------------------
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Member 4 = -----------------------------------
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Member 5 = ---------------------------
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Controlled LLC = ---------------------------------------------
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Controlled = -----------------------------------------
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Business 1 = ------------------------------------------------------------------------

Year = -------

Y = --

Z = ------

$x = ---------------

W = --

x% = --------

n = --------

Waiver 1 = -----------------------------------------------------

Waiver 2 = ----------------------------------------------------------

Ea% = ------

Eb% = ------

Ec% = --------

Ed% = --------

Ee% = ----

Ef% = ------

Eg% = ----

Eh% = ------

Ei% = ------

Ej% = ----

Va% = ------

Vb% = ------

Vc% = ------

Vd% = --------

Ve% = --------

Vf% = --------

Vg% = --------

Vh% = --------

Vi% = ------

Vj% = ------

Vk% = ----

Vl% = ----

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

This letter responds to your representative’s letter dated October 30, 2009, requesting
rulings as to the federal income tax consequences of the Proposed Transaction set forth
below. Additional information was submitted by letters dated December 31, 2009,
March 22, 2010, March 25, 2010, April 15, 2010, and May 17, 2010. The material
information submitted for consideration is summarized below.

                               Summary of Facts

Distributing is a closely-held State X corporation that was organized as a subchapter C
corporation on Date 1. Distributing has a shares of stock issued and outstanding, which
consists of one class of common stock and is owned by six shareholders: Shareholder
A, Shareholder B, Shareholder C, Shareholder D, Shareholder E, and Shareholder F.
Shareholder A is a State X limited liability company, which is treated as a partnership for
federal income tax purposes. Shareholder A is owned by: Member 1, Member 2,
Member 3, Member 4, Member 5, and Distributing. Distributing wholly owns Controlled
LLC, a State X limited liability company, which is treated as a disregarded entity for
federal income tax purposes.

Distributing is engaged in Business 1. Distributing has submitted financial information
which indicates that Business 1 has had gross receipts and operating expenses
representative of the active conduct of a trade or business for each of the past five
years.

In Year, Distributing purchased Y out of Z total member units in Shareholder A, for
approximately $x. Distributing retained W of the Y member units purchased, with the
remaining member unit being transferred to Member 5 in respect of its carry.
Distributing’s retained W units equate to a direct x% interest in Shareholder A and
indirectly, through Shareholder A, approximately n Distributing shares. In connection
with the Year purchase, Distributing and Shareholder A entered into Waiver 1 and
Waiver 2. In Waiver 1, Distributing waived distribution and dividend rights with respect
to its indirect ownership in n Distributing shares. In Waiver 2, Distributing waived profits
and cash rights with respect to its direct x% interest in Shareholder A. Distributing
retained all voting rights with respect to the W member units. As a result of entering into
Waiver 1 and Waiver 2, the members of Shareholder A and the shareholders of
Distributing hold different economic and voting interests in their respective entities.
(Above mentioned paragraph collectively, the “Year Steps”)

After the Year Steps, with respect to economic rights, Shareholder A is owned Ea% by
Member 1, Eb% by Member 2, Eb% by Member 3, Ec% by Member 4, and Ed% by
Member 5. Distributing is owned Ee% by Shareholder A, Ef% by Shareholder B, Eg%
by Shareholder C, Eh% by Shareholder D, Ei% by Shareholder E, and Ej% by
Shareholder F.

After the Year Steps, with respect to voting rights, Shareholder A is owned Va% by
Member 1, Vb% by Member 2, Vc% by Member 3, Vd% by Member 4, Ve% by Member
5, and Vf% by Distributing. Distributing is owned Vg% by Shareholder A, Vh% by
Shareholder B, Vi% by Shareholder C, Vj% by Shareholder D, Vk% by Shareholder E,
and Vl% by Shareholder F.

                             Proposed Transaction

To achieve what are represented to be valid corporate business purposes, Distributing
has proposed the following steps (collectively, the “Proposed Transaction”):

(i) Controlled LLC will convert from a limited liability company to a corporation
(the “Conversion”) under State X Law. The Conversion will be treated as a
contribution by Distributing of all the assets of Controlled LLC to Controlled in
exchange for all the stock of Controlled and the assumption by Controlled of
all of the liabilities associated with Controlled LLC. The authorized capital
stock of Controlled will consist of one class of a shares of common stock,
which will be wholly owned by Distributing.

(ii) Distributing will contribute various assets related to the conduct of Business 1
to Controlled in exchange for b shares of the stock of Controlled and the
assumption by Controlled of liabilities associated with the transferred assets
(collectively, the “Contribution”).

(iii) Distributing will distribute all of the Controlled stock received in step (ii) above,
pro rata, to the Distributing shareholders (the “Distribution”). In connection
with the Distribution and pursuant to a shares subscription agreement
between Distributing, Controlled, and Shareholder A, Controlled will issue an
additional n shares to Shareholder A for a nominal purchase price. The n
shares will be subject to Waiver 1 and hold voting, but no distribution or
dividend rights.

(iv) After the Distribution, Distributing will provide administrative services, through
three of its employees, to Controlled for a transitional period, at an arm’s
length fee.

                                 Representations

(a) 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.

(b) The 5 years of financial information submitted on behalf of Distributing is
representative of the corporation's present operation, and with regard to such
corporation, there have been no substantial operational changes since the date of the
last financial statements submitted.

(c) The 5 years of financial information submitted on behalf of the business contributed
to Controlled 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.

(d) Following the transaction, Distributing and Controlled will each continue the active
conduct of its business, independently and with its separate employees, except for
administrative services to be provided by Distributing to Controlled for a transitional
period following the Distribution.

(e) The Distribution is carried out for the following corporate business purposes:
facilitate corporate borrowings from institutional lenders, reduction of catastrophic risk
from third party liabilities, separate disparate businesses to allow greater focus on
objectives of independent businesses, and to allow greater employee incentives based
on their core business. The distribution of the stock, or stock and securities, of the
controlled corporation is motivated, in whole or substantial part, by one or more of these
corporate business purposes.

(f) The Distribution is not used principally as a device for the distribution of the earnings
and profits of the distributing corporation or the controlled corporation or both.

(g) The total fair market value of the assets that Distributing will transfer to Controlled in
the Contribution will exceed the sum of: (a) the amount of liabilities (if any) assumed
(within the meaning of § 357(d)) by Controlled in connection with the exchange, (b) the
amount of liabilities (if any) owed to Controlled by Distributing that are discharged or
extinguished in connection with the exchange, and (c) the amount of cash (if any) and
the fair market value of other property (if any) (other than stock or securities permitted to
be received under § 361(a) without the recognition of gain) received by Distributing from

Controlled 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.

(h) The total fair market value of the assets transferred to Controlled by Distributing in
the Contribution will equal or exceed the aggregate adjusted basis of the transferred
assets.

(i) The total adjusted bases and the fair market value of the assets transferred to
Controlled by Distributing in the Contribution each equals or exceeds the sum of the
liabilities assumed (within the meaning of § 357(d)) by Controlled plus any liabilities to
which the transferred assets are subject.

(j) The liabilities assumed (within the meaning of § 357(d)) by Controlled in the
Contribution and the liabilities to which the transferred assets are subject were incurred
in the ordinary course of businesses and are associated with the assets being
transferred.

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

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

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

(n) For purposes of § 355(d), immediately after the Distribution, no person (determined
after applying § 355(d)(7)) will hold stock possessing 50% or more of the total combined
voting power of all classes of Distributing stock entitled to vote, or 50% 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.

(o) For purposes of § 355(d), immediately after the Distribution, no person (determined
after applying § 355(d)(7)) will hold stock possessing 50% or more of the total combined
voting power of all classes of Controlled stock entitled to vote, or 50% 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 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.

(p) 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 possessing a 50% or greater interest (within the meaning of § 355(b)(4))
in Distributing and Controlled (including any predecessor or successor of any such
corporation), taking into account the special rules of § 355(e)(3)(A).

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

                                     Rulings

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

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

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

(4) Controlled's basis in each asset received from Distributing in the Conversion and
Contribution will equal the basis of that asset in the hands of Distributing immediately
before the Contribution. Section 362(b).

(5) Controlled's holding period for each asset received from Distributing in the
Conversion and Contribution will include the holding period during which Distributing
held that asset. Section 1223(2).

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

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

(8) The aggregate basis of the Distributing stock and Controlled stock in the hands of
the shareholders of Distributing immediately after the Distribution will equal the
aggregate basis of the Distributing stock held by the shareholders of Distributing
immediately before the Distribution, allocated between the stock of Distributing and
Controlled in proportion to the fair market value of each in accordance with Treas. Reg.
section 1.358-2(a)(2). Sections 358(a)(1), (b), and (c).

(9) The holding period of the Controlled stock received by the shareholders of

Distributing in the Distribution will include the holding period of the Distributing stock
with respect to which the Distribution is made, provided that such Distributing stock was
held as a capital asset on the date of the Distribution. Section 1223(1).

(10) Earnings and profits will be allocated between Distributing and Controlled in
accordance with section 312(h), and Treas. Reg. sections 1.312-10(a) and 1.1502-
33(f)(2).

                                     Caveats

No opinion is expressed about the tax treatment of the Proposed Transactions 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 Transactions 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 Treas. Reg.
section 1.355-2(b);

(ii) Whether the Distribution is 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. section 1.355-2(d));

(iii) Whether the Distribution is part of a plan (or series of related transactions) under
section 355(e)(2)(A)(ii);

(iv) The federal tax treatment of the Year Steps discussed in the Summary of Facts; and

(v) The characterization of the interests Distributing holds in Shareholder A and
indirectly in itself after the Year Steps discussed in the Summary of Facts.

                              Procedural Matters

The rulings contained in this letter are based on facts and representations submitted by
the taxpayer (Distributing) 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. 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
§ 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 or the 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 fifty percent
or greater interest in the distributing corporation or the controlled corporation (see
§ 355(e) and § 1.355-7).

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

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.

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,



                                    Mark S. Jennings
                                    Branch Chief, Branch 1
                                    Office of Associate Chief Counsel (Corporate)