PLR 201247001: IRS approves a tax-free split-off to resolve shareholder disputes

Plain-English summary

The IRS ruled on a proposed split-off designed to resolve disputes between two shareholders of an S corporation. The corporation would transfer selected business assets and related liabilities to a newly formed controlled corporation, then distribute all of the controlled corporation's stock to one shareholder in exchange for that shareholder's stock in the distributing corporation. The IRS concluded that the contribution and distribution would qualify as a Type D reorganization and that the specified transfers would generally receive nonrecognition, carryover-basis, holding-period, and earnings-and-profits treatment under the cited provisions. The ruling did not address several broader requirements, including the business-purpose, device, acquisition, and S corporation qualification questions.

Ruling snapshot

• Question: Would the proposed asset transfer and shareholder split-off qualify for the stated tax-free reorganization consequences?
• Outcome: Approved
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368, 1032, 1223, and 1361; Treas. Reg. §§ 1.355-2 and 1.355-7

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Third Party Communication: None
Number: 201247001
Date of Communication: Not Applicable
Release Date: 11/23/2012
Person To Contact:
---------------------, ID No. ------------- Index Number: 355.01-01, 368.04-00, 368.08- Telephone Number:
08
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Refer Reply To:
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CC:CORP:B04
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PLR-109532-12
Date:
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August 28, 2012
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Legend:

Distributing = --------------------------------------------------------------------------------------------
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Controlled = --------------------------------------------------------------------------------------------
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Business A = -------------------------------------------

State A = -------------

Assets = -------------------------------------------------------

Year 1 = -------

Year 2 = -------

Shareholder = --------------------------------------------------------------------------------------------
1
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Shareholder = --------------------------------------------------------------------------------------------
2
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Dear ------------:
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This letter responds to your February 1, 2012 request for rulings on certain federal income tax consequences of a series of proposed transactions. The information submitted in that request and in subsequent submissions is summarized below.

The rulings contained in this letter are based on facts and representations submitted by the taxpayer and accompanied by 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 on audit. Moreover, no information provided by the taxpayer has been reviewed and no determination has been made regarding whether the Distribution (defined 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 or controlled corporation or both (see § 355(a)(1)(B) 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 the controlled corporation (see § 355(e) and § 1.355-7).

SUMMARY OF FACTS

Distributing is a calendar year corporation engaged in Business A. Distributing was incorporated in Year 1 and elected to be treated as an S corporation in Year 2. Distributing has one class of stock outstanding that is owned equally by two shareholders, Shareholder 1 and Shareholder 2.

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

Controlled (defined below) will be formed by Distributing to implement the proposed transaction.

PROPOSED TRANSACTION

Shareholder 1 and Shareholder 2 disagree on a number of fundamental matters relating to Distributing’s Business A. The conflict between the shareholders is having an adverse effect on the day-to-day operations of Distributing. To eliminate the shareholder disputes, Distributing has proposed the following series of steps (collectively, the “Proposed Transaction”):

(i) Distributing will create a new corporation organized under the laws of State A, (“Controlled”).
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(ii) Distributing will contribute to Controlled certain assets, (the “Assets”), and related liabilities of Business A, in exchange for all of the outstanding Controlled stock (the “Contribution”). Distributing will retain the other assets used in conducting Business A.

(iii) Distributing will distribute all of its Controlled stock to Shareholder 1 in exchange for all of the Distributing stock held by Shareholder 1 (the “Distribution). Following the Distribution, Controlled will elect to be taxed as a Subchapter S corporation.

REPRESENTATIONS

(a) The fair market value of the Controlled stock to be received by Shareholder 1 will be approximately equal to the fair market value of the Distributing stock surrendered.

(b) No part of the consideration to be distributed by Distributing will be received by Shareholder 1 as a creditor, employee, or in any capacity other than that of a shareholder of Distributing.

(c) Distributing, Controlled and Shareholder 1 each will pay their own expenses, if any, incurred in connection with the Distribution.

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

(e) No intercorporate debt will exist between Distributing and Controlled at the time of, or after, the Distribution.

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

(g) The Distribution is being carried out for the following business purpose: to end shareholder disputes over the operation of Distributing and to resolve management, systemic and other problems that have arisen because of irreconcilable differences between Shareholder 1 and Shareholder 2. The Distribution is motivated, in whole or substantial part, by this corporate business purpose.

(h) 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 person will acquire, directly or indirectly, stock representing a 50-percent or greater interest (within the
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meaning of § 355(d)(4)) in either Distributing or Controlled (including any predecessor or successor of any such corporation.

(i) Immediately after the transaction (as defined in § 355(g)(4)), either (i) no person will hold a 50-percent or greater interest (within the meaning of § 355(g)(3)) in Distributing or Controlled, (ii) if any person holds a 50-percent or greater interest (within the meaning of § 355(g)(3)) in any disqualified investment corporation (within the meaning of § 355(g)(2)), such person will have held such interest in such corporation immediately before the transaction, or (iii) neither Distributing nor Controlled will be a disqualified investment corporation (within the meaning of § 355(g)(2)).

(j) 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.

(k) For purposes of § 355(d), immediately after the Distribution, no person (determined after applying the aggregation rules of § 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.

(l) The liabilities to be assumed (as determined under § 357(d)) in the 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 being transferred.

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

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

(o) 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.
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(p) The total fair market value of the assets transferred from Distributing to Controlled will exceed the sum of (i) the amount of any liabilities assumed (within the meaning of § 357(d) by Controlled, (ii) the amount of any liabilities owed to Controlled by Distributing that are discharged or extinguished, 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 the Contribution. The fair market value of the assets of Controlled will exceed the amount of its liabilities immediately after the Contribution.

(q) The total adjusted bases and the fair market value of the assets transferred to Controlled by Distributing each equals or exceeds the sum of any liabilities assumed by Controlled plus any liabilities to which the transferred assets are subject.

(r) Distributing is an S corporation within the meaning of § 1361(a).
Controlled will elect to be an S corporation pursuant to § 1362(a) on the first available date after the Distribution and there is no plan or intent to revoke or otherwise terminate the S corporation election of either Distributing or Controlled.

RULINGS

Based solely on the information submitted and the representations set forth above, we rule as follows:

(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" within the meaning of § 368(b).

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

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

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

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

(6) No gain or loss will be recognized by Distributing on the Distribution (§ 361(c)(1)).
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(7) No gain or loss will be recognized by (and no amount will be included in the income of) Shareholder 1 on the Distribution (§ 355(a)(1)).

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

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

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

(11) Distributing’s momentary ownership of Controlled will not cause Controlled to have an ineligible shareholder for any portion of its first taxable year under § 1361(b)(1)(B).

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 whether the Distribution: (i) satisfies the business purpose requirement of § 1.355-2(b), (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) and § 1.355-2(d), (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 the Controlled corporation (see § 355(e) and § 1.355-7); or, (iv) whether the S corporation election of Distributing or Controlled is valid.

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 this ruling letter.
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In accordance with the power of attorney on file in this office, a copy of this ruling letter will be sent to your authorized representative.

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