Parent may claim affiliated-subsidiary worthless stock deduction after conversion

Plain-English summary

A corporate taxpayer owned a services subsidiary whose group faced large settlement costs and client claims tied to investments made with a third party. Several lower-tier subsidiaries had already liquidated or converted into disregarded entities, carrying their tax attributes into the main subsidiary. The main subsidiary proposed to convert into a limited liability company while insolvent, producing a deemed liquidation and leaving its stock worthless. The IRS ruled that the subsidiary could include the historic gross receipts of its former subsidiaries when applying the section 165(g)(3)(B) active-income test, after removing distributions that would duplicate receipts. It also ruled that the parent could claim a worthless stock deduction when the conversion occurred, assuming the remaining section 165(g)(3) requirements were met.

Ruling snapshot

• Question: Can historic subsidiary receipts count toward the affiliated-corporation test, and may the parent deduct the main subsidiary's stock as worthless upon its conversion?
• Outcome: approved, subject to satisfying the remaining section 165(g)(3) requirements
• Key authorities: IRC §§ 165(g)(1), 165(g)(3), 332, 381, and 1504(a)(2); Rev. Rul. 2003-125

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201704003 Third Party Communication: None
Release Date: 1/27/2017 Date of Communication: Not Applicable
Index Number: 165.00-00, 165.06-00,
165.06-02 Person To Contact:
--------------------------
--------------------------------------------------- ID No. ------------------
--------------------------- Telephone Number:
------------------------------ ---------------------
Refer Reply To:
------------------------------ CC:ITA:B01
------------------------------------ PLR-114476-16
Date:
October 24, 2016

                                                  LEGEND

Taxpayer = ---------------------------------------------------

Parent 1 = -----------------------------------

Parent 2 = --------------------------------------------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

Year 5 = -------

Year 6 = -------

Services = ----------------------------------------

Clients = --------------------------------

US Sub 1 = ----------------------------------

US Sub 2 = ----------------------------

US Sub 3 = -------------------------------
PLR-114476-16 2

Foreign Sub 1 = --------------------------------------

Foreign Sub 2 = --------------------------------------------------------------

Investor = ---------------------------------------------------------

$A = ------------

$B = ------------

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

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

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

This is in response to a letter dated April 29, 2016, submitted on behalf of Taxpayer,
requesting a letter ruling under § 165 of the Internal Revenue Code (the "Code"). The
information submitted for consideration is summarized below.

                                               FACTS

Taxpayer was incorporated in Year 1 and is a wholly owned subsidiary of Parent 1, a
wholly owned subsidiary of Parent 2. In Year 2, Taxpayer acquired 100 percent of the
issued and outstanding equity interest in US Sub 1, a State corporation. US Sub 1 and
its wholly owned subsidiaries, US Sub 2, US Sub 3, Foreign Sub 1, and Foreign Sub 2,
provide Services to Clients. Parent 1, Parent 2, Taxpayer, US Sub 1, US Sub 2, and
US Sub 3 are all members of the Parent 2 consolidated group.

Prior to Year 3, certain Clients advised by US Sub 1 and its subsidiaries invested a
large portion of their assets with Investor. In Year 4, the trustee appointed to liquidate
Investor sued US Sub 1 and its subsidiaries for over $A to recover payments made by
Investor. In Year 5, US Sub 1 settled with the trustee for over $B. Beginning in Year 6,
Clients sued US Sub 1 and its subsidiaries to recover losses related to their investments
with Investor.

On Date 1, Foreign Sub 1 was liquidated into US Sub 1. On Date 2, US Sub 2 and US
Sub 3 converted from state law corporations to limited liability companies. Also on Date
2, Foreign Sub 2 made an election to be treated as a disregarded entity for U.S. federal
tax purposes.
PLR-114476-16 3

US Sub 1 proposes to convert from a state law corporation to a limited liability company
resulting in a deemed distribution of all of US Sub 1’s assets and liabilities to Taxpayer.

                              REPRESENTATIONS

1. The US Sub 2, US Sub 3, Foreign Sub 1, and Foreign Sub 2 transactions, i.e.,
  liquidation, conversion, and election, qualified as liquidations under section 332
  for U.S. federal income tax purposes and pursuant to section 381 the attributes
  carried over to US Sub 1.

2. Taxpayer owns directly more than 80 percent of the total voting power and 80
  percent of the total value of US Sub 1 within the meaning of section 1504(a)(2).

3. The US Sub 1 conversion will occur at a time when US Sub 1 will be insolvent
  (as described in Rev. Rul. 2003-125, 2003-2 C.B. 1243) and its stock will be
  worthless, within the meaning of section 165(g)(1).

4. US Sub 1 has not made any distributions that caused it to become insolvent.

                                    RULINGS

Based upon the information submitted and representations made by Taxpayer, we rule
as follows:

1. For purposes of computing the "more than 90 percent gross receipts" test under
  section 165(g)(3)(B), US Sub 1 will take into account the historic gross receipts of
  US Sub 2, US Sub 3, Foreign Sub 1, and Foreign Sub 2 provided, however, that
  US Sub 1 eliminates prior distributions received from US Sub 2, US Sub 3,
  Foreign Sub 1, and Foreign Sub 2, so as to prevent duplication.

2. Assuming the requirements for claiming a worthless stock deduction under
  § 165(g)(3) are otherwise satisfied, Taxpayer may claim a worthless stock
  deduction for the US Sub 1 stock upon the occurrence of the US Sub 1
  conversion.
                                    CAVEATS

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.
PLR-114476-16 4

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

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,



                                   Lewis K Brickates
                                   Branch Chief, Branch 1
                                   (Income Tax & Accounting)