Subsidiary stock distributed as reorganization boot triggers shareholder and corporate tax rules

Plain-English summary

A parent corporation proposed exchanging its stock in a partly owned subsidiary for new voting stock and then converting into a limited liability company that would not elect corporate status. Assuming those steps qualified as a reorganization, stock in two other corporations distributed to the parent's shareholders would be treated as boot. The IRS ruled that the shareholder-level distribution would fall under IRC § 301: dividend treatment first, then basis reduction, then gain for any remaining excess. The parent would also recognize gain under IRC § 361(c)(2) as though it sold the distributed stock at fair market value. The IRS did not decide whether the transaction actually qualified as a reorganization or address possible later charitable transfers by the shareholders.

Ruling snapshot

• Question: How is stock of two subsidiaries taxed when distributed to shareholders as boot in the proposed reorganization?
• Outcome: Approved conditionally. Shareholders apply IRC § 301, and the parent recognizes corporate-level gain under IRC § 361(c)(2), if the steps qualify as a reorganization.
• Key authorities: IRC §§ 301(c), 356(a), 361(c)(2), 368(a)(1); Treas. Reg. § 1.356-1(a)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201721014 Third Party Communication: None
Release Date: 5/26/2017 Date of Communication: Not Applicable
Index Numbers: 301.00-00, 356.00-00,
361.02-01 Person To Contact:
------------------------------------ ---------------------, ID No. ------------------
--------------------------------- Telephone Number:
----------------------------------------------- ----------------------
---------------------------------------- Refer Reply To:
CC:CORP:B03
PLR-127777-16
Date:
February 23, 2017

Parent/Target = ----------------------------------

Subsidiary/Acquiring = -------------------

Corp 1 = ---------------------------

Corp 2 = ----------------------------------------

Shareholder 1 -------------------

Shareholder 2 ------------------------

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

a = --------

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

This letter responds to your September 1, 2016, request for rulings regarding certain
federal income tax consequences of a series of proposed transactions (collectively, the
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“Proposed Transaction”). The material information submitted in that request and in
subsequent correspondence is summarized below.

The rulings contained in this letter are based on facts and representations submitted on
behalf of the taxpayer and accompanied by a penalty 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.

Summary of Facts:

Parent/Target, a State X corporation, is owned by two individuals, Shareholder 1 and
Shareholder 2, who are married. Parent/Target owns greater than 80 percent of the
stock of Corp 1 and Corp 2. Corp 1 and Corp.2 are members of Parent/Target’s
consolidated group. Parent/Target also owns a (less than 80) percent of the stock of
Subsidiary/Acquiring. Accordingly, Subsidiary/Acquiring is not a member of
Parent/Target’s consolidated group.

Proposed Transaction:

       Parent/Target has proposed the following transaction:

(i) Parent/Target will exchange all of its common stock in Subsidiary (Old Stock) in
exchange for voting common stock in Subsidiary (New Stock).
Subsidiary/Acquiring will neither assume any of Parent/Target’s liabilities nor
receive any of Parent/Target’s assets subject to liabilities. Shareholder 1 may
contribute cash to the capital of Parent/Target to enable it to pay off liabilities.
Alternatively, Shareholder 1 may pay or assume liabilities of Parent/Target.

(ii) Parent/Target will convert to a limited liability company under State X law. No
election will be made for Parent/Target to be taxed as a corporation.

(iii) Shareholder 1 and Shareholder 2 may transfer some of their
Subsidiary/Acquiring stock to tax exempt organizations. There is no plan to
make these transfers at this time.

Rulings:

    (1) Provided steps (i), and (ii), above, qualify as a reorganization under section
        368(a)(1), the distribution of Corp 1 and Corp 2 stock (“Boot”) will constitute a
        distribution of property with respect to the stock of Parent/Target to which section
        301 applies. (section 356(a) and § 1.356-1(a)). The excess, if any, of the amount
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   of Boot distributed with respect to a share of Parent/Target stock over the
   amount of such distribution treated as a dividend will be applied against and
   reduce the shareholder’s adjusted basis in the share, and any remaining excess
   will be treated as gain from the sale or exchange of property (section 301(c)(2)
   and (c)(3)).

(2) Provided steps (i), and (ii), above, qualify as a reorganization under section
368(a)(1), gain shall be recognized to Parent/Target as if it sold the Boot to its
shareholders at its fair market on the date of the reorganization (section
361(c)(2)).

Caveats:

Except as specifically provided herein, no opinion is expressed or implied concerning
the tax treatment of the proposed transaction under any provisions of the Code and
regulations or the tax treatment of any condition 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 as to whether section 368(a)(1) applies to
steps (i) and, (ii).Section 6.11 of Rev. Proc. 2017-1. Also, no opinion is expressed as to
the tax consequences of step (iii).

Procedural Statements:

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.

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 (PLR-
127777-16) of this letter ruling.
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PLR-127777-16

In accordance with the Power of Attorney on file with this office, copies of this letter are
being sent to your authorized representatives.

                                       Sincerely yours,




                                       __________________________
                                       Isaac W. Zimbalist
                                       Senior Technician Reviewer, Branch 3
                                       Office of Associate Chief Counsel (Corporate)

cc: