Four owners received tax-free split-up of an S corporation

Plain-English summary

A closely held S corporation had four equal owners who disagreed about how to operate its active business. It proposed forming two new S corporations, dividing its assets and liabilities equally between them, and distributing one corporation to two shareholders and the other to the remaining two shareholders in exchange for all stock in the original company. The original company would then liquidate, and both successors planned to sell a shared asset after completing required state-law steps. The IRS ruled that the contributions, distributions, and liquidation would qualify as a section 368(a)(1)(D) reorganization and section 355 split-up, with no gain or loss to the companies or shareholders as described. It also ruled that the original company's momentary ownership of the successors would not itself make them ineligible for S corporation elections in their first tax years.

Ruling snapshot

• Question: Would the proposed two-way S corporation split-up qualify for nonrecognition treatment and preserve first-year S election eligibility?
• Outcome: approved through 17 rulings
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368(a)(1)(D), 1032, 1223, 1361, 1368

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201930011                                             Third Party Communication: None
Release Date: 7/26/2019                                       Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-02,
              355.03-00, 368.04-00                            Person To Contact:
                                                              -------------------------, ID No. ---- ------------
------------------------                                      --------------
--------------                                                Telephone Number:
-------------------------------------------------             ----------------------
-------------------                                           Refer Reply To:
----------------------------------                            CC:CORP:3
                                                              PLR-129089-18
                                                              Date:
                                                              April 30, 2019




Legend



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

Controlled 1           =    ----------------------------------------------------------------------------------------
                            --------------

Controlled 2           =    ----------------------------------------------------------------------------------------
                            --------------

Partnership            =    ----------------------------------------------------------------------------------------
                            ----------------------------------------------------------------------------------------
                            ------------------------

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

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

Shareholder C          =    ----------------------------------------------------------------------------------------

                            -----------------------

Shareholder D           =   ----------------------------------------------------------------------------------------
                            -----------------------

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

Business                =   -----------------------------------------------------------------------------------

Asset 1                 =   -------------------------

Asset 2                 =   -------------------------

Asset 3                 =   ---------------------------

Asset 4                 =   ---------------------------

Asset 5                 =   ---------------------------

Asset 6                 =   --------------------------

Asset 7                 =   ----------------------------

Asset 8                 =   --------------------------

Asset 9                 =   ---------------------------------------

a                       =   ---------------

b                       =   --------------

c                       =   ------------

d                       =   ------------

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

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

This letter responds to your letter dated September 28, 2018, requesting rulings on
certain federal income tax consequences of a proposed transaction described below.
The information submitted in that letter and in subsequent correspondence is
summarized below.

This letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, as amplified
and modified by Rev. Proc. 2018-53, 2018-43 I.R.B. 667, regarding one or more
“Covered Transactions” under section 355 and/or section 368 of the Internal Revenue
Code (the “Code”). This Office expresses no opinion as to the overall tax
consequences of the transaction as to any issue not specifically addressed by the
rulings below.

This office has made no determination regarding whether any of the Distributions (as
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 the controlled corporations or both
(see section 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 corporations (see section 355(e) and § 1.355-7).

                                    Summary of Facts

Distributing is a closely held State A corporation that owns and operates Business.
Distributing has one class of common stock outstanding that is owned equally by
Shareholder A, Shareholder B, Shareholder C, and Shareholder D. Distributing has
made an election under section 1362(a) to be treated as a subchapter S corporation
(within the meaning of section 1361(a)) as of Date 1.

The fair market value of Distributing’s total gross assets is approximately $a.
Distributing also owns a general partnership interest in State A Partnership. The fair
market value of Distributing’s general partnership interest is approximately $b.
Financial information has been submitted in accordance with Rev. Proc. 2017-52
indicating that Business has had gross receipts and operating expenses representing
the active conduct of trade or business for each of the past five years.

To resolve differences of opinion among the shareholders as to how the Business
should be conducted, taxpayer proposes the following transaction (the “Proposed
Transaction”):

                                  Proposed Transaction

    1. Distributing will form Controlled 1 and Controlled 2 as State A corporations.
      Controlled 1 and Controlled 2 each will make an election under section 1362(a)
      to be treated as a subchapter S corporations (within the meaning of section
      1361(a)). Controlled 1 and Controlled 2 each will have one class of stock
      outstanding, all of which will be owned directly by Distributing.

    2. Distributing will transfer 50 percent of its assets and liabilities to Controlled 1,
      including 50 percent of its Partnership interest, 50 percent of Asset 1, 100
      percent of each of Asset 2, Asset 3, and Asset 4, and $c in cash in exchange for
      all of the stock of Controlled 1 and the assumption by Controlled 1 of liabilities
      (Contribution 1).
    3. Distributing will transfer 50 percent of its assets and liabilities to Controlled 2,
      including 50 percent of its Partnership interest, 50 percent of Asset 1, 100
      percent of each of Asset 5, Asset 6, Asset 7, Asset 8, and Asset 9, and $d in
      cash in exchange for all of the stock of Controlled 2 and the assumption by
      Controlled 2 of liabilities (Contribution 2).

    4. Distributing will distribute all of Controlled 1 stock to Shareholder A and to
      Shareholder B in exchange for all of their Distributing stock (Distribution 1).

    5. Distributing will distribute all of Controlled 2 stock to Shareholder C and to
      Shareholder D in exchange for all of their Distributing stock (Distribution 2).

    6. Distributing will be liquidated as part of the reorganization.

    7. Controlled 1 and Controlled 2 will sell Asset 1 as soon as necessary steps
      required by State A law are completed.

                                    Representations

Except as set forth below, Distributing makes all the representations in section 3 of the
Appendix to Rev. Proc. 2017-52 in the form set forth therein.

   (1) Distributing does not make the following representations:

          a. Representations 36, 37, 38, and 39 are not applicable because
             Distributing does not file a consolidated return.

          b. Representation 40 is not applicable because Distributing is not a member
             of an Expanded Affiliated Group (as defined in section 2.04 of the
             Appendix to Rev. Proc. 2017-52).

   (2) Taxpayer has made the following alternative representations set forth in section 3
       of the Appendix to Rev. Proc. 2017-52: 3(a), 8(a), 11(b), 15(a), 22(a), 31(a) and
       41(b).

   (3) Taxpayer has made the following representation concerning Rev. Proc. 2018-53:
       Distributing’s liabilities are not evidenced by debt instruments now or at the time
       of the distribution.

                                         Rulings

Based solely on the information submitted and the representations made, we rule as
follows with respect to the Proposed Transaction:

    1. Contribution 1 and Contribution 2, together with Distribution 1 and Distribution 2,
      followed by the liquidation of Distributing, will be a reorganization within the
      meaning of section 368(a)(1)(D). Distributing, Controlled 1, and Controlled 2 will
      each be “a party to a reorganization” within the meaning of section 368(b).

    2. No gain or loss will be recognized by Distributing on Contribution 1 or
      Contribution 2. Sections 357(a) and 361(a).

    3. No gain or loss will be recognized by Controlled 1 on Contribution 1 or by
      Controlled 2 on Contribution 2. Section 1032(a).

    4. Controlled 1’s basis in each asset received from Distributing in Contribution 1 will
      equal the basis of such asset in the hands of Distributing immediately before its
      transfer. Section 362(b).

    5. Controlled 2’s basis in each asset received from Distributing in Contribution 2 will
      equal the basis of such asset in the hands of Distributing immediately before its
      transfer. Section 362(b).

    6. The holding period for each asset received by Controlled 1 in Contribution 1 will
      include the period during which such asset was held by Distributing. Section
      1223(2).

    7. The holding period for each asset received by Controlled 2 in Contribution 2 will
      include the period during which such asset was held by Distributing. Section
      1223(2).

    8. No gain or loss will be recognized by Distributing on Distribution 1 or Distribution
        2. Section 361(c)(1).

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

    10. No gain or loss will be recognized by (and no amount will be included in the
       income of) Shareholder C or Shareholder D upon receipt of Controlled 2 stock in
       Distribution 2. Section 355(a)(1).

    11. The aggregate basis of the Controlled 1 stock received by Shareholder A and
       Shareholder B immediately after Distribution 1 will be the same as such
       shareholder’s aggregate basis in the Distributing stock surrendered in exchange
       therefor, allocated in the manner described in § 1.358-2(a)(2). Section 358(a)(1)
       and (b).

    12. The aggregate basis of the Controlled 2 stock received by Shareholder C and
       Shareholder D immediately after Distribution 2 will be the same as such
       shareholder’s aggregate basis in the Distributing stock surrendered in exchange
       therefor, allocated in the manner described in § 1.358-2(a)(2). Section 358(a)(1)
       and (b).

    13. The holding period of the Controlled 1 stock received by Shareholder A and
       Shareholder B in Distribution 1 will include the holding period of the Distributing
       stock exchanged therefor, provided that such Distributing stock is held as a
       capital asset on the date of Distribution 1. Section 1223(1).

    14. The holding period of the Controlled 2 stock received by Shareholder C and
       Shareholder D in Distribution 2 will include the holding period of the Distributing
       stock exchanged therefor, provided that such Distributing stock is held as a
       capital asset on the date of Distribution 2. Section 1223(1).

    15. Distributing’s earnings and profits will be allocated between Controlled 1 and
       Controlled 2 in accordance with section 312(h) and § 1.312-10(a).

    16. The accumulated adjustments account of Distributing will be allocated between
       Controlled 1 and Controlled 2 in a manner similar to the manner in which the
       earnings and profits of Distributing will be allocated under section 312(h) in
       accordance with § 1.1368-2(d)(3).

    17. Provided that Distribution 1 and Distribution 2 are undertaken immediately after
       Contribution 1 and Contribution 2, Distributing’s momentary ownership of the
       stock of Controlled 1 and Controlled 2, as part of the reorganization under
       section 368(a)(1)(D), will not cause Controlled 1 or Controlled 2 to have an
       ineligible shareholder for any portion of their respective first taxable year under
       section 1361(b)(1)(B) and will not, in itself, render Controlled 1 or Controlled 2
       ineligible to elect to be a subchapter S corporation for its respective first taxable
       year.

                                          Caveats

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

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.

                                 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 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,



                                       Ken Cohen
                                       Senior Technician Reviewer, Branch 3
                                       Office of Associate Chief Counsel (Corporate)