IRS rules a family-owned company's split-off to one of its three owner families is a tax-free D reorganization

Plain-English summary

A company owned equally by three families wants to separate part of its business and give it to one of those families, letting that family exit as owners of the parent. The company will form a new subsidiary ("Controlled"), transfer a portion of its business (and related liabilities) into it, and then distribute all of the subsidiary's stock to one family in exchange for that family's stock in the parent. This kind of divided distribution is called a split-off. The company asked the IRS to confirm the standard tax-free treatment under Sections 355 and 368(a)(1)(D). The IRS issued a package of ten rulings: the contribution-plus-distribution is a tax-free "D" reorganization; neither the parent nor the subsidiary recognizes gain or loss on the contribution; the parent recognizes no gain or loss on the distribution; and the departing family recognizes no gain or loss on receiving the subsidiary's stock, carrying over its old basis and holding period. The IRS did not rule on some key requirements it leaves to audit, including whether the split-off has a valid business purpose, whether it is a device to bail out earnings and profits, or whether it is part of a plan for a 50%-or-greater acquisition under Section 355(e).

Ruling snapshot

• Question: Does the contribution of part of a business to a new subsidiary, followed by distributing that subsidiary's stock to one owner family in exchange for its parent stock, qualify as a tax-free split-off (D reorganization) under Sections 355 and 368(a)(1)(D)?
• Outcome: Approved (ten rulings granting tax-free treatment; certain § 355 requirements reserved for audit)
• Key authorities: IRC §§ 355, 368(a)(1)(D); §§ 357(a), 361, 362(b), 358(a), 1032(a), 1223, 312(h); Rev. Proc. 2017-52; Rev. Proc. 2018-53

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202211009 Third Party Communication: None
Release Date: 3/18/2022 Date of Communication: Not Applicable
Index Numbers: 355.01-01, 368.04-00
Person To Contact:
-------------------------------- ---------------------, ID No. ---------------------
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----------------------------------- Telephone Number:
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Refer Reply To:
CC:CORP:B03
PLR-118385-21
Date:
December 17, 2021

Legend

Distributing = ---------------------------------
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Controlled = -------------------------------------------------
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State A = -------------

Business A = ----------------------------------------------------------

Family A = ------------------------------------------------------------------------
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Family B = -------------------------------------------------------------------------------
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Family C = -----------------------------------------------------------------------------
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Related Party Note = ----------------------------------------------------------
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Dear --------------:

This letter responds to the letter dated August 24, 2021, submitted on behalf of
Distributing and its shareholders requesting rulings on certain federal income tax
consequences of a proposed transaction (the “Proposed Transaction”). The material
information submitted in that request and 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 of the Internal Revenue Code (the "Code").
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.

This Office has made no determination regarding whether the Distribution (as defined
below): (i) satisfies the business purpose requirement of Treas. Reg. § 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 section 355(a)(1)(B)
and Treas. Reg. § 1.355-2(d)); or (iii) is part of a plan (or series of related transaction)
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, or any predecessor or successor of the distributing corporation
or the controlled corporation, within the meaning of Treas. Reg. § 1.355-8T (see section
355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

                                Summary of Facts

Distributing is a State A corporation engaged in Business A which has a single class of
voting common stock issued and outstanding (the "Distributing Stock"). Distributing
Stock is owned equally by three families, Family A, Family B, and Family C. Distributing
has outstanding debt, including the Related Party Note.

Distributing has submitted financial information indicating that Business A has had the
gross receipts and operating expenses representing the active conduct of a trade or
business for each of the past five years.

                              The Proposed Transaction

For what has been represented to be a valid business purpose, Distributing proposes to
divide Business A operations in the following Proposed Transaction:

(i)          Distributing will form Controlled as a State A corporation and contribute a
             portion of the assets of Business A to Controlled in exchange for all the
             issued stock of Controlled and the assumption by Controlled of
             Distributing’s liabilities associated with the assets contributed, including
             the Related Party Note (the “Contribution”).

(ii)         Distributing will distribute all of the Controlled stock to Family B in
             exchange for all Family B’s Distributing’s stock (the “Distribution”).

                           Rev. Proc. 2017-52 Representations

With respect to the Contribution, Distributing has made all of the representations in
Section 3 of the Appendix to Rev. Proc. 2017-52, except as otherwise set forth below:

       (1) Distributing has made the following alternative representations:

             Representations 3(a), 11(a), 15(a), 22(a), 31(a), and 41(a).

       (2) Distributing has not made the following representations, which do not apply to
           the Proposed Transaction:

             Representation 6, 24, 25, 36, 37, 38, 39, and 40.

       (3) Distributing has not made Representation 42 but has provided the required
           explanation.

                         Rev. Proc. 2018-53 Representations

Except as otherwise provided below, Distributing has made all the representations
provided in Section 3 of Rev. Proc. 2018-53 with respect to the Proposed Transaction.
For purposes of the other representations, which Distributing has modified as set forth
below, terms used but not otherwise defined in this letter have the meanings set forth in
Rev. Proc. 2018-53. Distributing has made the following modified representations:

       Representation 2: With the exception of the Related Party Note, no holder of
       Distributing Debt that will be assumed is a person related to Distributing or
       Controlled within the meaning of section 267(b) or section 707(b)(1). No Related
       Person will receive any section 361 Consideration in satisfaction of the Related
       Party Note.

     Representation 3: Excluding the Related Party Note, the holder of Distributing
     Debt that will be assumed or satisfied will not hold the debt for the benefit of
     Distributing, Controlled, or any Related Person.

                                       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 section 368(a)(1)(D) of the Code. Distributing and
Controlled will each be a "party to a reorganization" within the meaning of
section 368(b).

(2) Distributing will not recognize gain or loss on the Contribution. Sections 357(a)
and 361(a).

(3) Controlled will not recognize gain or loss on the Contribution. Section 1032(a).

(4) Controlled’s basis in each asset received in the Contribution will be the same
as the basis of that asset in the hands of Distributing immediately before the
Contribution. Section 362(b).

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

(6) Distributing will not recognize gain or loss on the Distribution. Section 361(c)(1).

(7) The holders of Distributing Stock will not recognize gain or loss on the receipt of
Controlled stock in the Distribution. Section 355(a).

(8) The basis of the Controlled stock in the hands of each Family B shareholder
immediately after the Distribution will be the same as the basis of the
Distributing Stock held by that Family B shareholder immediately before the
Distribution. Section 358(a)(1).

(9) Each Family B shareholder’s holding period in the Controlled stock received in
the Distribution will include the period during which that Family B shareholder
held the Distributing Stock exchanged therefor, provided that such stock is 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. § 1.312-10(a).

                                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.

                             Procedural Statements

The ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be sued 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 returns that provides the date on and control number
(PLR-118385-21) of this ruling letter.

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

                                       Sincerely,

                                       _________________
                                       John B. Lovelace,
                                       Senior Counsel, Branch 3
                                       Office of Associate Chief Counsel (Corporate)

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