IRS confirms a bankruptcy liquidating trust keeps its grantor-trust status even after its term is extended again

Plain-English summary

When a company goes through Chapter 11 bankruptcy, its remaining assets are often placed in a "liquidating trust" whose only job is to sell them off and pay creditors. Under Treas. Reg. § 301.7701-4(d), such a trust is taxed as a trust (not as a corporation or partnership) as long as it is really winding things down and not running a business, and the IRS spells out the conditions for that treatment in Rev. Proc. 94-45. One of those conditions is that the trust have a fixed termination date, generally no more than five years out, though a bankruptcy court can approve finite extensions when the liquidation needs more time. This trust had already had its term extended several times, and unresolved legal claims meant the trustee planned to ask the court to extend it once more. The trust asked the IRS to confirm the extra time would not cost it its status. The IRS ruled that the trust still meets the Rev. Proc. 94-45 conditions, so it remains a liquidating trust under § 301.7701-4(d) and stays a grantor trust, meaning its beneficiaries (not the trust) are taxed on its income under § 671.

Ruling snapshot

• Question: Does extending a bankruptcy liquidating trust's term yet again jeopardize its classification as a liquidating trust (and grantor trust) under § 301.7701-4(d)?
• Outcome: Approved (classification preserved; extension does not adversely affect it)
• Key authorities: Treas. Reg. §§ 301.7701-4(d), 1.671-4(a); IRC § 671; Rev. Proc. 94-45

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202226004                                             Third Party Communication: None
Release Date: 7/1/2022                                        Date of Communication: Not Applicable
Index Numbers: 7701.00-00, 7701.03-00,
              7701.03-06                                      Person To Contact:
                                                              --------------------, ID No. -----------------
-------------------------------                               Telephone Number:
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---------------------------------                             Refer Reply To:
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----------------------------------                            PLR-121281-21
                                                              Date:
                                                              March 31, 2022




                                                   LEGEND

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PLR-121281-21                                  2

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

        This letter responds to a letter dated September 9, 2021, and subsequent
correspondence, submitted on behalf of Trust, requesting a ruling under § 301.7701-
4(d) of the Procedure and Administration Regulations.

                                           FACTS

       The information submitted states that Debtors filed a voluntary petition for relief
under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court on
Date1. On Date 2, the Bankruptcy Court approved the Second Amended Plan of
Liquidation (the "Plan") with an effective date of Date 3. On Date 3, Trust was
established as part of the Plan with an initial term ending on Date 4. The Bankruptcy
Court, however, subsequently extended the term of Trust to Date 5, then to Date 6 and
then to Date 7. Because of unresolved legal claims, Trustee intends to file a motion
with the Bankruptcy Court to extend the termination date of Trust to Date 8.

         Pursuant to the provisions of the Plan and the Trust agreement, Trust was
created for the purpose of liquidating, converting to cash and distributing the assets of
Trust in accordance with § 301.7701-4(d), with no objective to continue or engage in the
conduct of a trade or business. Trust is not permitted to receive or retain cash in
excess of a reasonable amount to meet claims and contingent liabilities (including
disputed claims) or to maintain the value of the assets during liquidation. Cash not
available for distribution and cash pending distribution is to be held in demand and time
deposits, such as short term certificates of deposit, in banks or other savings
institutions, or other temporary, liquid assets such as Treasury bills. Trust is required,
under the terms of Trust, to distribute to the beneficiaries of Trust at least annually its
net income and all net proceeds from the sale of Trust's assets, except that Trust may
retain an amount of net proceeds or net income reasonably necessary to maintain the
value of the property or to meet claims or contingent liabilities.

       Trust provides that the beneficiaries of Trust will be treated as the grantors and
deemed owners of Trust. It further provides that the parties will value all assets
transferred to Trust consistently and use such values for all federal income tax
purposes.

      Trust provides that the trustee of Trust shall file tax returns as a grantor trust
pursuant to § 1.671-4(a) of the Income Tax Regulations.

       Trust, consistent with the requirements set out in Rev. Proc. 94-45, 1994-2 C.B.
684, provides that the transfer of Trust assets to Trust will be treated for all federal tax
purposes as a deemed transfer by the Debtors to the beneficiaries followed by a
deemed transfer by the beneficiaries to Trust.

        Trust further represents that, from its establishment, Trust has been formed and
operated consistent with the conditions set forth in Rev. Proc. 94-45. As of the date of
this request, Trust has distributed amounts in Trust to its beneficiaries. Trust represents
PLR-121281-21                                  3

that certain developments, generally beyond the control of the Trustee of Trust, have
occurred that require additional time and effort to facilitate the recovery of certain
remaining trust assets and to complete the liquidation of Trust.

                                   LAW AND ANALYSIS

       Section 671 of the Internal Revenue Code (the "Code") provides that where it is
specified in subpart E that the grantor or another person shall be treated as the owner
of any portion of a trust, there shall then be included in computing the taxable income
and credits of the grantor or the other person those items of income, deductions, and
credits against tax of the trust that are attributable to that portion of the trust to the
extent that such items would be taken into account under chapter 1 of the Code in
computing taxable income or credits against the tax of an individual.

       Section 1.671-4(a) provides that, except as provided in §§ 1.671-4(b) and 1.671-
5, items of income, deduction, and credit attributable to any portion of a trust that, under
the provisions of subpart E (§ 671 and following), part I, subchapter J, chapter 1 of the
Code, are treated as owned by the grantor or another person should not be reported by
the trust on Form 1041, "U.S. Income Tax Return for Estates and Trusts," but should be
shown on a separate statement attached to that form.

        Section 301.7701-4(d) provides that certain organizations which are commonly
known as liquidating trusts are treated as trusts for purposes of the Code. An
organization will be considered a liquidating trust if it is organized for the primary
purpose of liquidating and distributing the assets transferred to it, and if its activities are
all reasonably necessary to, and consistent with, the accomplishment of that purpose.
A liquidating trust is treated as a trust for purposes of the Code if it is formed with the
objective of liquidating particular assets and not as an organization having as its
purpose the carrying on of a profit-making business which normally would be conducted
through business organizations classified as corporations or partnerships. However, if
the liquidation is unreasonably prolonged or if the liquidation purpose becomes so
obscured by business activities that the declared purpose of liquidation can be said to
be lost or abandoned, the status of the organization will no longer be that of a liquidating
trust.

       Rev. Proc. 94-45 provides the conditions under which the Service will consider
issuing advance rulings classifying certain trusts as liquidating trusts under § 301.7701-
4(d).

        Section 3.06 of Rev. Proc. 94-45 provides that the trust instrument must contain
a fixed or determinable termination date that is generally not more than five years from
the date of creation of the trust and that is reasonable based on all the facts and
circumstances. If warranted by the facts and circumstances, provided for in the plan
and trust instrument, and subject to the approval of the Bankruptcy Court with
jurisdiction over the case upon a finding that the extension is necessary to the
liquidating purpose of the trust, the term of the trust may be extended for a finite term
based on its particular facts and circumstances. The trust instrument must require that
PLR-121281-21                                  4

each extension be approved by the court within 6 months of the beginning of the
extended term.

                                      CONCLUSIONS

       Based on the information submitted and the representations made, we conclude
that the conditions of Rev. Proc. 94-45 have been satisfied. Accordingly, based on the
representations made and the information submitted, we rule that Trust is classified as a
liquidating trust under § 301.7701-4(d) for federal tax purposes and that the extension of
Trust's term to Date 8 will not adversely affect Trust's classification as a liquidating trust
under § 301.7701-4(d). Therefore, Trust will continue to be treated as a grantor trust
and the beneficiaries of Trust will continue to be treated as the owners of Trust under
§ 671 to the extent Trust otherwise qualifies as such.

       Except as expressly set forth above, we express or imply no opinion concerning
the federal income tax consequences of the facts described above under any other
provision of the Code.

      This ruling is directed only to the taxpayer requesting it. According to
§ 6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

       The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

        Under a power of attorney on file with this office, we are sending a copy of this
letter to Trust's authorized representatives.


                                              Sincerely,



                                               Mary Beth Carchia
                                               Senior Technician Reviewer, Branch 3
                                               Office of the Associate Chief Counsel
                                               (Passthroughs & Special Industries)



Enclosure:
       Copy of this letter for § 6110 purposes


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