Rev. Rul. 2008-18 posits two situations in which an S corporation becomes a qualified subchapter S subsidiary (QSub) of a newly formed corporation that will qualify as an F reorganization. The ruling also provides new guidance on the proper employer identification number (EIN) to be used by the entities in each situation.
Rev. Rul. 73-526 explains which EIN may be used by the surviving corporation in certain transactions. Situation 3 of Rev. Rul. 73-526 involves an F reorganization under which the shareholders of Oldco form Newco, and Oldco merges with and into Newco, with Newco surviving. The IRS ruled that because Newco is the alter ego of Oldco, Newco should continue to use Oldco’s EIN following the reorganization. In Rev. Rul. 64-250, the IRS provided a similar carryover concept with respect to the historic S election, where Oldco, an S corporation, merged into Newco in an F reorganization.
Rev. Rul. 2008-18 describes two situations that expand the principles of Rev. Rul. 64-250 and modify the results of Rev. Rul. 73-526 in the case of certain F reorganizations involving QSubs.
In situation 1, B, an individual, owned all the stock of Y, an S corporation. In year 1, as part of an overall plan, B formed Newco and contributed all the Y stock to Newco, which elected to treat Y as a QSub. The IRS ruled that these transactions constituted an F reorganization. In year 2, Newco sold a 1% interest in Y to D, an unrelated party, thus terminating Y’s QSub status.
In situation 2, C, an individual, owned all the stock of Z, an S corporation. In year 1, as part of an overall plan, Z formed Newco, which in turn formed Mergeco. Thereafter, Mergeco merged with and into Z, with Z surviving and C receiving solely Newco stock in exchange for Z stock. Subsequently, Newco elected to treat Z as a QSub. Again, the IRS ruled that the transaction constituted an F reorganization.
Notwithstanding the holding of Rev. Rul. 73-526, in Rev. Rul. 2008-18 the IRS required Newco to obtain a new EIN in each of the situations described above. The IRS’s departure from the approach of Rev. Rul. 73-526 arises from unique issues relating to QSubs. Generally, a QSub does not maintain its own separate corporate status for federal tax purposes; rather, its assets, liabilities, and items of income, deduction, and credit are treated as those of the parent S corporation (see Sec. 1361(b)(3)(A)). In 2004, Congress amended Sec. 1361(b)(3)(E) to provide that, in limited circumstances, a QSub is treated as a separate entity (e.g., for information-reporting purposes and for purposes of employment taxes and certain excise taxes). See Regs. Secs. 1.13614(a)(7) and (8). In addition, a QSub may not use its parent’s EIN once its QSub status terminates. For these reasons, the IRS ruled in Rev. Rul. 2008-18 that it would be inappropriate for Newco to use the EIN of Y or Z in these situations.
Although Rev. Rul. 2008-18 addresses two common transactions, there are other permutations of F reorganizations for which additional guidance would be helpful.
Example 1: A, an individual, owns all the stock of Oldco (O), an S corporation. Pursuant to an overall plan, A forms Newco (N), a limited liability company, and makes a check-the-box election to treat N as a corporation for federal tax purposes. Subsequently, A transfers all the O stock to N, and N elects to treat O as a QSub.
This transaction, which is similar to situation 1 of Rev. Rul. 2008-18, likely (absent the technical matter discussed below) qualifies as an F reorganization. In order to make a check-the-box election, N must have its own EIN (see Regs. Sec. 301.7701-3(c)(1)(i)). Presumably, under Rev. Rul. 2008-18, N would be required to use its own EIN and would not be able to use O’s EIN.
Example 2: A, an individual, owns all the stock of Oldco (O), an S corporation, and O owns all the stock of Y, a QSub. Under an overall plan, O merges into Y, with Y surviving, in a transaction that qualifies as an F reorganization. As a result, Y’s QSub status terminates, and Y is treated as a new corporation that acquired all O’s assets and liabilities in exchange for Y stock. (See Regs. Sec. 1.1361-5(b)(1)(i).)
Arguably, this transaction is distinguishable from those described in Rev. Rul. 2008-18 because it does not involve a transferor corporation becoming a QSub of a newly formed entity. Query whether the principles of Rev. Rul. 73-526 should apply—i.e., if Y should be permitted to use O’s EIN—or whether Rev. Rul. 2008-18 would prohibit Y from using O’s EIN.
Technical ConundrumRev. Rul. 2008-18 also raises an interesting technical conundrum. The IRS ruled that each situation qualified as an F reorganization; accordingly, under Rev. Rul. 64-250, Newco was not required to make a new S election. However, the QSub election for Y and Z is a critical component of the F reorganization in the respective situations. As described in the facts, no S election was made for Newco in either situation. A QSub election may be made only by an entity for which a valid S corporation election currently is in effect. If the QSub election were invalid, the transactions would not qualify as F reorganizations. The ruling applies to F reorganizations occurring on or after January 1, 2009. The IRS appears to acknowledge this technical conundrum and suggests that it may be prudent for taxpayers to make an S election for Newco for any reorganizations prior to January 1, 2009. It is expected that future guidance will be issued regarding this ruling.
Annette B. Smith is with Washington National Tax Services PricewaterhouseCoopers LLP in Washington, DC
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.
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