Double and Triple Drops With Liquidations Clarified in Pair of Revenue Rulings

By Andrew Gottlieb, J.D., LL.M., CPA, Washington

Editor: Annette B. Smith, CPA

For years, practitioners have struggled with the Subchapter C characterization of certain multistep transactions, especially in situations in which the stock of a target corporation is transferred and the target corporation subsequently liquidates. Fortunately, the IRS has provided clarity in two of these situations: one involving a double drop and liquidation (Rev. Rul. 2015-9) and the other dealing with a triple drop and liquidation (Rev. Rul. 2015-10). This item discusses these rulings along with the technical aspects surrounding their issuance and addresses whether the IRS reached the right results.

Double Drop and Liquidation

Rev. Rul. 2015-9 revokes Rev. Rul. 78-130, characterizing a double drop and liquidation as a Sec. 351 transfer followed by a reorganization under Sec. 368(a)(1)(D) (D reorganization).

In Rev. Rul. 78-130, the IRS applied step-transaction principles to integrate the transfer of a target corporation to an indirectly owned second-tier subsidiary, followed by a liquidation of the target corporation into the second-tier subsidiary (double drop and liquidation). The facts of the 1978 ruling were as follows: P owned all the stock of S1 and S2. S2 owned all the stock of X, Y, and Z. Pursuant to a prearranged plan, S2 formed a new corporation, N, and P transferred the stock of S1 to S2 in exchange for S2 stock. Immediately thereafter, S1, X, Y, and Z transferred all their assets and liabilities to N in exchange for N stock, followed by the distribution by S1, X, Y, and Z of their remaining assets (i.e., N stock) to S2 in complete liquidation. The IRS ruled that the direct transfers of the assets of X, Y, and Z to N were treated as D reorganizations. In viewing the transaction as a whole, the IRS ruled that the transaction should be recharacterized as a triangular Sec. 368(a)(1)(C) reorganization (triangular C reorganization) with respect toS1.

On identical facts, Rev. Rul. 2015-9 revoked Rev. Rul. 78-130 and treated the contribution of S1 as a Sec. 351 exchange followed by a D reorganization of S1. Rev. Rul. 2015-9 relies on Rev. Rul. 77-449, holding that successive transfers of property from a domestic corporation to its wholly owned subsidiary and from that subsidiary to another wholly owned subsidiary pursuant to the same plan are each analyzed separately for purposes of Sec. 351. In addition, in Rev. Rul. 2015-9, the IRS stated that "an analysis of the transaction as a whole does not dictate that P's transfer be treated other than in accordance with its form in order to reflect the substance of the transaction."

Rev. Rul. 78-130 was influenced by Sec. 367 issues, with the IRS specifically noting that the transaction was not done for the principal purpose of tax avoidance. Prior to 2006, a triangular C reorganization potentially subjected a taxpayer to the risk of an income inclusion under prior Regs. Sec. 1.367(b)-4 (T.D. 9243). Under those prior regulations, a foreign-to-foreign transfer would have required a U.S. shareholder that receives stock in a domestic corporation in exchange for its stock in a controlled foreign corporation (CFC) to include the Sec. 1248 amount as a deemed dividend. However, in 2006, Regs. Secs. 1.367(b)-4 and -13 added an exception in the case of a triangular reorganization, providing for a basis and holding period in each share of stock in the surviving corporation to reflect the Sec. 1248 amount in the subsidiary stock and the target stock. Under current Regs. Sec. 1.367(b)-4(b)(1)(ii)(B), the transfer of stock in a CFC in a triangular C reorganization will not result in a Sec. 1248 inclusion if the stock received in the exchange is stock of a U.S. corporation and, immediately after, the U.S. corporation is a Sec. 1248 shareholder of the acquired corporation, reducing the risk of a Sec. 1248 income inclusion under the facts of Rev. Rul. 78-130.

Taxpayers found Rev. Rul. 78-130 particularly troublesome because a triangular C reorganization also could result in unfavorable basis consequences. Specifically, under Regs. Sec. 1.358-2, P's basis in the stock of S2 must be traced to its basis in S1, creating a second basis block distinct from P's "old and cold" basis in S2. As a result of the separate block of stock, an ordinary distribution by S2 to P in excess of earnings and profits could result in gain with respect to low-basis shares before the high-basis shares are fully recovered (Johnson, 435 F.2d 1257 (4th Cir. 1971)).

However, under Rev. Rul. 2015-9, the characterization as a Sec. 351 exchange followed by a D reorganization could yield a more favorable result. Specifically, the initial Sec. 351 exchange would result in P's having a blended basis in S2, allowing more return of capital before recognizing gain under Sec. 301(c)(3) (see Rev. Rul. 85-164). The revenue rulings fail to address whether the Sec. 351 exchange could result in a reorganization under Sec. 368(a)(1)(B) and therefore result in P's having two blocks of stock under the tracing method, as described above. However, treating the first step as a B reorganization likely would violate Regs. Sec. 1.368-2(k), in that the target goes out of existence.

Triple Drop and Liquidation

In Rev. Rul. 2015-10, the IRS extended the principles of Rev. Rul. 2015-9, treating a "triple drop and liquidation" as two successive Sec. 351 exchanges followed by a D reorganization. The facts of the ruling are as follows: P owns all the interests in a domestic limited liability company (LLC) treated as a corporation for U.S. federal income tax purposes. P also owns all the stock of S1, which owns all the stock of S2. S2 owns all the stock of S3. In the ruling, (1) P transferred the LLC to S1; (2) S1 transferred the LLC to S2; (3) S2 transferred the LLC to S3; and (4) the LLC elected to be treated as a disregarded entity. The IRS treated the first two transfers as Sec. 351 transfers. The IRS cited Rev. Ruls. 67-274 and 2004-83, treating S2's transfer of the LLC to S3 and the LLC's election to be treated as a disregarded entity as a D reorganization.

Why the Rulings Reach the Right Result

Substantial legal changes have surrounded reorganizations since Rev. Rul. 78-130 was issued, which raised questions about its application. Specifically, in 1984 the definition of control in a D reorganization was amended to conform to Sec. 304. Also, the IRS issued Regs. Sec. 1.368-2(l) (cash D regulations), which provides that a transaction is treated as satisfying the D reorganization requirements, notwithstanding that there is no direct issuance of stock of the transferee corporation, if the same person or persons own, directly or indirectly, all the stock of the transferor and transferee corporation in identical proportions. In addition, where a transferor receives all boot, the regulations deem the transferee corporation to issue a nominal share in order to satisfy the distribution requirement. The cash D regulations also include an overlap rule that the nominal share will not apply if the transaction is a triangular reorganization.

Questions regarding the application of Rev. Rul. 78-130 increased after the IRS issued two letter rulings that were inconsistent with the principles of Rev. Rul. 78-130. In Letter Rulings 201150021 and 201252002, the IRS appeared to be applying the principles of Rev. Rul. 67-274 in ruling that a triple drop and liquidation were Sec. 351 exchanges followed by a D reorganization. The letter rulings were unclear as to whether the transaction could have satisfied the requirements of a triangular C reorganization. However, because another taxpayer cannot rely on a letter ruling, Rev. Rul. 78-130 still applied to recharacterize a double drop and liquidation as a triangular C reorganization.


While Rev. Ruls. 2015-9 and 2015-10 provide welcome clarification with respect to the uncertainty in applying Rev. Rul. 78-130, questions remain. Specifically, it is uncertain how a taxpayer could structure a double drop and liquidation transaction as a triangular C reorganization instead of as a Sec. 351 exchange followed by a D reorganization. In addition, the new rulings do not address whether the Sec. 351 exchange could be treated as a B reorganization. However, these rulings continue the trend of guidance that follows the form of a transaction as the substance.


Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.

For additional information about these items, contact Ms. Smith at 202-414-1048 or

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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