Letter ruling provides guidance on distributions in a reorganization

Editor: Mark G. Cook, CPA, CGMA

Recently, in Letter Ruling 201721014, dealing with a reorganization transaction, the IRS ruled on how the distribution of stock is treated in a tax-free reorganization and whether there is any potential recognition of gain.

In the letter ruling, the parent and target corporation is owned by two individuals, who are married. The parent company owns more than 80% of two other corporations (Corporation 1 and Corporation 2) that are part of the parent company’s consolidated group. The parent company similarly owns less than 80% of another subsidiary company that is also the acquiring company and is not part of the consolidated group. In the transaction, the target company will exchange all its common stock in the acquirer (old stock) in exchange for voting common stock in the acquirer (new stock). The acquirer will not assume any of the target company’s liabilities nor receive any of the target’s assets subject to liabilities. The individual shareholders may contribute cash to the capital of the target to enable it to pay off liabilities, or the shareholders may pay or assume liabilities of the target. The target company will convert to a limited liability company, and no election will be made for it to be taxed as a corporation.

The letter ruling states that if the series of steps above qualifies as a reorganization under Sec. 368(a)(1):

1. Under Sec. 356(a), the distribution of Corporation 1 and Corporation 2 stock will constitute a distribution of property with respect to the stock of the target company to which Sec. 301 applies. The excess, if any, of the amount of this additional consideration distributed with respect to a share of target stock over the amount of the distribution treated as a dividend will be applied against and reduce the shareholder’s adjusted basis in the share, and any remaining excess will be treated as gain from the sale or exchange of property under Secs. 301(c)(2) and 301(c)(3).
2. The target company will recognize gain as if it sold the additional consideration to its shareholders at its fair market value on the date of reorganization under Sec. 361(c)(2).

Under this letter ruling, a holding company may reorganize into a partially owned subsidiary by exchanging old shares for new shares of the subsidiary and then liquidating. An analysis of any gain to be recognized would have to be done in applying the letter ruling to other situations. As the IRS notes in the letter ruling, it applies only to the taxpayer who requested it and may not be used or cited as precedent.

EditorNotes

Mark G. Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.

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