Tax Executives Institute
Seminar on Mergers and Acquisitions
October 26, 2007
Gregory N. Kidder
Steptoe & Johnson LLP
Washington, DC
Steven B. Teplinsky
Steptoe & Johnson LLP
Washington, DC
Copyright © 2007 Steven B. Teplinsky, and Lisa M. Zarlenga
Lisa M. Zarlenga
Steptoe & Johnson LLP
Washington, DC
Steven B. Teplinsky
steplinsky@steptoe.com
TEL: 202.429.6245
FAX: 202.429.3902
Steven B. Teplinsky is a partner in the Washington office of Steptoe & Johnson LLP, where he is a
member of the firm's Tax group. His practice focuses on the taxation of corporate and partnership
transactions.
AREAS OF PRACTICE
Corporate Tax Transactions
Tax
Tax Planning & Controversy
Mr. Teplinsky assists sophisticated corporate clients in planning for tax-free and taxable corporate
acquisitions, dispositions, and spinoffs. In addition, Mr. Teplinsky provides advice on the special
rules applicable to consolidated groups and the special rules applicable to Subchapter S
corporations. He also has substantial experience with debt securitization transactions and has been
involved in structuring innovative partnership transactions and financial products. In addition to
providing tax planning advice, Mr. Teplinsky has significant experience in seeking advance rulings
from the Internal Revenue Service (IRS), where he was an attorney-advisor in the Corporate
Division of the Office of Chief Counsel, and in assisting clients in protesting adjustments proposed
by the IRS during the audit process.
EDUCATION
The University of Chicago Law School
J.D., 1983
Associate Editor, The University of
Chicago Law Review
University of Michigan
A.B., with highest honors and high
distinction, 1980.
JUDICIAL CLERKSHIPS
Law Clerk to Honorable Charles L.
Levin, Michigan Supreme Court, 198384
BAR & COURT ADMISSIONS
District of Columbia
Mr. Teplinsky currently is an adjunct professor at the Georgetown University Law Center, where he
teaches federal income taxation in the LLM program.
Lisa M. Zarlenga
lzarlenga@steptoe.com
TEL: 202.429.8109
FAX: 202.429.3902
AREAS OF PRACTICE
Corporate Tax Transactions
IRS Controversy & Tax Litigation
Partnerships/LLCs/S Corporations
Tax
EDUCATION
Georgetown University Law Center
LL.M., Taxation, with honors, 1997
Ohio State University College of Law
J.D., with honors, 1994
Order of the Coif
Ohio State Law Journal
Ohio State University
B.S., Honors Accounting, summa cum
laude, 1991
Beta Gamma Sigma
JUDICIAL CLERKSHIPS
Law Clerk to the Honorable Robert P.
Ruwe, US Tax Court, 1994-96
BAR & COURT ADMISSIONS
District of Columbia; Ohio; US Supreme
Court; US Tax Court; US Court of
Federal Claims
Lisa M. Zarlenga is a partner in the Washington office of Steptoe & Johnson LLP, where she is a
member of the firm's Tax group. She practices in the area of federal income taxation. Ms. Zarlenga has
significant experience in both transactional and planning matters and tax controversy matters. Ms.
Zarlenga's practice also involves addressing tax policy matters with Congress and the Department of
Treasury with respect to proposed tax legislation or Treasury regulations.
Ms. Zarlenga is heavily involved in the tax bar, holding leadership positions with both the American
Bar Association and the District of Columbia Bar Tax Sections. Ms. Zarlenga was elected to and
currently serves as a member of the DC Bar Tax Section Steering Committee, which oversees the
operation of the entire Tax Section. She also serves as the Chairman of the Corporate Tax Committee of
the DC Bar. Ms. Zarlenga is an officer of the ABA Corporate Tax Committee and also serves on the
ABA Government Relations Committee.
Transactional and Planning Matters
Ms. Zarlenga has significant experience structuring tax-free and taxable acquisitions and dispositions
for both public and private companies, including providing opinion letters and seeking advance rulings
from the IRS. She has particular experience in the areas of section 355 spin-offs and the use of
disregarded entities in corporate transactions. She is also frequently called upon to assist in restructuring
financially troubled businesses and to advise clients with respect to the special rules governing
consolidated groups.
Tax Controversy Matters
Ms. Zarlenga's practice also involves advising clients in the context of complex tax controversies, both
at the administrative level and in litigation. Ms. Zarlenga has advised clients during the audit process,
prepared protests, participated in IRS Appeals conferences, responded to requests for technical advice,
and handled matters in US district courts and the Court of Federal Claims. She has assisted in
negotiating settlements both at the IRS Appeals level and once the matter has been docketed in court.
Ms. Zarlenga also has experience handling controversy matters involving tax-advantaged transactions
and has assisted in negotiating a global tax settlement with the IRS with respect to one such transaction.
Gregory N. Kidder
gkidder@steptoe.com
TEL: 202.429.6755
FAX: 202.429.3902
Gregory N. Kidder is an associate in the Washington office of Steptoe & Johnson LLP, where he is a
member of the firm’s Business Solutions Department. Mr. Kidder’s practice focuses primarily on
taxation.
AREAS OF PRACTICE
Corporate Tax Transactions
International Tax
Tax
Prior to graduating from Harvard Law School, Mr. Kidder worked as a summer associate for both
Steptoe and a Chicago law firm.
EDUCATION
Harvard Law School, J.D., 2002
Duke University, A.B., Political Science,
magna cum laude, 1999
BAR & COURT ADMISSIONS
District of Columbia; Virginia
During the summer of 1998, Mr. Kidder worked as a White House Intern in the Office of the Counsel to
the President, where he assisted attorneys and staff with work relating to the President’s federal judicial
appointments.
Overview
•
•
The purpose of this presentation is to explain the basic requirements of taxable and tax-free
transactions and the resulting tax consequences.
The presentation is organized as follows:
8:30-9:30
9:30-10:00
10:00-10:15
10:15-11:15
11:15-12:00
12:00-1:00
1:00-2:00
2:00-3:00
3:00-3:15
3:15-4:00
•
Incorporations - Sections 351, 357, 358, 362, 1032
Speaker:
Steven B. Teplinsky
Liquidations - Sections 331, 332, 336, 337
Speaker:
Gregory N. Kidder
BREAK
Tax-Free Acquisitions - Sections 368, 354, 356, 358, 361, 362
Speaker:
Steven B. Teplinsky
Use of LLCs in Acquisitions and Dispositions
Speaker:
Lisa M. Zarlenga
LUNCH
Taxable Acquisitions – Sections 338, 338(h)(10), 1060, 197
Speaker:
Gregory N. Kidder
Section 355 Stock Distributions
Speaker:
Lisa M. Zarlenga
BREAK
Economic Substance
Speaker:
Steven B. Teplinsky
At the end of the presentation is a description of Steptoe & Johnson LLP’s tax practice.
5
Table of Contents
•
Introduction
•
Incorporations – pg. 9
–
–
–
–
–
–
•
Liquidations – pg. 56
–
–
–
–
–
•
Section 351
Statutory Requirements
Tax Consequences
Rev. Rul. 70-140 and Rev. Rul. 2003-51
Limitations on Transfer and Importation of Built-in Losses
Troubled Companies
Sections 331 and 332
Statutory Requirements
Tax Consequences
Actions to Avoid or Comply with Requirements of Section 332
Troubled Companies
Tax-Free Acquisitions – pg. 81
–
–
Reorganizations under Section 368
• A, B, C, D, E, F, a2D, a2E
Current Developments
• Troubled Companies
• All Cash D reorganizations
• Rev. Rul. 2007-8 & Section 357(c)(1)
6
Table of Contents (cont’d)
•
Use of LLCs in Acquisitions and Dispositions – pg. 125
–
–
–
–
–
•
Taxable Acquisitions – pg. 168
–
–
–
–
•
Disregarded Entities in General
Sale of an Interest in a Disregarded Entity
Reorganizations Involving Disregarded Entities
Section 355 Transactions
Insolvency and Bankruptcy Issues
Asset Purchases and Stock Purchases
Sections 1060, 338, 338(h)(10)
Section 197
Contingent Liabilities
Section 355 Stock Distributions – pg. 235
– Spin-offs, split-offs, and split-ups
– Current Developments
• Active Trade or Business Requirement
• Section 355(g)
•
Economic Substance – pg. 289
7
Introduction - Terms
T S/H’s
P S/H’s
T
P
T Assets
P Assets
•
P = The purchasing corporation (buyer)
•
T = The target corporation (seller)
•
For purposes of this presentation, unless otherwise noted, all entities are domestic C
corporations.
•
Taxable and tax-free acquisitions frequently involve S corporations, partnerships, and
LLCs. LLCs are addressed briefly at the end of this presentation. Partnerships and S
corporations are beyond this presentation’s scope.
•
All section references are to the Internal Revenue Code of 1986, as amended.
8
Incorporations
9
General Exchange Rules
•
Assume:
– Property owned by individuals or other persons (transferor)
– Is transferred to a corporation (transferee corporation) in exchange for its stock
•
General rule of the Code – section 1001
– Section 1001(c) -- except as otherwise provided, gain must be recognized on a sale or
exchange of property
– Section 1001(a) gain -- FMV of stock received less basis of property exchanged
•
Example -– A transfers assets:
FMV
basis
$50,000
$10,000
– A receives stock:
FMV
$50,000
stock (FMV)
less basis
equals gain realized
•
$50,000
$10,000
$40,000
However, section 351 provides an exception to this general rule.
10
Section 351 In General
•
Section 351 – No gain or loss is recognized if property is transferred to a corporation
solely in exchange for stock of such corporation.
•
Section 351 -- Statutory Requirements
–
–
–
–
One or more persons
Transfer property to a corporation
Solely in exchange for stock
The transferor(s) are in control of the corporation immediately after the transfer
•
Section 351 is not elective -- if tests met, it applies -- Gus Russell, Inc. v.
Commissioner, 36 T.C. 965 (1961).
•
If section 351 applies, the following statutes govern the tax consequences
– Section 351 -- nonrecognition of gain or loss to the transferor
– Section 1032 (not section 361) -- nonrecognition of gain or loss to the transferee
corporation
– Section 358 -- basis of corporate stock received by the transferor generally is basis of
property transferred (substituted basis)
– Section 362 -- basis of property to the corporation generally is basis of property in the
hands of the transferor (carryover basis)
– Stock and assets take the same basis (substituted and carryover basis) -- causes double tax
on sale of stock and assets
11
Section 351 – Statutory Requirements
•
One or More Persons
– Section 7701(a)(1) -- "person" is broader than "individual" -- covers corporations,
partnerships, estates, and trusts
– Multiple persons may transfer property for stock
– Transfers need not be simultaneous -- so long as all are pursuant to a single plan (with
orderly execution) and parties' rights are defined in advance -- Treas. Reg. § 1.3511(a)(1)
12
Section 351 – Statutory Requirements
•
Transfer of "Property"
– Not defined in the statute
• section 317 defines property but it applies only to Part I of Subchapter C (which does not
include section 351)
• property includes most assets –
– money -- Rev. Rul. 69-357, 1969-1 C.B. 101
– nonexclusive license -- held to be property -- E. I. DuPont De Nemours & Co. v. United States,
471 F.2d 1211 (Ct. Cl. 1973)
– corporate name and goodwill -- held to be property -- Rev. Rul. 79-288, 1979-2 C.B. 139
– letter of intent relating to the financing of the construction of a hotel -- held to be property -United States v. Stafford, 727 F.2d 1043 (11th Cir. 1984)
– Services are not property -- section 351(d)(1)
• Recipients of stock for services recognize income to the extent of value of stock received
-- James v. Commissioner, 53 T.C. 63 (1969); cf. Hospital Corporation of America v.
Commissioner, 81 T.C. 520 (1983)
• Example -- receive stock for legal and accounting services
– Bankruptcy Tax Act of 1980 -- amended section 351 to treat the following as "nonproperty" -• debts of the transferee corporation not evidenced by a security
• interest on the transferee's debt accrued during the transferor's holding period
• persons who receive stock in exchange for unsecured debt of the transferee corporation or
accrued but unpaid interest will recognize gain or loss on the exchange -- cf. Rev. Rul.
77-81, 1977-1 C.B. 97; PLR 8245010
13
Section 351 – Statutory Requirements
•
Solely in Exchange for Stock
– Solely
• Section 351(b), i.e. gain (but no loss) recognition, applies if the transferors receive
property other than stock
– In Exchange
• Transfer entire interest in property or an interest which is continuous, perpetual and
irrevocable -- E. I. DuPont De Nemours & Co., 471 F.2d 1211 (Ct. Cl. 1973); Rev. Rul.
71-564, 1971-2 C.B. 179; Rev. Rul. 69-156, 1969-1 C.B. 101; Rev. Rul. 64-56, 1964-1
C.B. 133
• Transfer of a limited interest with retained economic ownership may constitute a license
and not an exchange -- see also TAM 9215005
• Under proposed regulations, to constitute an “exchange” there must be both a surrender of
net value and a receipt of net value.
– For Stock
•
•
•
•
•
•
no statutory definition
broad interpretation -- need not be voting stock
same meaning as in the reorganization area (sections 354 and 361 et al.)
stock rights and warrants do not qualify
contingent right to acquire additional stock may qualify
wholly owned corporation need not issue new stock when its owner transfers property to
it -- section 351 does not require this "meaningless gesture" -- Lessinger v. Commissioner,
85 T.C. 824 (1985), rev'd on other grounds, 872 F.2d 519 (2d Cir. 1989); see also Scallen
v. Commissioner, 54 T.C.M. 177 (1987), aff'd, 877 F.2d 1364 (8th Cir. 1989)
14
Section 351 – Statutory Requirements
•
Solely in Exchange for Stock (cont’d)
– Section 351(g)
• excludes "nonqualified preferred stock" from the definition of "stock" for purposes of
section 351 (and sections 354, 355, 356, and 1036)
• Definition of “nonqualified preferred stock”
– as amended by the 2004 JOBS Act, nonqualified preferred stock is defined as
preferred stock that is limited and preferred as to dividends and does not
participate in a real and meaningful way in corporate growth to any significant
extent and for which:
» the holder has the right to require the issuer or a related person to redeem
or purchase the stock;
» the issuer or a related person is required to redeem or purchase the stock;
» the issuer or a related person has the right to redeem or purchase the stock
and, as or the issue date, it is more likely than not that such right will be
exercised; or
» the dividend rate for the stock varies in whole or in part (directly or
indirectly) with reference to interest rates, commodity prices, or other
similar indices
15
Section 351 – Statutory Requirements
•
Control
–
–
Transferor or transferors must be in control of the corporation
• Control need not be obtained in this transaction -- can own stock from previous transactions
• Defined in section 368(c): (a) 80% of total combined "voting power" of all stock "entitled to
vote," and (b) 80% of the total number of shares of each class of nonvoting stock -- Rev. Rul.
59-259, 1959-2 C.B. 115
General rules
• outstanding stock not authorized stock or treasury stock
• beneficial ownership not mere legal title
• constructive ownership provisions do not apply -- see Yamamoto v. Commissioner, 51 T.C.M.
1560 (1986), aff'd in part and dismissed in part without published opinion, 891 F.2d 297 (9th
Cir. 1989)
• convertible stock or debentures and preferred stock having contingent voting rights -- not voting
stock
• little guidance in defining "voting power" or "voting stock"
• troublesome if multiple classes of stock with disproportionate voting and equity rights
16
Section 351 – Statutory Requirements
•
Multiple transferors
– can have more than one transferor and qualify under section 351 -- provided transferors as a
group have control
– existing shareholders who do not transfer property are not transferors
– a person who receives stock for services only is not a transferor
– a person who receives stock for indebtedness of the transferee corporation (not evidenced by a
security) is not a transferor
– if a person transfers property for stock and also receives stock for services or indebtedness -- all
of his stock is counted in determining whether transferors have control -- Treas. Reg. § 1.3511(a)(2), ex. 3
– person who transfers stock or property to a subsidiary in exchange for parent's stock is not
counted in determining whether group of transferors has control of parent -- Rev. Rul. 84-44,
1984-1 C.B. 105
– factual question whether transferor is part of control group -- Russell v. Commissioner, 832 F.2d
349 (6th Cir. 1987)
– accommodation transferor -- transfer of minor amount of property so that the group of
transferors have control -- will not be recognized
• Rev. Proc. 77-37, 1977-2 C.B. 568 -- to qualify as a transferor a shareholder must convey property
valued at 10% of stock already owned (for advance ruling)
17
Section 351 – Statutory Requirements
•
Immediately After the Exchange
– Is there control if the shareholder disposes of part of the stock shortly after receiving it
• shareholder receives 100% of the stock and immediately sells 25%
• shareholder receives 100% of the stock and the corporation issues additional stock
reducing the shareholder's interest to 75%
– Step transaction doctrine -- momentary control is generally not sufficient
• transferor agrees prior to transfer to dispose of sufficient stock to cause loss of
control -- need not be binding commitment
• the subsequent transfer is an integral part of the incorporation, i.e., first transfer
would not have happened without the second
–
Authority
• McDonald's of Zion, Inc. v. Commissioner, 688 F.2d 520 (7th Cir. 1982); Intermountain Lumber
Co. v. Commissioner, 65 T.C. 1025 (1976); American Bantam Car v. Commissioner, 11 T.C.
397 (1948)
• Cf. National Bellas Hess, Inc. v. Commissioner, 20 T.C. 636 (1953) (transferor's control "real
and lasting," not momentary formality, subsequent relinquishment not part of plan of
reorganization or exchange)
• Rev. Rul. 79-70, 1979-1 C.B. 144 -- section 351 not applicable because of required subsequent
transfer
• Rev. Rul. 79-194, 1979-1 C.B. 145 (Situation 1) -- transferor sells stock to another transferor -section 351 applies
• TAM 8735009 -- section 351 applies to transfers by two corporations notwithstanding right of
one corporation to purchase stock initially acquired by second corporation
18
Section 351 – Example – In General
A
Assets
FMV=$75
Basis = $50
X stock
X
Facts: A transfers assets with a FMV of $75 and a basis of $50 to newly formed X in exchange for 100% of X Stock.
Result: The transaction qualifies as a section 351 transaction.
• A does not recognize gain on the contribution.
• A takes a basis of $50 in the X stock.
• X takes a basis of $50 in the transferred assets.
19
Section 351 – Example: Control Requirement
A
A
Assets
FMV=$75
Basis = $50
B
100%
X
A
B
75%
X
25% of
X stock
25%
X
Facts: A owns 100% of X. B transfers assets with a FMV of $75 and a basis of $50 to X in exchange for 25% of X Stock.
Result: The transaction does not qualify as a section 351 transaction because B is not in control after the exchange.
• B recognizes $25 gain on the exchange (i.e., $75 - $50).
• B takes a basis of $75 in the X stock..
• X takes a $75 basis in the transferred assets.
20
Section 351 – Example: Multiple Transferors
B
A
C
X
First Scenario
Second Scenario
Facts: A, B, and C form X corporation, A and
B transfer property for 78% of the X stock, C
performs services for 22% of the stock.
Facts: A and B receive 80% of the X stock for
property and C receives 20% of the stock for
services.
Result: Section 351 does not apply because
persons who transferred property (i.e., A and
B) are not in control -- A, B, and C are taxed.
Result: Section 351 applies to A and B.
However, section 351 does not apply to C and
C is taxed on the receipt of stock for services.
21
Section 351 – Example – Multiple Transferors
B
A
C
X
Third Scenario
Facts: Instead, A and B receive 78% of the stock for property, C receives 22% of the stock for
property and services.
Result: Section 351 applies regardless of the amount of property transferred by C (provided the
property transferred by C is not only of nominal value) and C is taxed to extent he receives stock
for services.
22
Section 351 – Example: Successive Transfers
A
Y
Z
•
Facts: A transfers assets to Y corporation in exchange for all the stock of Y, and Y immediately transfers
the assets to Z corporation in exchange for all the Z stock. Does section 351 apply to each exchange -- does
A have "control“?
– Rev. Rul. 77-449, 1977-2 C.B. 110, treats each transfer as a separate transaction --section 351 applies
to each exchange
– Rev. Rul. 83-34, 1983-1 C.B. 79, same facts as above except A holds only 80% of the Y stock and Y
holds only 80% of the Z stock --section 351 applies to each exchange -- see also Rev. Rul. 83-156,
1983-2 C.B. 66
– Unclear whether result changes if Y receives only 50% of the Z stock and a third party (which also
transfers property to Z) receives the other 50%
– See PLR 9137003 -- successive transfers among related parties are in the nature of a business
adjustment and do not have the effect of the taxpayer's "cashing in" of a gain
23
Rev. Rul. 70-140
STEP ONE
STEP TWO
END
A
A
A
Business
Assets
X Stock
X
X Stock
S/Hs
S/Hs
Y
Y Stock
X
Y
X
Facts: All the outstanding stock of X corporation was owned by A, an individual. A also operated a similar business
in the form of a sole proprietorship on the accrual basis of reporting income. Pursuant to an agreement between A and
Y, an unrelated corporation, A transferred all the assets of the sole proprietorship to X in exchange for additional
shares of X stock. A then transferred all his X stock to Y solely in exchange for voting common stock of Y, which
was widely held.
Ruling: The two steps must be treated as an integrated transaction. The transfer of business assets from A to X is
transitory and should be ignored. The transaction is recharacterized as a sale of the business assets from A to Y,
followed by a contribution of the business assets from Y to X.
24
Rev. Rul. 70-140 (Variation)
W
X
Business A
Business B
STEP ONE
Business A Assets
Z Stock
STEP TWO
Merge
Z
Y
Y Voting Stock
(< 80%)
Facts: Corporation W transfers it Business A assets to Z in exchange for Z stock. Z then merges into
Y in exchange for Y voting stock, which is distributed to W. Both steps are part of a prearranged plan.
Result: The transfer of Business A assets by W to Z for Z stock does not satisfy the requirements of
section 351 because the transaction is recharacterized under Rev. Rul. 70-140 as a transfer of the
business assets by W directly to Y in exchange for Y voting stock and W did not end up with control
of Y immediately after the exchange.
25
Rev. Rul. 2003-51
W
40%
(3)
Z stock
$30x
(4)
Z
$30x and Business A
60%
Y stock
Y
Business A
Z Stock
X
Y stock
Business A, B, C
(1)
W
X
(2)
Y
Business A
Z
$30x
Business A
Facts: Corporation W engages in Businesses A, B, and C. X, an unrelated corporation, also engages in Business A through its whollyowned subsidiary, corporation Y. The corporations desire to combine their businesses in a holding company structure. Under a
prearranged plan, the following transfers take place: (1) W forms Z and contributes its Business A to Z for Z stock; (2) W contributes
its Z stock to Y in exchange for Y stock; (3) simultaneously, X transfers $30x to Y in exchange for additional Y stock to meet the
capital needs of Business A; and (4) Y transfers the $30x and its Business A to Z, which is now a wholly-owned subsidiary of Y. After
the transfers, W owns 40% of Y stock and X owns 60% of Y stock.
Result: W’s transfer of Business A to Z for Z stock (Transfer 1) qualifies as a tax-free exchange under section 351, notwithstanding
the subsequent transfers. The Service did not recharacterize the steps of the transaction, but instead adhered to the form of the
transfers. Cf. Rev. Rul. 67-274, Rev. Rul. 2001-26, and Rev. Rul. 2001-46. Transfer 1, Transfers 2 and 3, and Transfer 4 are treated as
three successive tax-free exchanges under section 351. See Rev. Rul. 77-448. The Service distinguished Rev. Rul. 70-140 on the basis
that the transfer of Business A to Z was not necessary for the parties to have structured the transaction in a tax-free manner. Rev. Rul.
26
2003-51 appears limited to section 351 transactions.
Application of Rev. Rul. 70-140 to
Facts of Rev. Rul. 2003-51
W
X
Business A,B,C
Y stock Y stock
(1)
W
(2)
$30x
Business A
X
40%
60%
Y
Y
Business A
(3)
Z stock
Business A and $30x
Z
Z
$30x
Business A
Facts: Same facts as Rev. Rul. 2003-51.
Result: Under Rev. Rul. 70-140, the transaction would be recharacterized as follows: (1) W contributes
Business A to Y for Y stock; (2) simultaneously, X contributes $30x to Y for additional Y stock; and (3) Y
contributes Business A and $30x to Z for Z stock, with Z becoming a wholly-owned subsidiary of Y. Steps 1
and 2 qualify as a tax-free exchange under section 351 and Step 3 qualifies as a tax-free exchange under
section 351.
27
Rev. Rul. 2003-51 (Variation)
(2)
(1)
A
W
$
Z Stock
(60%)
$
60%
Y stock
Y
Business A
Z Stock
(40%)
X
40%
(3)
Z stock
(60%)
Business A
X
Y stock
Business
A, B, C
W
(4)
Z Stock
Z
$ and Business A
Y
Business A
A
75%
25%
Z
$30x
Business A
Facts: Corporation W engages in Businesses A, B, and C. X, an unrelated corporation, also engages in Business A through its whollyowned subsidiary, corporation Y. Individual A has Business A assets. Under a prearranged plan, the following steps take place: (1)
W and A form Z. W contributes its Business A to Z for 60% of the Z stock and A contributes its Business A assets and cash to Z for
40% of the Z stock; (2) W contributes its Z stock (60%) to Y in exchange for Y stock; (3) simultaneously, X transfers cash to Y in
exchange for additional Y stock to meet the capital needs of Business A; and (4) Y transfers the cash and its Business A to Z for
additional Z stock. After the transfers, W owns 40% of Y stock and X owns 60% of Y stock. Y owns 75% of Z stock and A owns
25% of Z stock.
Result: Under the reasoning of Rev. Rul. 2003-51, W’s transfer of Business A and A’s transfer of Business A assets and cash to Z for
Z stock (Transfer 1) should qualify as a tax-free exchange under section 351, notwithstanding the subsequent transfers. Query whether
under Rev. Rul. 2003-51, Transfers 2 and 3 (combined) and Transfer 4 would be treated as separate exchanges? If so, Transfers 2 and
3 would be a tax-free exchange under section 351, but Transfer 4 would not be a tax-free exchange under section 351 because Y does
not satisfy the control test. Is this inconsistent with Rev. Rul. 70-140?
28
Section 351(b) -- Transfers Not Solely for Stock
•
Section 351(b) provides for limited recognition of gain if property is
transferred in exchange for stock and other consideration -- cash, securities
or other property (i.e., boot)
– “Solely" requirement of section 351(a) is not met
– Realized gain (FMV of stock and boot received less basis of property given up)
is recognized to the extent of the value of the boot received
– No loss recognized
•
Character of gain (capital gain or ordinary income)
– Depends on character of property transferred
– Sections 291, 1239, 1245, 1250 apply if gain is recognized
– Under section 1239, gain recognized on a sale or exchange of depreciable
property between "related parties" is taxed as ordinary income
• “Related party” transactions include a sale or exchange from a parent corporation to
its subsidiary or from a corporation to a commonly controlled partnership
•
Multiple Assets
– If there are multiple assets, the amount and character of gain determined on an
individual asset basis. See Rev. Rul. 68-55, 1968-1 C.B. 140
29
Section 351 – Example: Boot
A
•
A transfers
Asset 1:
Asset 2:
•
A receives
stock:
boot:
X
FMV
Total
$50,000
(100%)
boot allocated to each asset:
stock (FMV)
plus boot (FMV)
equals amount realized
Minus Basis
equals gain realized
gain recognized
$30,000
$20,000
$50,000
$50,000
0
FMV
basis
FMV
basis
FMV
FMV
Asset 1
$45,000
(90%)
Asset 2
$5,000
(10%)
$20,000
x 90%
$18,000
$20,000
x 10%
$2,000
$27,000
$18,000
$45,000
$25,000
$20,000
$18,000
$3,000
$2,000
$5,000
$25,000
($20,000)
0
$45,000
$25,000
$5,000
$25,000
$30,000
$20,000
30
Section 351: Tax Consequences to Transferor-Shareholder
•
Section 358 -- Basis of Stock Received by Transferor-Shareholder
– Concepts of basis
• Cost basis -- what you pay
• Substituted basis -- the basis of property received takes the basis of the property given up -section 7701(a)(44)
• Carryover (or "transferred") basis -- the basis of the property received is equal to the basis
of the property in the hands of the transferor -- section 7701(a)(43)
– Section 358 -- generally the basis of the stock received by the transferor equals the basis of the
property given up (substituted basis)
• Reduced by money or other property received (i.e., boot)
• Increased by gain recognized
• Basis of money is face amount -- basis of other property is FMV
– If the transferor receives several classes of stock, the basis is allocated among the stock on a
FMV basis -- Rev. Rul. 85-164, 1985-2 C.B. 117
31
Section 351: Tax Consequences to Transferor-Shareholder
•
Liabilities
– Liabilities assumed by the corporation (for purposes of determining basis) are treated as
money received -- reduce shareholder's basis in the stock
– Section 357 determines whether gain is recognized on assumption of liabilities
• A recourse liability will be treated as assumed to the extent that, based on all the
facts and circumstances, the transferor has agreed to, and is expected to, satisfy such
liability (or portion thereof), whether or not the transferor has been relieved of such
liability
• Where property is transferred subject to a nonrecourse liability, unless the facts and
circumstances indicate otherwise, the transferee would be treated as assuming a
ratable portion of the liability, based on the relative fair market values of all assets
subject to such liability
• Section 357(d), added by the Miscellaneous Trade and Technical Corrections Act of
1999, eliminates the distinction between the assumption of a liability and the
acquisition of an asset subject to a liability.
32
Section 351: Tax Consequences to Transferor-Shareholder
•
Section 357(a) -- General Rule
–
–
–
–
•
The assumption of a liability of the transferor by the corporation is not treated as money or other
property (i.e., not boot) for purposes of determining gain (it is treated as money when determining
basis -- section 358)
Liability generally does not cause recognition of gain to the transferor
Permits ongoing business to incorporate without fear of tax
Immediate payment of liability by the corporation is treated as an assumption and not a distribution of
boot. Therefore no gain is recognized See Kniffen v. Commissioner, 39 T.C. 553 (1962); Rev. Rul.
74-477, 1974-2 C.B. 116 (payment or assumption of expenses incurred by the transferor in a
section 351 transaction does not constitute boot)
Section 357(b) -- Exception to General Rule -- No Bona Fide Business Purpose
–
–
–
–
–
–
If the principal purpose for the assumption of the liability was
• To avoid tax, or
• Not a bona fide business purpose
Then the entire amount of the liability is considered money, contrary to the general rule of
section 357(a)
Gain or loss is thus recognized pursuant to section 351(b)
If section 357(b) applies to one liability it applies to all liabilities assumed -- Treas. Reg. § 1.357-1(c)
Section 357(b)(2) places the burden of proof on the taxpayer “by the clear preponderance of the
evidence.”
Generally applies to liabilities created shortly before incorporation and to personal liabilities of a
shareholder not related to the business
33
Section 351 – Example: Liabilities
A
X
•
A transfers
Asset 1:
FMV
basis
Liabilities assumed:
•
A receives
stock:
FMV
plus liabilities assumed:
equals amount realized
less basis
equals gain realized
gain recognized
Basis of stock (section 358)
old basis
less liability assumed
equals
$50,000
$10,000
$5,000
$45,000
$5,000
$50,000
$10,000
$40,000
0
$10,000
$5,000
$5,000
34
Section 351: Tax Consequences to Transferor-Shareholder
•
Section 357(c) -- exception to general rule when liabilities exceed basis of assets
–
–
–
–
–
–
if the liabilities of the transferor assumed by the corporation exceed the basis of the
assets transferred -- excess of liabilities over basis is treated as gain from sale of the
assets
compare section 357(b) (all liabilities treated as boot -- recognized only if gain realized)
with section 357(c) (excess liabilities treated as if gain recognized on sale -- whether or
not gain realized)
policy -- section 357(c) is required or gain would never be taxed -- alternative is to use
negative basis
character of gain -- capital gain or ordinary income depends on nature of property
transferred -- if multiple assets, then allocate gain among assets on FMV basis (similar
to boot provision of section 351(b))
aggregate basis of all assets transferred compared to total liabilities -- Treas. Reg.
§ 1.357-2(a); PLR 8715003
section 357(c)(2)
•
•
if both section 357(b) and section 357(c) apply, then section 357(b) controls
section 357(c) does not apply to a bankruptcy reorganization pursuant to section 368(a)(1)(G)
35
Section 351: Tax Consequences to Transferor-Shareholder
•
Section 357(c)(3) - Incorporating Business with Deductible Liabilities
–
–
–
Rule
• Under section 357(c)(3), if a taxpayer transfers liabilities the payment of which “would give rise to a deduction,” the
liabilities are excluded for purposes of section 357 (i.e., basis is not reduced and gain is not recognized).
History
• Revenue Act of 1978 added section 357(c)(3) to cure problem created on incorporation of cash basis business
• In Focht v. Commissioner, 68 T.C. 223 (1977), the Tax Court held that an obligation should not be treated as a liability
under sections 357 and 358 to the extent that its payment would have been deductible if made by the transferor.
• Section 357(c)(3) was intended to adopt the Tax Court’s ruling in Focht.
• Rev. Rul. 95-74, 1995-2 C.B. 36 -- contingent environmental liabilities are not included in determining whether
liabilities assumed exceed basis if contingent environmental liabilities had not yet been taken into account, i.e., have not
given rise to capital expenditure or effected basis -- expands the scope of 357(c)(3) to exclude not only deductible
liabilities, but some capital expenditures as well
• The Service has taken the position that section 357(c)(3) does not apply to exclude a liability to the extent the transferor
remains entitled to claim the deduction subsequent to the exchange. The Service has argued that therefore section
357(c)(3) applies only to the extent the transferee (rather than the transferor) would be entitled to a deduction. See e.g.,
TAM 2000060014 (Oct. 22, 1999); FSA 200122022 (June 1, 2001); FSA 200134008 (May 15, 2001); FSA 200121013
(Feb. 12, 2001); CCA 200117039 (Mar. 13, 2001); FSA 200217021 (Jan. 17, 2002); FSA 200218022 (Jan. 31, 2002);
FSA 200224011 (Mar. 5, 2002).
• The language of section 357(c)(3), the legislative history, and the Tax Court’s reasoning in Focht contradict the
Service’s position.
Recent Developments
• Courts have rejected the Service’s technical position. See Coltec Industries, Inc. v. United States, 2006-2 U.S.T.C. ¶
50,389 (Fed. Cir. 2006); Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006).
36
Section 351: Tax Consequences to Transferor-Shareholder
•
Section 358(h)
– provides (with exceptions) that if the basis of stock received by a taxpayer as part of a
tax-free exchange is greater than the stock’s FMV, the stock basis is reduced, but not
below zero, by the amount of the liability assumed in the exchange which did not
otherwise reduce the transferor’s basis.
– Added by Community Renewal Tax Relief Act of 2000, P.L. 106-554.
– Promulgated to stop perceived abusive transactions in which a taxpayer transferred
property to a corporation in exchange for stock and the assumption of certain liabilities;
the taxpayers took the position that the assumption of the liabilities did not reduce stock
basis but did reduce stock value. Accordingly, the sale of the corporation’s stock
created a loss.
37
Section 351: Tax Consequences to Corporation
•
•
•
Section 1032 -- No Gain or Loss Recognized to the Corporation on Receipt of
Property
–
Corporation recognizes no gain or loss on the receipt of property in exchange for its
stock
•
Section 1032 applies whether or not section 351 applies -- i.e., even if section 351
is not applicable the corporation recognizes no gain
Corporation May Recognize Gain on Transfer of Property Other than Stock
–
Section 351(f) treats a transfer by a corporation to its shareholders in a section 351
transaction as a nonliquidating distribution governed by section 311
–
Therefore, a corporation recognizes gain (but not loss) on a distribution of property other
than its own stock or obligations. See section 311(b).
Section 362 -- Basis of Property to the Corporation
–
Property in hands of the corporation has the same basis as in the hands of the transferor
(carryover basis) – increased by gain recognized to the transferor
–
Section 362(d) provides that the basis of any property shall not be increased above the
fair market value of such property by reason of any gain recognized to the transferor as a
result of the assumption of a liability
–
Section 362(e) added by 2004 American Jobs Creation Act to stop perceived abusive
transactions
•
Limitation on Transfer of built-in loss
•
Limitation on Importation of built-in loss
38
Limitation on Transfer of Built-in Losses
•
Section 362 Prior to 2004 American Jobs Creation Act (“AJCA”): Section 351 Transactions (Other than
Loss Importation Transactions Discussed Below)
– Under section 358, the transferor's basis in the stock of the controlled corporation was the same as the basis
of the property contributed to the controlled corporation, increased by the amount of any gain (or dividend)
recognized by the transferor on the exchange, and reduced by the amount of any money or property
received and by the amount of any loss recognized by the transferor
– Under section 362, the corporation’s basis in the transferred property was the same as it would have been
in the hands of the transferor, increased by the amount of gain recognized by the transferor on such transfer
•
Section 362 as Amended by AJCA: Section 362(e)(2)—Transfer of losses in a Section 351 Transaction
– If the aggregate adjusted basis of property contributed by a transferor (or by a control group of which the
transferor is a member) to a corporation exceeds the aggregate fair market value of the property transferred:
• The transferee’s aggregate basis in the properties is limited to the aggregate fair market value of the
transferred property
• Any required basis reduction is allocated among the transferred properties in proportion to their builtin-loss immediately before the transaction
• Transferor and transferee may elect to limit the basis in the stock received by the transferor to the
aggregate fair market value of the transferred property, in lieu of limiting the basis in the assets
transferred
–
Such election must be included with the tax returns of the transferor and transferee for the taxable year in which
the transaction occurs and, once made, is irrevocable
39
Limitation on Transfer of Built-in Losses—Example
P
Asset A
FMV = $100
Basis = $200
S Stock
Asset B
FMV = $100
Basis = $90
S
Facts: P contributes: (i) Asset A with a fair market value of $100 and an adjusted basis of $200 and (ii) Asset B with a
fair market value of $100 and a basis of $90 to S in exchange for S stock in a section 351 exchange.
Result: Unless P and S elect otherwise, P’s basis in its S shares is $290. There is an aggregate built-in loss of $90 in
Assets A and B. Thus, S’s aggregate basis in Assets A and B must be reduced $200 (i.e., the aggregate fair market value
of Assets A and B). Specifically, S’s basis in Asset A is reduced to $110 [200 – ($90 x $90/$90)] (i.e., the proportionate
share of built-in loss allocable to Asset A); S’s basis in Asset B remains $90 [$90 – ($90 x $0/90]. See section 362(e)(2).
40
Limitation on Importation of Built-in Losses
•
Section 362 Prior to AJCA: Incorporations, Reorganizations and Liquidations
– The basis of property received by a corporation, whether from domestic or foreign
transferors, in a tax-free incorporation, reorganization, or liquidation of a subsidiary
corporation was the same as the adjusted basis in the hands of the transferor, adjusted for
gain or loss recognized by the transferor.
•
Section 362 as Amended by AJCA: Section 362(e)(1)—Importation of Losses
(Incorporations, Reorganizations and Liquidations)
– If a “net built-in loss” is imported into the U.S in a tax-free incorporation or reorganization
from persons not subject to U.S. tax, the basis of each property so transferred is its fair
market value.
• A “net built-in loss” is treated as imported into the U.S. if the aggregate adjusted
bases of property received by a transferee corporation exceed the fair market value of
the properties transferred.
– Similar rules apply in the case of the tax-free liquidation by a domestic corporation of its
foreign subsidiary.
41
Limitation on Importation of Built-in Losses - Example
FP
Asset A
FMV = $100
Basis = $200
S Stock
Asset B
FMV = $100
Basis = $90
S
Facts: FP, a non-U.S. corporation not subject to U.S. taxation, incorporates S, a U.S. corporation. FP contributes to S:
(i) Asset A with a fair market value of $100 and an adjusted basis of $200 and (ii) Asset B with a fair market value of
$100 and a basis of $90 in exchange for S stock in a section 351 exchange. Immediately before the contribution, FP’s
gain or loss with respect to Assets A and B is not subject to U.S. taxation.
Analysis: FP’s basis in its S shares is $290. Although this transaction is subject to the rules of sections 362(e)(1) and
(e)(2), the loss importation rules of section 362(e)(1) have priority. See section 362(e)(2)(A)(i). Thus, S’s basis in
Asset A is reduced to $100 and S’s basis in Asset B is increased to $100. See section 362(e)(1).
42
Proposed Section 362(e)(2) Regulations
•
•
The IRS published proposed regulations under section 362(e)(2) on October 23, 2006.
The proposed regulations do not address the application of section 362(e)(2) to transfers
between members of a consolidated group and do not address the application of section
362(e)(1).
– Treasury and the IRS published proposed regulations on January 23, 2007 that address the
application of section 362(e)(2) in the consolidated context. See Prop. Treas. Reg. § 1.150213(e)(4).
•
•
•
The proposed regulations clarify that section 362(e)(2) applies separately to each
transferor where multiple transferors transfer property to a single transferee. Prop.
Treas. Reg. § 1.362-4(b)(2).
The proposed regulations clarify that section 362(e)(2) will not apply to certain transfers
of property where the net-built in loss is eliminated (e.g., a transaction described in
sections 351 and 368(a)(1)(D)). Prop. Treas. Reg. § 1.362-4(b)(6).
The proposed regulations clarify that section 362(e)(2) can apply to transfers wholly
outside the U.S. tax system, but will not apply if (i) neither party to the transfer was a
U.S. person, (ii) neither party was required to file a return (including an information
return), (iii) neither party was a CFC, (iv) the transfer occurred more than two years
before the assets enter into the U.S. tax system and (v) neither the transfer nor the later
importation of the assets was entered into with a view of reducing Federal income tax
liability. Prop. Treas. Reg. § 1.362-4(b)(7).
43
Proposed Section 362(e)(2) Regulations (Continued)
•
•
•
•
The proposed regulations clarify that for purposes of determining whether the
transferred property has a net built-in loss in the hands of the transferee, the bases of
such property first must be increased under section 362(a) or (b) for any gain
recognized by the transferor on the transfer of such property. Prop. Treas. Reg. §
1.362-4(b)(ii).
The proposed regulations detail the process by which the transferor and transferee
make a joint election to reduce the transferor’s basis in the transferee stock instead of
reducing the transferee’s basis in the property received in the transfer. Prop. Treas.
Reg. § 1.362-4(c).
The proposed regulations contain an example demonstrating how section 362(e)(2)
applies to a deemed section 351 transaction occurring by reason of section 304.
The Preamble to the proposed regulations states that section 336(d) and section
362(e)(2) are fully compatible where the parties do not make an election to reduce
the transferor’s basis in the transferee stock received. However, the Preamble notes
that if an election had been made, sections 336(d) and 362(e)(2) may operate to deny
part or all of an economic loss and invite comments regarding this issue.
44
Proposed Section 362(e)(2) Regulations –Example 1
P
Asset 1
Basis = $90
FMV = $60
S Stock
Asset 2
Basis = $110
FMV = $120
S
Facts: P contributes: (i) Asset 1 with a fair market value of $60 and an adjusted basis of $90 and (ii)
Asset 2 with a fair market value of $120 and a basis of $110 to S in exchange for S stock in a section 351
exchange.
Analysis: Unless P and S elect otherwise, P’s basis in its S shares is $290. There is an aggregate built-in
loss of $20 in Assets 1 and 2. Thus, S’s aggregate basis in Assets A and B equals $180 (i.e., the aggregate
fair market value of Assets 1 and 2). S’s basis in Asset 1 is reduced to $70 [$90 – ($20 x $30/$30)] (i.e.,
the proportionate share of built-in loss allocable to Asset 1). S’s basis in Asset 2 remains $110 [$110 –
($20 x $0/$30]. See section 362(e)(2); Prop. Treas. Reg. § 1.358-4(d), ex. 1.
45
Proposed Section 362(e)(2) Regulations –Example 2:
Boot in Section 351 Exchange
P
Asset 1
Basis = $80
FMV = $100
10 Shares -- S Stock
$25
Asset 2
Basis = $30
FMV = $25
S
Facts: P contributes: (i) Asset 1 with a fair market value of $60 and an adjusted basis of $90 and (ii)
Asset 2 with a fair market value of $120 and a basis of $110 to S in exchange for 10 shares of S stock and
$20 in a section 351 exchange.
Analysis: The proposed regulations require that the built-in loss in the hands of S, if any, be adjusted to
reflect the gain recognized by P in the exchange. P is required to recognize gain (but not loss) under
section 351(b) to the extent P receives boot in addition to the S stock received. For purposes of computing
the amount of gain required under section 351(b), the amount of boot ($25) is allocated to Asset 1 and
Asset 2 in proportion to their relative fair market values. Thus, P is treated as having received 8 shares of
S stock and $20 in exchange for Asset 1 and 2 shares of S stock and $5 in exchange for Asset 2. P must
recognize $20 of gain, and the basis of Asset 1 is increased by $20 to $100. The aggregate basis of Assets
1 and 2 ($130) exceeds their aggregate fair market value ($125), and thus section 362(e)(2) applies to
46
reduce S’s basis in Asset 2 to $25. Prop. Treas. Reg. § 1.358-4(d), ex. 6.
Proposed Section 362(e)(2) Regulations – Example 3:
‘D’ Reorganization & Spin-Off
A
B
Y Stock
2
X
Asset
Basis = $100
FMV = $60
Y Stock
1
Y
Facts: A and B are individuals that each own 50 percent of corporation X. X owns Asset with a basis of $100 and a fair
market value of $60. In a transaction described under section 351 and qualifying as a ‘D’ reorganization, X contributes
Asset to a newly formed corporation, Y, in exchange for Y stock., and then distributes all of the Y stock to A in exchange
for all of A’s X stock in a transaction described in section 355. A has no plan to dispose of his Y stock. B has no plan to
dispose of his X stock. No election is made under section 362(e)(2)(C).
Analysis: Although Asset has a built-in loss, the proposed regulations provide that section 362(e)(2) will not apply
because X distributes all of the Y stock received in the exchange without recognizing gain or loss under section 361(c),
and, upon completion of the transaction, no person holds Y stock or any other asset with a basis determined in whole or in
part by reference to X’s basis in the Y stock received in the exchange. If A were to dispose of his Y stock one year after
the spin-off, section 355(e) would apply to require A to recognize gain on the spin-off under section 361(c) and, as a
result, section 362(e)(2) would apply. Prop. Treas. Reg. § 1.358-4(d), ex. 4.
47
Proposed Section 362(e)(2) Regulations – Example 4:
Section 304 Transactions
X stock
Basis = $90
FMV = $60
X
A
$60
X stock
Y
X
Facts: A is an individual who owns all of the stock of both corporation X and Y. A has a basis of $90
in his X stock. A sells all of his X stock to Y for $60. Pursuant to section 304, A is treated as if he
transferred his X stock to Y in exchange for Y stock in a section 351 transaction and then as if he
redeemed the Y stock. No election is made pursuant to section 362(e)(2)(C).
Analysis: Under section 362(a), Y would otherwise receive a $90 basis in the X stock. Section 362(e)(2)
operates to reduce Y’s basis in X stock to $60. Prop. Treas. Reg. § 1.358-4(d), ex. 6.
48
Troubled Companies in Section 351
Incorporations
49
In General
•
Section 351 – No gain or loss is recognized if property is transferred to a corporation solely in
exchange for stock of such corporation.
•
Where the transferor of property is the sole shareholder of the transferee corporation, issuance
of new stock is not necessary, because it would be a meaningless gesture. See Lessinger v.
Commissioner, 85 T.C. 824 (1985), aff’d, 872 F.2d 519 (2d Cir. 1989); Rev. Rul. 64-155, 19641 CB 138.
•
In Rosen v. Commissioner, 62 T.C. 11 (1974), the taxpayer transferred the assets and liabilities
of a sole proprietorship to a newly formed corporation. At the time of the transfer, the liabilities
exceeded the value of the assets, and the corporation was insolvent. The court held that the
taxpayer realized gain under section 357(c) to the extent the liabilities assumed exceeded the
adjusted basis of the assets transferred. See also Focht v. Commissioner, 68 T.C. 223 (1977);
G.C.M. 33,915 (Aug. 26, 1968). But see DeFelice v. Commissioner, 386 F.2d 704 (10th Cir.
1967) (rejecting the taxpayer’s argument that section 357(c) did not apply, because he was
insolvent; the court found that the taxpayer failed to prove he was insolvent).
50
In General
•
Proposed No Net Value Regulations
– The proposed regulations provide that stock will not be treated as issued for
property if either:
• (i) the fair market value of the transferred property does not exceed the sum of the
amount of liabilities of the transferor that are assumed by the transferee in connection
with the transfer and the amount of money and fair market value of any other property
received by the transferor in connection with the transfer (i.e., the transferor does not
transfer net value); or
• (ii) the fair market value of the assets of the transferee does not exceed the amount of
its liabilities immediately after the transfer (i.e., the transferee is insolvent). Prop.
Treas. Reg. §1.351-1(a)(1)(iii).
– For purposes of (i), any liability of the transferor to the transferee that is
extinguished in connection with the transfer is treated as a liability assumed by
the transferee.
51
Insolvent Subsidiary
P
S LLC
Bank
$100 Debt
Assets = 50
Facts: P owns all of the interests of S LLC, which is disregarded for tax purposes. S has assets worth $50
and is indebted to the bank in the amount of $100. S LLC incorporates. The bank debt remains
outstanding.
Result: P is deemed to contribute all of the assets and liabilities of S LLC to a newly formed corporation in
exchange for stock of such corporation. Treas. Reg. §301.7701-3(g)(1)(iv). The transaction arguably
qualifies under section 351 under current law. See Rosen, 62 T.C. 11, Focht, 68 T.C. 223; G.C.M. 33,915
(Aug. 26, 1968). But see DeFelice, 386 F.2d 704.
However, under the proposed regulations, the transaction would not qualify, because P does not transfer net
value and the transferee is insolvent immediately after the transfer. Prop. Treas. Reg. §1.351-1(a)(1)(iii).
What if P agrees to satisfy S LLC’s obligation to Bank? See section 357(d).
52
Underwater Property
P
Asset A
FMV=$100
Liability=$150
S stock
S
Assets = $500
Liabilities = $200
Facts: P owns all of the stock of S. S has assets worth $500 and liabilities of $200. P contributes to S Asset
A, which is worth $100 but is subject to a nonrecourse liability of $150.
Result: The transaction arguably qualifies under section 351 under current law. See Rosen, 62 T.C. 11, Focht,
68 T.C. 223; G.C.M. 33,915 (Aug. 26, 1968); cf. section 301(b)(2) (amount of distribution reduced, but not
below zero, for liabilities assumed or to which property is subject); section 311(b)(2) (fair market value of
property received in distribution not less than amount of liability assumed or to which the property is
subject); section 336(b) (same). But see DeFelice, 386 F.2d 704. However, under the proposed regulations,
the transaction would not qualify, because P does not transfer net value. Prop. Treas. Reg. §1.3511(a)(1)(iii).
What if, in addition to Asset A, P transfers Asset B, which is unencumbered and has a value of $75?
53
Transfer to Make S Solvent
P
Asset A
FMV=$75
S stock
S
Assets = $100
Liabilities = $150
Facts: P owns all of the stock of S. S has assets worth $100 and liabilities of $150. P contributes to S Asset
A, which is worth $75.
Result: The transaction should qualify under section 351 under either current law or the proposed regulations.
54
Rev. Rul. 2006-2
X
S/H’s
X treasury stock
Newly issued Y stock
(80% of only outstanding class)
Y
Facts: In Rev. Rul. 74-503, 1974-2 C.B. 117, X corporation transferred shares of its treasury stock (with a FMV of
$3,000x and purchased by X several years previously from its shareholders for $2,000x) to Y in exchange for newly
issued shares of Y stock (with a FMV of $3,000x) which constituted 80 percent of the only outstanding class of stock
of Y. Rev. Rul. 74-503 determined that (i) X's transfer of its X stock to Y for Y stock is a section 351 transaction, (ii)
X has a 0 basis in its own stock, and (iii) under section 362, Y takes a 0 basis in X stock received and X takes a 0 basis
in the Y stock received.
Result: Rev. Rul. 2006-2 revokes Rev. Rul. 74-503, effective December 20, 2005. The ruling states that the
conclusion in Rev. Rul. 74-503 that the basis in the Y stock received by X in the exchange is determined under section
362(a) is incorrect. The ruling also states that the other conclusions in Rev. Rul. 74-503, including the conclusions that
X’s basis in the Y stock received in the exchange and Y’s basis in the X stock received in the exchange are zero, are
under study.
Analysis: Even if the transfer of X stock for Y stock is a section 351 transaction, section 362 does not apply to
determine X’s basis in the Y stock. Section 362 only applies to the transferee in a section 351 transaction. Section 358
generally applies to the transferor in a section 351 transaction. However, Rev. Rul. 74-503 determined that section 358
does not apply in this case because it does not apply to property acquired by a corporation in exchange for its own55
stock. See section 358(e). Because section 362 does not apply and section 358 does not apply, it is unclear what code
provision determines X’s basis in the Y stock.
Liquidations
56
In General
P
Liquidates
S
•
In liquidation, corporate stock is cancelled and shareholders succeed to ownership
of the corporate assets
– corporation may sell assets and distribute cash in liquidation
– corporation may distribute assets in kind and shareholders may sell or retain and operate
business as sole proprietorship or partnership
•
Complete liquidation not defined in Code
– Treas. Reg. § 1.332-2(c) -- status of liquidation exists when corporation ceases to be an
ongoing concern and its activities are merely for winding up affairs and paying debts
– Olmsted v. Commissioner, 48 T.C.M. 594 (1984) -- liquidation is a process, not an event
-- test for status of liquidation: (1) a manifest intent to liquidate, (2) a continuing
purpose to achieve liquidation, and (3) corporate activities oriented toward liquidation
57
In General
P
Liquidates
S
•
•
General rule
– under section 331, a liquidation is treated as a sale or exchange and gain must be
recognized is taxable to the liquidating corporation and its shareholders under sections
331 and 336.
Section 332(a) exception
– A liquidation is not taxable to a corporate shareholder if the corporate shareholder owns
at least 80 percent (by vote and value) of the stock of the liquidating subsidiary. Section
337 shields the liquidating company from tax.
– This type of transaction is in the nature of a reorganization -- combining business
operations rather than terminating operations
– History
• enacted in Revenue Act of 1935
• encourage simplification of corporate structure through tax-free liquidation of
subsidiaries
58
Section 331
•
Statute
– Section 331(a) -- distribution treated as full payment in exchange for stock
– Section 331(b) -- section 301 not applicable, i.e., no dividend consequences attach
•
Tax Consequences to Shareholder
– Shareholder is deemed to have sold his stock to the corporation in exchange for
assets received in the liquidation
– Gain or loss to shareholder
• The shareholder recognizes gain or loss to the extent of the difference between the FMV
of the assets received and the shareholder's basis in his stock -- section 1001; see Treas.
Reg. §1.331-1(b)
• Gain or loss is usually capital gain or loss (unless sections 341, 1246, 1248, 1291, dealer
situations, or Corn Products doctrine apply) -- section 1221
• Amount and character of gain determined on a per share basis; see Treas. Reg. §1.3311(e)
– if acquire stock in one block simply determine gain or loss for entire block
– if hold several blocks of stock, determine gain or loss for each block --can have gain on some
and loss on others and because of different holding periods can have short-term and long-term
gains and losses
– Basis of assets to shareholder
• section 334(a) -- basis of property received is its fair market value at time of the
distribution
59
Section 331: Example
Other
S/Hs
A
<80%
A
•
A owns 10 shares of X stock
–
–
5 shares acquired on January 1, 2005, for $12,000
5 additional shares acquired on January 15, 2007, for $17,000
•
On January 1, 2008, X is liquidated and A receives $30,000 for his stock ($3,000 per share)
•
2005 shares
2007 shares
5 x $3,000 = $15,000
less basis
-12,000
LTCG
3,000
5 x 3,000 = $5,000
less basis -17,000
STCL
(2,000)
60
Section 332 - Requirements
•
Section 332(b)(1)
– Requires that parent corporation ("P") own, on the date the plan of complete liquidation is
adopted, and every day thereafter until the receipt of the property, stock meeting the
requirements of section 1504(a)(2):
• 80% of the total voting power of subsidiary corporation's stock ("S") and 80% of the total
value of stock
• General intent is that other parts of section 1504(a) apply, including sections 1504(a)(4)
and (5) (other than section 1504(a)(5)(E)) -- H.R. Rep. No. 426 99th Cong., 1st Sess. 894
(1986)
• Thus, in applying 80% vote/value test -- nonvoting, nonparticipating, nonconvertible,
limited and preferred stock is excluded -- section 1504(a)(4)
• See also Treas. Reg. § 1.1504-4 for regulations issued under section 1504(a)(5)(A) and
(B) that treat certain options as exercised, certain warrants as stock, and certain stock as
not stock -- according to Notice 87-63, 1987-2 C.B. 375, such regulations will not apply
to liquidation plans adopted under section 332(b)(1) on or before the date the regulations
were published in proposed form (i.e., March 2, 1992) -- applies also to old sections 337
and 338(d)(3))
• The aggregate stock ownership rules of Treas. Reg. § 1.1502-34, in which all stock owned
by members of an affiliated group that files a consolidated return is taken into account,
apply for purposes of determining whether a member satisfies the 80% test of section
332(b)(1) -- see also Rev. Rul. 89-46, 1989-1 C.B. 272
61
Section 332 - Requirements
•
Section 332(b)(2)
– S, pursuant to a plan of liquidation which does not specify the time for distribution, must
distribute all of its assets in complete liquidation in one taxable year, or
•
Section 332(b)(3)
– S, pursuant to a plan of liquidation, must distribute all of its assets in complete liquidation
within three years from the close of the year the first distribution is made
• S need not be formally dissolved pursuant to state law -- Rev. Rul. 84-2, 1984-1 C.B.
92; see also Treas. Reg. §1.332-2(c)
• P need not continue S's business following the liquidation -- Rev. Rul. 70-357, 1970-2
C.B. 79; but see Fairfield S.S. Corp. v. Commissioner, 157 F.2d 321 (2d Cir.), cert.
denied, 329 U.S. 774 (1946); TAM 8837003
• For section 332 to apply, P must receive a distribution with respect to "all its stock" -sections 332(b)(2) and (3) -- if more than one class of stock held, then distribution must
be made as to each class
– Treas. Reg. § 1.332-2(b) states that section 332 applies “only to those cases in
which the recipient corporation receives at least partial payment for the stock
which it owns in the liquidating corporation.” This is often referred to as the
“partial payment” rule.
– The Service has issued proposed regulations confirming the “partial payment rule.”
See Preamble to Prop. Treas. Reg. 1.332-2(b), 70 Fed. Reg. 11,903 (March 10,
2005) (“No Net Value Regulations,” discussed below).
62
Section 332: Tax Consequences
•
Effect of Section 332
– P recognizes no gain or loss
– The basis of the assets in the hands of S carries over to P
• Section 334(b)(1) -- see also TAM 9003005 (basis of property not limited to FMV
on date of distribution)
– P's basis in S stock disappears
– P succeeds to the tax attributes of S -- section 381 (net operating losses, capital
loss carryovers, earnings and profits, etc.) -- note possible application of
section 269(b), enacted in DEFRA 84
• But see Russell v. Commissioner, 832 F.2d 349 (6th Cir. 1987), which held that the
parent corporation could not carryback an NOL of its subsidiary which liquidated
pursuant to section 332 and old section 334(b)(2) because basis stepped up
• See also section 384(a)(2), added by OBRA 87, which limits a corporation that
acquires the assets of its subsidiary in a section 332 liquidation from offsetting any
built-in gain of the subsidiary with any preacquisition loss of any other corporation
unless at least 50% of the stock (by vote and value) of the subsidiary was held
throughout the 5-year period ending on the acquisition date by the acquiring
corporation or members of its affiliated group
63
Section 332 - Example
P
Assets
P's basis in S stock
S's basis in assets
FMV of assets
Ex. 1
$100,000
$40,000
$75,000
Ex. 2
$100,000
$135,000
$125,000
S
Ex. 1
FMV of assets
less basis of stock
realized loss
(not recognized)
$75,000
$100,000
($25,000)
P takes S's basis in assets = 40,000
if P sells assets, will have 35,000 gain
Ex. 2
FMV of assets
less basis of stock
realized gain
(not recognized)
$125,000
$100,000
25,000
P takes S's basis in assets = 135,000
if P sells assets, will have a (10,000) loss
64
Section 332: Actions to Avoid or Comply with Statute
•
Avoid Application of Section 332
– Sell sufficient stock to reduce interest below 80% between adoption of plan and distribution
– Spread distributions out over more than three years
– Section 332 does not apply even if sole motive was to avoid the statute. See Avco Manufacturing Corp.
v. Commissioner, 25 T.C. 975 (1956)
– However, steps to avoid section 332 must be bona fide.
• See Associated Wholesale Grocers, Inc. v. United States, 720 F. Supp. 887 (D. Kan. 1989), aff'd,
927 F.2d 1517 (10th Cir. 1991) (Holding that step transaction doctrine applied because sale of stock
was not bona fide and therefore section 332(a) applied to deny taxpayer capital loss treatment).
– If section 332 does not apply, the subsidiary is taxed under section 336 and the shareholder is taxed under
section 331.
•
Comply with Section 332
– Acquire stock to bring ownership interest to 80% before the plan is adopted
• Rev. Rul. 75-521, 1975-2 C.B. 120 -- purchase stock from third party to reach 80% -- section 332
applied because purchase of shares occurred prior to plan of liquidation
• Rev. Rul. 70-106, 1970-1 C.B. 70 -- redemption of minority shareholder to increase P's interest to
80% -- section 332 does not apply because redemption was part of the plan of liquidation
– But see Madison Square Garden Corp. v. Commissioner, 58 T.C. 619 (1972), aff'd in part
and rev'd in part, 500 F.2d 611 (2d Cir. 1974); George L. Riggs, Inc. v. Commissioner, 64
T.C. 474 (1975)
– A similar issue exists with respect to section 338. Treas. Reg. § 1.338-3(b)(5) provides that a
redemption from an unrelated person is taken into account for purposes of determining
whether the percentage ownership requirements of section 338(d)(3) are satisfied
65
Commissioner v. Day & Zimmerman (3d Cir. 1945)
S1, S2 stock
P
S1
•
•
•
•
•
sale
Individual
(Treasurer of P)
S2
In Commissioner v. Day & Zimmerman, 151 F.2d 517 (3d Cir. 1945), P sold enough voting stock in two subsidiaries to P’s treasurer
to reduce P’s ownership in each subsidiary to below 80%. P then liquidated both subsidiaries and claimed a capital loss on each.
The sale of stock to P’s treasurer was done after advice from counsel that such sales were necessary for P to claim capital losses on
the liquidation. The sales were made to avoid the application of section 112(b)(6) (the predecessor to current section 332).
The sales of S1 and S2 stock were done at public auction. P’s treasurer was the highest bidder and purchased the shares for his own
account and at his own risk and paid for them with his own funds. After the sale, P retained no interest in the shares purchased by
P’s treasurer.
The government argued that the only purpose for the sales of stock was to avoid section 112(b)(6) and therefore the sales should not
be recognized.
The court held that the sales to the treasurer were legitimate and therefore there was no alternative but to hold that section 112(b)(6)
did not apply (because P did not own 80% of S1 or S2 stock on the date of liquidation). Accordingly, P’s losses were recognized.
66
Granite Trust Co. v. United States (1st Cir. 1956)
Howard Johnson
(Individual)
sale
GTC
sale
sale
Sale
for FMV
Build
Co
gift
Building
•
•
•
HJ
Ralph Richmond
(Individual)
United
War Fund
In Granite Trust Co. v. United States, 238 F.2d 670 (1st Cir. 1956), Granite Trust (GTC) sold 20.5% of the stock in BuildCo to
Howard Johnson Co. and shortly thereafter purchased the Building held by BuildCo for fair market value. After the building was
purchased, GTC sold a small amount of stock of Buildco to both Howard Johnson and Ralph Richmond (individuals), and gifted a
small amount to the Greater Boston United War Fund. Thereafter, BuildCo was liquidated.
The taxpayer conceded that the sales were made to avoid the application of section 112(b)(6) to the liquidation of BuildCo. The
government challenged the transaction on two grounds: (1) an “end result” step transaction argument that the final outcome was the
complete liquidation of a wholly owned subsidiary and therefore “circuitous steps” to avoid application of the statute should be
disregarded; and (2) the sales should be disregarded because the purchasers held the stock for only a few days and then received their
money back, plus a small profit.
The court rejected the government’s “end result” step transaction argument and stated the legislative history of section 112(b)(6) and
section 332 (enacted after the transactions at issue in the case) indicated that taxpayers can, by taking appropriate steps, render the
statute applicable or inapplicable as they choose. The court stated that the question was whether or not there are actually legitimate
sales. The court stated that title actually passed and there was no understanding that GTC would retain any interest in the transferred
shares. Therefore the sales were bona fide. The court acknowledged that there was a business relationship between Howard Johnson
Co. and GTC, but refused to strike down the sales on “the alleged defect that they took place between friends and for tax motives.”
67
TAM 8428006 (Mar. 26, 1984)
333 shares
Y
sale
W
1000 shares
(100%)
Z
•
•
•
•
In TAM 8428006, Corp. Y owed tax deficiencies as a result of long-term capital gains with respect to sales by Z of certain investment
assets. On the advice of tax counsel, Y sought to recognize a capital loss by selling stock of Z to an unrelated buyer, and then
ultimately liquidating Z. Y was advised that it would recognize a capital loss on both the stock sale and the ultimate liquidation.
Y sold one-third of its stock in Z to W for $200,000 ($40,000 in cash, and a $160,000 note). The TAM stated that the sale of the stock
was “absolute, unconditional, non-contingent, and unrestricted.”
The TAM also stated that at the time of the transaction, Y understood that while a liquidation of Z approximately a year after the sale
would be economically advantageous, there was no advantage to an earlier liquidation. This understanding changed shortly after the
sale when Y realized that the capital loss from the sale of the stock was not sufficient to offset its balance of capital gains. Therefore,
Y decided to liquidate Z earlier than anticipated (approximately 3 weeks after the sale). W ultimately satisfied its note to Y by paying
the $160,000 plus accrued interest about 6 months after the liquidation. The TAM stated, “[i]t is not known whether Corp. W used any
funds it obtained in the liquidation of Corp. Z to pay off this obligation of Corp. Y.”
The TAM stated that the transaction was governed by the holding in Granite Trust. The sale was given independent significance for
tax purposes because “Corp. Y made an unconditional sale of [one-third] of the Corp. Z stock to an unrelated buyer, Corp. W, which
sale was neither transitory nor illusory and was in no way conditioned upon the subsequent liquidation of Corp. Z.” Therefore Corp. Y
was able to recognize a loss upon the liquidation.
68
Assoc. Wholesale Grocers v. United States (10th Cir. 1991)
AWG
Minority (.03%)
S/H’s
E
AWG
E
AWG
E
New E
SMD
New E
Other Subs
WM
cash
+ note
SMD
cash
+ note
W
merge
New E
SMD
Other Subs
Other Subs
•
•
•
WM
Other Subs
WM
In Assoc. Wholesale Grocers, the taxpayer (AWG) sought to sell one of its grocery store subsidiaries in a transaction that would also
cash out minority shareholders and generate a large capital loss. As part of a pre-arranged plan, AWG (through its sub SMD) transferred
the assets of its subsidiary W in an all-cash merger to a corporation newly formed by E, manager of the grocery store held by the WM
subsidiary. Immediately thereafter, SMD used some of the cash received in the merger to repurchase the assets of W other than WM
from New E. Thus, New E obtained control of WM, and SMD claimed losses on the sale and repurchase of its assets.
The government sought to recharacterize the transaction as a sale of WM to New E and a section 332 liquidation of W. The taxpayer
cited Granite Trust for the proposition that the step transaction doctrine did not apply in the section 332 context. The court disagreed,
and stated that Granite Trust only considered whether the “end result” formulation of the step transaction doctrine applied. Furthermore,
although taxpayers are able to take steps to avoid the application of section 332, the court stated that such steps are not immunized from
the question of whether the transaction under scrutiny is in fact what it appears to be in form.
The court stated that the degree of interdependence between the steps in the transaction was sufficient under the step transaction doctrine
to ignore the form of the transaction. The court stated there was an understanding between the parties that the taxpayer would retain an
interest in the assets transferred. The court stated the obvious substance of the transaction was a sale of WM followed by a liquidation
of W. Therefore section 332 applied to disallow the losses claimed on the effective sale and repurchase of the retained assets (“Other
69
Subs”).
FSA 200148004 (July 11, 2001)
I
I
loan
HoldCo
HoldCo
cash
S1
new
S3
shares
S2
> 20%
S1
S2
< 80%
S3
•
•
•
S3
In FSA 200148004, Individual (I) reduced S1’s holdings in S3 to below 80% by taking a loan from S1 and investing the proceeds in S3
in exchange for newly issued S3 shares. HoldCo filed a consolidated return as the common parent of an affiliated group that included S1
and S2. S3 was a foreign corporation. The newly issued shares diluted S1’s interest in S3 below 80%. In the following year, the
shareholders of S3 elected to convert S3 from a corporation to a limited liability company under foreign law. The shareholders of S3
“checked the box” to treat S3 as a partnership for US tax purposes and treated the conversion as a deemed liquidation under section 331.
The FSA examined the question of whether the transaction reducing S1’s ownership in S3 was “a sham and without economic
substance” under the court’s holding in Assoc. Wholesale Grocers.
The FSA stated that “[g]enerally, courts have allowed the parent corporation to avoid § 332 as long as the sale of stock that reduces the
parent corporation’s ownership below 80% is bona fide, notwithstanding that the sale is tax-motivated.” The FSA sated that the theory
in Assoc. Wholesale Grocers did not apply to the present transaction because (1) no facts were submitted indicating that Individual’s
purchase of shares in S3 was done in anticipation of the deemed liquidation; (2) no facts suggested the loan was a sham; and (3) S1 and
S2 did not transfer their interests in S3 to Individual and then immediately reacquire them; instead Individual made an investment that
was “difficult to view as transitory.” The FSA stated that the transactions permanently realigned the parties’ interests in S3. Therefore
70
Individual’s investment was not a sham and section 332 did not apply.
Liquidation/Reincorporation
Other
S/Hs
P
P
Assets
Assets
+$
•
–
New S
shareholder liquidates the corporation, retains the cash and immediately reincorporates the operating
assets under section 351
the corporation sells the operating assets to a related corporation under old section 337, liquidates and
distributes the cash to the shareholder
Tax consequences -- if treated as a liquidation
–
–
–
•
$
Pre-TRA 86 strategies
–
•
S
capital gain to the shareholder
stepped-up basis for the operating assets
tax attributes disappear
Substance of the transaction -- withdraw cash and leave operating assets in corporate solution,
i.e., a dividend
71
Liquidation/Reincorporation
• IRS may challenge in three different ways
– In effect simply a dividend -- Treas. Reg. § 1.331-1(c);
• “A liquidation which is followed by a transfer to another corporation of all
or part of the assets of the liquidation corporation or which is preceded by
such a transfer may, however, have the effect of the distribution of a
dividend or of a transaction in which no loss is recognized and gain is
recognized only to the extent of “other property.” See section 301 and
356.”
• See also Treas. Reg. § 1.301-1(l); Rev. Rul. 61-156, 1961-2 C.B. 62
– Section 368(a)(1)(D) reorganization -- Smothers v. United States, 642
F.2d 894 (5th Cir. 1981); Rose v. United States, 640 F.2d 1030 (9th
Cir. 1981); Viereck v. United States, 83-2 U.S.T.C. ¶ 9664 (Cl. Ct.)
– Lack of complete liquidation -- Telephone Answering Service Co. v.
Commissioner, 63 T.C. 423 (1974), aff'd without published opinion,
546 F.2d 423 (4th Cir. 1976), cert. denied, 431 U.S. 914 (1977)
72
Troubled Companies in Liquidations
73
In General
•
•
Treas. Reg. §1.332-2(b)
– Section 332 applies only where the parent receives at least partial payment for its stock.
– This requirement has been held to apply to section 331 liquidations as well. See Braddock
Land Co. v. Commissioner, 75 T.C. 324 (1980); Jordan v. Commissioner, 11 T.C. 914 (1948).
– Section 332 requires a distribution in cancellation or redemption of all of the stock of the
liquidating company. Thus, a distribution that is sufficient to redeem only the company’s
preferred stock is not a liquidation. See Commissioner v. Spaulding Bakeries, Inc., 252 F.2d
693 (2d Cir. 1958); H.K. Porter Co. v. Commissioner, 87 T.C. 689 (1986).
Therefore, section 332 does not apply when a parent liquidates an insolvent subsidiary, and the
parent can recognize loss on its sub stock under section 165(g). Iron Fireman Mfg. Co. v.
Commissioner, 5 T.C. 452 (1945); H.G. Hill Stores, Inc. v. Commissioner, 44 B.T.A. 1182 (1941);
Rev. Rul. 70-489, 1970-2 C.B. 53, amplifying, Rev. Rul. 59-296, 1959-2 C.B. 87.
74
In General
•
Proposed No Net Value Regulations
– The proposed regulations retain the partial payment rule of the current regulations and
provide new rules with respect to liquidations involving multiple classes of stock. Prop.
Treas. Reg. §1.332-2(b).
– If partial payment is not received for every class of stock but is received for at least one
class, the proposed regulations look separately to each class of stock to determine the tax
consequences.
– With respect to those classes of stock for which no payment is received, the proposed
regulations refer to section 165(g) worthless stock deductions.
– With respect to those classes of stock for which payment is received, the proposed
regulations refer to section 368(a)(1) regarding a potential reorganization or to section 331
if the distribution does not qualify as a reorganization.
•
The Service also takes the position that an upstream merger cannot qualify as a tax-free A
reorganization. Rev. Rul. 70-489. But see Norman Scott, Inc., 48 T.C. 598 (noting that unlike
the requirement for a liquidation that there be a payment in cancellation or redemption of stock,
there is no such requirement for a statutory merger to qualify under section 368(a)(1)(A)).
75
Liquidations vs. Upstream Merger
P
$160 Debt
Liquidation
S
Facts: P owns all of the stock of S. S has assets worth $100 and is indebted to P in the amount of $160. S
adopts a plan of liquidation, and distributes all of its assets to P.
Result: The transaction does not qualify as a section 332 liquidation under either current law or the proposed
regulations. Instead, S should be treated as transferring its $100 of assets in satisfaction of its $160 debt to P,
and P should be entitled to a worthless stock deduction of $100 and a bad debt deduction of $60.
What if S merged upstream into P? See Norman Scott, Inc., 48 T.C. 598. But see Rev. Rul. 70-489, 1970-2
C.B. 53, amplifying, Rev. Rul. 59-296, 1959-2 C.B. 87. Could the liquidation be treated as an upstream C
reorganization?
76
Liquidation with No Payment on Common Stock
P
Preferred
Stock
Common
Stock
Liquidation
S
Facts: P owns all of the common and preferred stock of S. The preferred stock has a liquidation preference
of $200. S has assets worth $100 and no liabilities. S adopts a plan of liquidation, and distributes all of its
assets to P.
Result: The transaction does not qualify as a section 332 liquidation under either current law or the proposed
regulations, because P did not receive any payment on its common stock. See Commissioner v. Spaulding
Bakeries, Inc., 252 F.2d 693 (2d Cir. 1958); H.K. Porter Co. v. Commissioner, 87 T.C. 689 (1986); Prop.
Treas. Reg. §1.332-2(b), (e), Ex. 2. Thus, P is entitled to a worthless stock deduction for its common stock
under section 165(g). Under the proposed regulations, the transaction may qualify as a reorganization with
respect to P’s preferred stock, since it received partial payment on that. If the transaction does not qualify as
a reorganization, then P would recognize gain or loss on the preferred stock under section 331.
77
Deemed Liquidation
P
$160
Debt
S
Convert to LLC
Facts: P owns all of the stock of S. S has assets worth $100 and is indebted to P in the amount of $160. S
converts into a single-member LLC pursuant to state law.
Result: The conversion into a single-member LLC results in a deemed liquidation under Treas. Reg.
§301.7701-3(g)(1)(iii). However, because S is insolvent, the deemed liquidation does not qualify as a section
332 liquidation under either current law or the proposed regulations. The deemed liquidation is considered an
identifiable event that fixes the loss with respect to the stock for purposes of a worthless stock deduction
under section 165(g). Rev. Rul. 2003-125, 2003-52 I.R.B. 1 (reversing the result in F.S.A. 200226004 (Mar.
7, 2002)). Thus, P should be entitled to worthless stock and bad debt deductions, even though P continues
the business formerly conducted by S. Id.; see also Rev. Rul. 70-489, 1970-2 C.B. 53, amplifying Rev. Rul.
59-296, 1959-2 C.B. 87.
78
Revenue Ruling 68-602
P
$160 Debt
(1)
$160
Debt
(2)
Liquidation
S
Facts: P owns all of the stock of S. S has assets worth $100 and is indebted to P in the amount of $160. P
cancels the $160 debt by contributing it to S’s capital. S then adopts a plan of liquidation, and distributes all
of its assets to P.
Result: In Rev. Rul. 68-602, 1968-2 C.B. 135, the Service ruled that the debt cancellation was an integral part
of the liquidation and had no independent significance other than to secure the tax benefits of S’s net
operating loss carryover. Therefore, the Service regarded the cancellation as transitory and disregarded it.
Cf. Rev. Rul. 78-330, 1978-2 C.B. 147 (respecting debt cancellation immediately before a sideways merger
because such cancellation had independent economic significance). As a result, the liquidation in this
example does not qualify as a section 332 liquidation, and the result is the same as in the prior two examples.
The proposed regulations do not change this result.
79
Revenue Ruling 68-602 - Variation
P
$200
Debt
(1)
$200
Debt
(2)
Liquidation
S
Bank
$100 Debt
Facts: P owns all of the stock of S. S has assets worth $150 and is indebted to P in the amount of $200 and
to the bank in the amount of $100. P cancels the $200 debt by contributing it to S’s capital. S then adopts a
plan of liquidation, repaying the bank debt in full and distributing the remaining assets (i.e., $50) to P.
Result: Absent the debt cancellation, 1/3 of S’s assets (i.e., $50) would have gone to the bank, and 2/3 (i.e.,
$100) would have gone to P. Arguably, in these circumstances, the debt cancellation has independent
economic significance and Rev. Rul. 78-330, not Rev. Rul. 68-602, should apply. Query whether the
cancellation has independent economic significance only to the extent of $150, the value of S’s assets
available to repay its outstanding debt.
80
Tax-Free Transactions
81
Reorganizations in General
•
•
An acquisition will be tax-free if it qualifies as a “reorganization” under section
368.
An acquisition will qualify under section 368 if it satisfies one of the definitions
listed in that section (see following slide). In addition, the acquisition must meet
the following requirements:
– Continuity of Interest
– Continuity of Business Enterprise
– Business Purpose
•
•
•
No gain or loss will be recognized at either the corporate level or the shareholder
level if stock or securities of a corporation are exchanged for stock or securities of
another corporation pursuant to a plan of reorganization.
Gain will be recognized to the extent that property in addition to stock or securities
is used as consideration in the reorganization (referred to as “boot”). The gain
recognized is limited to the amount of the boot. The presence of boot does not
trigger the recognition of loss.
The unrecognized gain or loss is preserved in the carryover basis of qualifying
property received in a reorganization and will be recognized upon a subsequent
taxable disposition.
82
Reorganizations under Section 368
•
•
•
•
•
•
•
•
§ 368(a)(1)(A) – “A” Reorg – statutory merger or consolidation
§ 368(a)(1)(B) – “B” Reorg – acquisition of target stock constituting control of
target in exchange solely for voting stock of acquiring
§ 368(a)(1)(C) – “C” Reorg – acquisition of substantially all of the assets of target
in exchange for voting stock of acquiring
§ 368(a)(1)(D) – “D” Reorg – corporation transfers all or part of its assets to
another controlled corporation and distributes stock in controlled corporation either
in non-divisive § 354 transaction or divisive § 355 transaction
§ 368(a)(1)(E) – “E” Reorg – Recapitalization
§ 368(a)(1)(F) – “F” Reorg – “mere change in identity, form, or place of
organization of one corporation, however effected.”
§ 368(a)(2)(D) – Forward Subsidiary Merger – “A” reorganization (statutory
merger) where the target is merged into a subsidiary of acquiring and the target
shareholders receive stock of acquiring.
§ 368(a)(2)(E) – Reverse Subsidiary Merger – “A” reorganization (statutory
merger) where a subsidiary of acquiring is merged into the target and the target
shareholders receive stock of acquiring.
83
General Reorganization Requirements
•
•
•
Continuity of Interest
– Continuity of interest requires that a substantial part of the value of the
proprietary interests in the target corporation be preserved in the
reorganization through acquisition of acquiring company stock.
– The continuity requirement is generally 40%.
Continuity of Business Enterprise
– The acquiring corporation must either (1) continue the transferor’s
historic business or (2) continue to use a significant portion of the
transferor’s historic business assets in its business.
Business Purpose
– The reorganization must be for a corporate business purpose other than
tax avoidance.
84
Tax Consequences of a Reorganization
•
Stock Reorganizations
–
Consequences to Stockholders and Security Holders
•
•
–
Consequences to Corporate Transferee
•
•
•
•
If consideration given by transferee (acquiring) consists exclusively of its own stock, transferee recognizes no
gain or loss under § 1032.
If acquiring corporation transfers some boot, it recognizes gain or loss under § 1001, but does not receive any
increase in the basis of the acquired property as a result of the gain recognized. See § 362(b).
Generally takes basis in property acquired equal to its basis in the hands of the acquired corporation, increased
by any gain recognized by the acquired corporation on the exchange.
Asset Reorganizations
–
Consequences to Corporate Transferor
•
•
–
•
No gain or loss is recognized if stock or securities of one corporate party to a reorganization is exchanged solely
for stock or securities of another corporate party to the reorganization. See § 354(a)(1)
If boot received, the shareholder must recognize any realized gain to the extent of the boot under § 356. No loss
is recognized.
Corporate party to a reorganization recognizes no gain or loss on an exchange of property, pursuant to the
reorganization, solely for stock or securities of another corporate party to the reorganization. See § 361(a).
Corporate transferor also recognizes no gain on any other consideration received in addition to stock and
securities as long as the transferor distributes the boot pursuant to the reorganization.
Consequences to Corporate Transferee
Single Entity Reorganizations
85
Tax Consequences of a Reorganization
•
Stock Reorganizations
– No tax to Acquired Corporation
– No tax to Acquired Corporation Shareholders
– Acquired Corporation Shareholders Take a Substituted Basis in the Acquiring
Corporation’s Stock
– Acquiring Corporation Takes a Carryover Basis in the Acquired Corporation’s Stock
– Tax attributes of Acquired Corporation (e.g., net operating losses) are Unchanged
•
Asset Reorganizations
– No tax to Acquired Corporation on the Exchange or the Liquidation
– No tax to Acquired Corporation Shareholders
– Acquired Corporation Shareholders Take a Substituted Basis in the Acquiring
Corporation’s Stock
– Acquiring Corporation Takes a Carryover Basis in the Acquired Corporation’s Assets
– Tax attributes of Acquired Corporation (e.g., net operating losses) carry over to
Acquiring Corporation
86
“A” Reorganization
T S/H’s
T S/H’s
P S/H’s
P S/H’s
P Stock
T
T Assets
•
•
•
Merge
P
P
P Assets
T Assets
P Assets
Definition: An “A” reorganization is a statutory merger or consolidation.
Requirements: The requirements of an “A” reorganization are that it must be (1) a merger or consolidation
under state law and it must satisfy (2) continuity of interest, (3) continuity of business enterprise, and (4)
business purpose.
Tax Consequences:
– No tax to T
– No tax to T shareholders
– T shareholders take a substituted basis in the P stock
– P takes a carryover basis in the T assets
– T’s tax years ends on the date of the merger
– Tax attributes of T (e.g., net operating losses) carry over to P
87
“B” Reorganization
T S/H’s
T
T Assets
•
•
•
P
Voting
Stock
T Stock
T S/H’s
P S/H’s
P S/H’s
P
P
T
T Assets
Definition: Acquisition of stock of one corporation (T) in exchange solely for voting stock of the acquiring
corporation (P), provided that the acquiring corporation has control of the acquired corporation immediately
after the transaction.
Requirements: P must acquire (1) “control” of T (2) “solely for voting stock.”
– “Control” for this purpose means ownership of at least 80% of the total combing voting power of
voting stock and at least 80% of each class of nonvoting stock.
Tax Consequences:
– No tax to T
– No tax to T Shareholders
– T shareholders take a substituted basis in the P stock
– P takes a carryover basis in the T stock
– Tax attributes of T (e.g., net operating losses) are unchanged
88
“C” Reorganization
T S/H’s
P S/H’s
T S/H’s
P
Voting
Stock
T Assets
T Assets
•
•
P S/H’s
T
P
T
T S/H’s
P S/H’s
P
T Assets
Liquidates
P
T Assets
Definition: Acquisition of substantially all of the assets of target corporation (T) solely in exchange for
voting stock of the acquiring corporation (P).
Requirements: P must acquire (1) “substantially all the assets” of T (2) “solely for voting stock.” In
addition, (3) T must liquidate.
– “Substantially all” means 90% of the net assets and 70% of the gross assets of T
– “Solely for voting stock” has two exceptions for purposes of a C reorganization:
• P may assume liabilities of T in any amount as long as other consideration is only voting stock.
• Cash or other property may be used as consideration in addition to voting stock, provided voting
stock is used to acquire at least 80% of the T’s assets (measured by gross FMV).
89
“C” Reorganization
T S/H’s
P S/H’s
T S/H’s
P S/H’s
T
P Stock
T Assets
•
Liquidates
P
T
T Assets
T S/H’s
P S/H’s
P
T Assets
P
T Assets
Tax Consequences:
– No tax to T on the exchange or the liquidation
– No tax to T shareholders
– T shareholders take a substituted basis in the P stock
– P takes a carryover basis in the T assets
– Tax year of T ends on liquidation
– Tax attributes of T (e.g., net operating losses) carry over to P
90
“D” Reorganization
T/P S/H’s
T/P S/H’s
T
P Stock
T Assets
T Assets
•
•
P Stock
P
T
T/P S/H’s
P
T Assets
P
T Assets
Definition: Transfer by a corporation of all or part of its assets to a corporation controlled (immediately after
the transfer) by the transferor or its shareholders, but only if stock or securities of the controlled corporation
are distributed in pursuance of the plan of reorganization either in a non-divisive § 354 transaction or a
divisive § 355 transaction.
Requirements: (1) P must be “controlled” by T immediately after the asset transfer and (2) T must distribute
P stock in a distribution that qualifies as either (a) a non-divisive § 354 transaction or (b) a divisive § 355
transaction.
–
–
–
“Control” for purposes of a D reorganization means ownership of 50% of the voting stock or 50% of the FMV of all
classes of stock
A transaction will qualify as a nondivisive D reorganization only if it satisfies the requirements of § 354: (i) the
transferee corporation acquires “substantially all” of the assets of the transferor corporation and (ii) the transferor
distributes any retained assets, as well as the stock and securities received from the transferee, pursuant to a plan of
reorganization
See later slides for requirements of § 355 for a transaction to qualify as a divisive D reorganization.
91
“D” Reorganization
T/P S/H’s
T/P S/H’s
T
P Stock
T Assets
T Assets
•
P Stock
P
T
T/P S/H’s
P
T Assets
P
T Assets
Tax Consequences:
– No tax to T on the exchange or the liquidation
– No tax to T shareholders
– T shareholders take a substituted basis in the P stock
– P takes a carryover basis in the T assets
– Tax year of T ends on distribution
– Tax attributes of T (e.g., net operating losses) carry over to P
92
“E” Reorganization
B
B
pref.
stock
A
common
stock
common
stock
common
stock
debentures
T
•
•
C
A
common
stock
C
common
stock
common
stock
T
Definition: A recapitalization. For example, in the picture above, B receives common stock in exchange
for preferred stock and C receives common stock in exchange for debentures.
Tax Consequences:
– No tax to B
– No tax to C
– No tax to T
– B and C take a substituted basis in the common stock
93
“F” Reorganization
A
A
Old
T
New
T
Alabama
•
•
Delaware
Definition: An F reorganization is a “mere change in identity, form, or place of organization of one
corporation, however effected” (e.g., a corporation reincorporating in another state).
Tax Consequences:
– No tax to T or A
– T’s tax attributes remain the same
– T’s tax year continues
94
Forward Subsidiary Merger (§ 368(a)(2)(D))
P Stock
T S/H’s
T
T Assets
•
•
•
Merge
P S/H’s
T S/H’s
P S/H’s
P
P
S
S
T Assets
Definition: “A” reorganization (statutory merger) where the target is merged into a subsidiary of acquiring.
Requirements: (1) Substantially all the properties of the target corporation are acquired by the subsidiary;
(2) the target is merged into the subsidiary; (3) the merger would have qualified as an “A” reorganization if
the target had merged directly into the parent; and (4) no stock of the subsidiary is used in the transaction.
Tax Consequences:
– No tax to T
– No tax to T Shareholders
– P takes a carryover basis in the T assets
– T shareholders take a substituted basis in the P stock
– Tax attributes of T (e.g., net operating losses) carry over to S
95
Reverse Subsidiary Merger (§ 368(a)(2)(E))
T S/H’s
T
T Assets
•
•
•
P
Voting
Stock
Merge
P S/H’s
T S/H’s
P S/H’s
P
P
S
T
T Assets
Definition: “A” reorganization (statutory merger) where a subsidiary is merged into the target.
Requirements: (1) The subsidiary is merged into the target; (2) the surviving target corporation holds
substantially all of its properties and substantially all of the properties of merged subsidiary after the
transaction; and (3) the target’s shareholders before the transaction (T S/H’s) must receive, in the
transaction, voting stock of the merged subsidiary’s parent (P) in exchange for stock constituting control of
target.
– “Control” for this purpose means ownership of at least 80% of the total combing voting power of
voting stock and at least 80% of the total number of shares of nonvoting stock.
Tax Consequences:
– No tax to T
– No tax to T Shareholders
– T shareholders take a substituted basis in the P stock
– Tax attributes of S (e.g., net operating losses), if any, carry over to T
96
Current Developments
97
Troubled Companies in Tax-Free
Reorganizations
98
Proposed No Net Value Regulations
•
On March 10, 2005, Treasury and the IRS issued proposed regulations regarding
corporate formations, reorganizations, and liquidations of insolvent corporations. The
proposed regulations generally require the exchange (or, in the case of a section 332
liquidation, the distribution) of net value for the nonrecognition rules of sections 332,
351, and 368 to apply. Thus, the proposed regulations would reverse the result in
Norman Scott, Inc.
•
For tax-free reorganizations under section 368, the proposed regulations require that
there be both a surrender and a receipt of net value. Prop. Treas. Reg. §1.368-1(f)(1).
– Whether net value is surrendered is determined by reference to the assets and
liabilities of the target corporation.
– Whether net value is received is determined by reference to the assets and
liabilities of the issuing corporation.
99
Proposed No Net Value Regulations
•
Asset Reorganizations
– There is a surrender of net value if the FMV of the property transferred by the
target exceeds the sum of (i) the target liabilities assumed by the acquiror in
connection with the exchange and (ii) the amount of money and the FMV of any
other property received by the target in connection with the exchange. Prop.
Treas. Reg. §1.368-1(f)(2)(i).
• Any liability that the target owes the acquiror that is extinguished in the
exchange is treated as assumed in connection with the exchange.
– There is a receipt of net value if the FMV of the assets of the issuing corporation
exceeds the amount of its liabilities immediately after the exchange. Prop. Treas.
Reg. §1.368-1(f)(2)(ii).
100
Proposed No Net Value Regulations
•
Stock Reorganizations
– There is a surrender of net value if the FMV of the assets of the target exceeds the
sum of (1) the amount of the target liabilities immediately prior to the exchange
and (ii) the amount of money and the FMV of any other property received by the
target shareholders in connection with the exchange. Prop. Treas. Reg. §1.3681(f)(3)(i).
• Assets of the target that are not held immediately after the exchange and
liabilities of the target that are extinguished in the exchange are disregarded.
– There is a receipt of net value if the FMV of the assets of the issuing corporation
exceeds the amount of its liabilities immediately after the exchange. Prop. Treas.
Reg. §1.368-1(f)(3)(ii).
101
Proposed No Net Value Regulations
•
Exceptions
– The net value requirement does not apply to E and F reorganizations. Prop. Treas.
Reg. §1.368-1(b)(1).
– The net value requirement does not apply to acquisitive D reorganizations,
provided the FMV of the property transferred to the acquiror by the target exceeds
the amount of target liabilities immediately before the exchange (including any
liabilities cancelled, extinguished, or assumed in connection with the exchange),
and the FMV of the assets of the acquiror equals or exceeds the amount of its
liabilities immediately after the exchange. Prop. Treas. Reg. §1.368-1(f)(4); see
also Rev. Rul. 70-240.
102
Sideways Asset Reorganization -- Parent Debt
P
$160
Debt
A
s to
ck
A stock
T
Merger
A
Assets = $100
Facts: P owns all of the stock of T and A. T has assets with a fair market value of $100 and liabilities of $160, all of which
are owed to P. T merges into A, with P receiving $100 worth of additional A stock in exchange for its T debt. A is solvent
both before and after the merger.
Result: The transaction should qualify as a tax-free A reorganization under current law. See Norman Scott, Inc., 48 T.C.
598; Rev. Rul. 54-610, 1954-2 C.B. 152; see also G.C.M. 33,859 (June 25, 1968). The result is the same under the proposed
no net value regulations, because (i) T surrendered net value in that the FMV of the property transferred by T ($100) exceeds
the sum of the liabilities assumed by A ($0) and the amount of money and fair market value of other property received by T
in connection with the exchange ($0), and (ii) T received net value in that the FMV of A’s assets exceeds its liabilities
immediately after the exchange. Prop. Treas. Reg. §1.368-1(f)(2), (f)(5), Ex. 2.
What if A issues no stock to T in the reorganization? Compare Laure v. Commissioner, 653 F.2d 253 (6th Cir. 1981) and
Rev. Rul. 64-155, 1964-1 C.B. 138 with Warsaw Photographic Associates, Inc. v. Commissioner, 84 T.C. 21 (1985); see also
Prop. Treas. Reg. §1.368-1(f)(5), Exs. 2 & 3.
103
Sideways Asset Reorganization -- Third-Party Debt
P
A
s to
ck
A stock
Creditor
$160 Debt
T
Merger
A
Assets = $100
Facts: P owns all of the stock of T and A. T has assets with a fair market value of $100 and liabilities of $160, all of
which are owed to Creditor. T merges into A, with P receiving $100 worth of additional A stock. A is solvent both
before and after the merger.
Result: The transaction is distinguishable from Norman Scott, Inc., but it should qualify as a tax-free A reorganization
under the IRS’s reasoning in G.C.M. 33,859 (June 25, 1968) that because Creditor had not taken affirmative steps to
assert its proprietary interest, P remains the holder of the proprietary interest. However, the merger does not satisfy the
net value requirement of the proposed regulations, because T does not surrender net value—the FMV of the property
transferred by T ($100) does not exceed the sum of the liabilities assumed by A ($160) and the amount of money and
fair market value of other property received by T in connection with the exchange ($0). Prop. Treas. Reg. §1.3681(f)(2)(1).
104
Sideways Asset Reorganization -- Brother-Sister Debt
P
A
s to
ck
A stock
T
Assets = $100
Merger
A
$160 Debt
Facts: P owns all of the stock of T and A. T has assets with a fair market value of $100 and liabilities of $160, all of which
are owed to A. T merges into A, with P receiving $100 worth of additional A stock. Assume further that the T debt is worth
$100, and A has other assets worth $400, so A is solvent both before and after the merger.
Result: The transaction should qualify as a tax-free A reorganization under current law. See Norman Scott, Inc., 48 T.C.
598; G.C.M. 33,859 (June 25, 1968). However, the merger does not satisfy the net value requirement of the proposed
regulations, because T does not surrender net value. The proposed regulations treat debt owed by the target to the acquiring
corporation that is extinguished in an exchange as if it were assumed by the acquiring corporation. Prop. Treas. Reg. §1.3681(f)(2)(i). Thus, the FMV of the property transferred by T ($100) does not exceed the sum of the liabilities assumed by A
($160) and the amount of money and fair market value of other property received by T in connection with the exchange ($0).
Prop. Treas. Reg. §1.368-1(f)(2)(1).
What if the direction of the merger were reversed, so that A merged into T?
See Prop. Treas. Reg. §1.368-1(f)(5), Ex. 6
105
Sideways Asset Reorganization -- D Reorganization
P
$160
Debt
Ca
sh
Cash
T
Assets
A
Assets = $100
Facts: P owns all of the stock of A and T. T has assets worth $100 and is indebted to P in the amount of $160. A
is solvent. T transfers all of its assets and liabilities to A in exchange for $100 cash. T distributes the cash to P in
complete liquidation.
Result: The transaction should be a tax-free D reorganization under current law. See Rev. Rul. 70-240, 1970-1
C.B. 81; Rev. Rul. 2004-83, 2004-32 I.R.B. 157. Although the proposed regulations exclude D reorganizations
from the net value requirement, they do so only if the target is solvent immediately before the exchange and the
acquiror is solvent immediately after. Because T is insolvent before the exchange, the exclusion does not apply.
The transaction would not qualify as tax free, because T does not surrender net value – the FMV of the property
transferred by T ($100) does not exceed the sum of the liabilities assumed by A ($0) and the amount of money and
fair market value of other property received by T in connection with the exchange ($100). Prop. Treas. Reg.
§1.368-1(f)(2)(1); see Prop. Treas. Reg. §1.368-1(f)(5), Ex. 8.
106
All Cash “D” Reorganizations
2
‘D’ Reorganizations – Stock
Step One
Step Two
Liquidation
P
Assets
X
Y
X
P
Y
Stock
Facts: P, X, and Y are corporations. P owns all of the stock of X and Y. X transfers all of its assets to
Y in exchange for stock. X then liquidates into P.
Result: This transaction qualifies as a tax-free ‘D’ reorganization under section 368(a)(1)(D). A
transfer by one corporation (X) of substantially all of its assets to another corporation (Y) qualifies as a
reorganization described in section 368(a)(1)(D) if, immediately after the transfer, one or more of the
transferor corporation’s shareholders (P) is in control of the acquiring corporation (Y), and if stock or
securities of the acquiring corporation (Y) are distributed in a transaction which qualifies under section
354, 355, or 356. See Section 354(b)(1).
108
‘D’ Reorganizations – Cash – Direct Ownership
P
Liquidation
(2)
(1)
X Assets
X
Cash
Y
Facts: P, X, and Y are corporations. P owns all of the stock of X and Y. X transfers all of its assets
to Y in exchange for cash. X then liquidates into P.
Result: This transaction qualifies as a tax-free ‘D’ reorganization under section 368(a)(1)(D). In the
transaction, X distributes substantially all of its assets to D and its shareholder (P) is in control of Y
after the exchange. However, the requirement that stock or securities of the acquiring corporation (Y)
be distributed is not technically satisfied. This requirement is treated as satisfied because a
distribution of Y stock in this example would be a meaningless gesture. See Rev. Rul. 70-240. Note
that the same result would obtain if P transferred X stock to Y in exchange for cash and, immediately
109
thereafter, X liquidated into Y. See Rev. Rul. 2004-83.
‘D’ Reorganizations -- Indirect Ownership
P
S
Liquidation
(2)
S1
(1)
X Assets
X
Y
Cash
Facts: P owns all of the stock of S and S1. S owns the stock of X and S1 owns the stock
of Y. X transfers its assets to Y in exchange for cash and immediately thereafter
liquidates into S.
Result: The transaction qualifies as a ‘D’ reorganization because Y stock is treated as
being distributed up the chain to P and then back down. See PLR 8911067; PLR
9229026. In the consolidated return context, the following events are deemed to occur:
(i) Y is treated as issuing its stock to X in exchange for X’s assets; (ii) X is treated as
distributing Y stock to S in a liquidation; and (iii) Y is treated as redeeming its stock
from S for cash. See Treas. Reg. § 1.1502-13(f) and (f)(7), ex. 3.
110
‘D’ Reorganizations -- Constructive Ownership
A
B
S
Liquidation
(1)
(2)
X Assets
X
Y
Cash
Facts: A and B are mother and son. A owns the stock of S which owns the stock of X.
B owns the stock of Y. X transfers its assets to Y and immediately thereafter liquidates
into S.
Result: Has there been a ‘D’ reorganization? Does S control Y after the transaction?
Would a distribution of Y stock be a meaningless gesture? PLR 9111055 supports the
position that this is a ‘D’ reorganization.
111
‘D’ Reorganizations -- PLR 200551018
A
50%
B
Liquidation
(2)
50%
C
90%
10%
(1)
X Assets
X
Newco
Two Notes
Facts: A and B own 50 percent of the stock of X. B and C own Newco, with B owning
90 percent and C owning 10 percent of the stock, respectively. X Corporation transfers
its assets to Newco in exchange for two notes. Immediately thereafter, X liquidates,
distributing one note to each A and B.
Result: PLR 200551018 assumes that the transaction does not qualify as a ‘D’
reorganization in holding that Newco is entitled to amortize the cost of goodwill
acquired as a result of the purchase of X assets.
112
‘D’ Reorganizations -- Temporary & Proposed
Regulations
•
On December 18, 2006, the IRS issued temporary and proposed regulations under
sections 368(a)(1)(D) and 354(b)(1)(B) in response to requests for immediate
guidance regarding whether certain all-cash acquisitive transactions can qualify as a
‘D’ reorganization. See Temp. Treas. Reg. § 1.368-2T(l).
•
The Preamble to the temporary regulations states that the IRS and Treasury
contemplate that the proposed regulations may change upon completion of a
broader study and the comments received regarding the proposed regulations.
•
On March 1, 2007, the IRS amended the temporary regulations so that certain
related party triangular reorganizations that qualify as tax-free triangular
reorganizations under section 368 would not be treated as ‘D’ reorganizations with
boot under the temporary regulations.
113
‘D’ Reorganizations -- Temporary & Proposed
Regulations
•
The temporary and proposed regulations provide that a transaction
otherwise described in section 368(a)(1)(D) will be treated as satisfying the
requirements of sections 368(a)(1)(D) and 354(b)(1)(B) even if there is no
actual issuance of stock and / or securities of the transferee corporation if
the same person or persons own, directly or indirectly, all of the stock of
the transferor and transferee corporations in identical proportions.
•
In such cases, the transferee corporation will be deemed to issue a nominal
share of stock to the transferor corporation in addition to the actual
consideration exchanged for the transferor corporation’s assets.
•
The nominal share of stock in the transferee corporation will then be
deemed distributed by the transferor corporation to its shareholders and,
where appropriate, further transferred through chains of ownership to the
extent necessary to reflect the actual ownership of the transferor and
transferee corporations.
114
‘D’ Reorganizations -- Temporary & Proposed
Regulations
•
The constructive ownership rules of section 318 apply with modification.
– Section 318(a)(1) applies such that an individual and all members of his or her
family described in section 318(a)(1) will be treated as one individual.
– Section 318(a)(2) applies without regard to the 50-percent limitation in section
318(a)(2)(C).
•
The same person or persons will be treated as owning all of the stock of the
transferor and transferee corporation in identical proportions notwithstanding
the fact that there is a de minimis variation in shareholder identity or
proportionality of ownership.
– The temporary and proposed regulations do not define what level of variation
would be treated as de minimis, although an example does conclude that a 1%
ownership in the stock of the transferee by an individual who owns no stock in the
transferor is de minimis variation in identity and proportionality where the other
three shareholders own 34%, 33%, and 33% of the stock of the transferor and each
owns 33% of the stock of the transferee. See Temp. Treas. Reg. § 1.368-2T(l)(3),
ex. 4.
•
Section 1504(a)(4) stock (i.e., vanilla nonvoting preferred stock) is not taken
into account.
115
‘D’ Reorganizations -- Direct Ownership (Revisited)
P
Liquidation
(2)
(1)
X Assets
X
Cash
Y
Facts: P owns all of the stock of X and Y. X transfers its assets to Y in
exchange for cash and immediately thereafter liquidates into P.
Result: The transaction will be treated as a ‘D’ reorganization because there is
complete shareholder identity and proportionality of ownership in X and Y. See
Temp. Treas. Reg. § 1.368-2T(l)(2); Cf. Temp. Treas. Reg. § 1.368-2T(l)(3), ex.
1.
116
‘D’ Reorganizations -- Indirect Ownership (Revisited)
P
S
Liquidation
(2)
S1
(1)
X Assets
X
Y
Cash
Facts: P owns all of the stock of S and S1. S owns the stock of X and S1
owns the stock of Y. X transfers its assets to Y in exchange for cash and
immediately thereafter liquidates into S.
Result: The transaction will be treated as a ‘D’ reorganization because there is
complete shareholder identity and proportionality of ownership in X and Y.
See Temp. Treas. Reg. § 1.368-2T(l)(3), ex. 4.
117
‘D’ Reorganizations -- Constructive Ownership (Revisited)
A
B
S
Liquidation
(1)
(2)
X Assets
X
Y
Cash
Facts: A and B are mother and son. A owns the stock of S which owns the stock of X.
B owns the stock of Y. X transfers its assets to Y and immediately thereafter liquidates
into S.
Result: The temporary regulations adopt the constructive ownership rules of section
318(a)(1) to treat A and B as the same person and, thus, there is complete shareholder
identity and proportional ownership in X and Y. The transaction is treated as a valid
‘D” reorganization under the temporary regulations. See Temp. Treas. Reg. § 1.3682T(l)(3), ex. 2.
118
‘D’ Reorganizations -- PLR 200551018 (Revisited)
A
50%
B
Liquidation
(2)
50%
C
90%
10%
(1)
X Assets
X
Newco
Two Notes
Facts: A and B own 50 percent of the stock of X. B and C own Newco, with B owning
90 percent and C owning 10 percent of the stock, respectively. X Corporation transfers
its assets to Newco in exchange for two notes. Immediately thereafter, X liquidates,
distributing one note to each A and B.
Result: Under the temporary regulations, there is no shareholder identity and
proportionality of ownership in X and Newco and, thus, this transaction does not qualify
as a tax-free ‘D’ reorganization. See Temp. Treas. Reg. § 1.368-2T(l)(3), ex. 6.
119
Temporary Regulations and Certain Acquisitive
Triangular Reorganizations
P stock
P
T assets
S
T
P stock
Facts: P owns all of the stock of S and T. T transfers substantially all of its assets to S solely in
exchange for P stock and T liquidates.
Result: This transaction satisfies the technical requirements of a ‘C’ reorganization. Prior to the
March 2007 amendment to the temporary regulations, this transaction was also treated as a valid
‘D’ reorganization, even though no stock of the acquiring corporation, S, is transferred in exchange
for T’s assets. Because section 368(a)(2)(A) precludes the transaction from being treated as a ‘C’
reorganization if it also a ‘D’ reorganization, the temporary regulations would have treated the
transfer of P stock as boot in a ‘D’ reorganization. The March 2007 amendment prevents this
transaction from being treated as a ‘D’ reorganization under the temporary regulations. See Temp.
Treas. Reg. 1.368-2T(l)(2)(iv).
120
Rev. Rul. 2007-8 & Section 357(c)(1)
121
Rev. Rul. 2007-8 & Section 357(c)(1)
•
Section 357(a) provides that if, as part of the consideration in an exchange to which section
351 or section 361 applies, a liability of the taxpayer is assumed by another party to the
exchange then such assumption shall not be treated as money or other property.
•
However, section 357(c)(1) requires that the transferor recognize gain in certain exchanges if
the sum of the amount liabilities assumed exceeds the total of the adjusted basis in the
property transferred.
•
Prior to the enactment of the American Jobs Creation Act of 2004 (the “AJCA”), section
357(c)(1) required the transferor to recognize gain if the liabilities assumed in a section 351
exchange or a section 368(a)(1)(D) reorganization exceed the total adjusted basis of the
property transferred.
•
The AJCA amended section 357(c)(1)(B) to remove acquisitive section 368(a)(1)(D)
reorganizations from the application of section 357(c)(1).
•
In Rev. Rul. 2007-8, the IRS cited legislative history to conclude that such transactions were
excluded from the application of section 357(c)(1) because the transferor ceases to exist and
cannot be enriched by the assumption of its liabilities.
•
Therefore, the IRS concluded that the intent of the AJCA amendment was to exclude
acquisitive reorganizations under sections 368(a)(1)(A), (C), (D), or (G) if the requirements of
section 354(b)(1) are met, regardless of whether they are also section 351 exchanges.
122
Rev. Rul. 2007-8 – Situation 1: D Reorganization
2
A
A
Liquidation
Y stock
1
X Assets
X
Y
Y stock
Assumption of X Liabilities
Y
X Assets
X Liabilities
Facts: A, an individual, owns all of the stock of corporations X and Y. X transfers its assets to Y in exchange for Y
stock (constituting control for purposes of section 368(c)) and the assumption by Y of X’s liabilities. Pursuant to the
plan, X liquidates and transfers its Y stock to A. At the time of the acquisition, the amount of X liabilities assumed
by Y in the transfer is greater than the X’s aggregate adjusted basis in its assets transferred to Y, but less than the
value of those assets. In addition, immediately after the exchange, the value of Y’s assets exceeds the amount of its
liabilities. The transaction qualifies as a ‘D’ reorganization and as an exchange to which section 351 applies.
Result: Rev. Rul. 2007-8 provides that section 357(c)(1) does not apply to X’s transfer of assets to Y in exchange for
Y stock and the assumption of X liabilities notwithstanding the fact that section 351 applies to such transfers. X
ceases to exist and thus cannot be enriched as a result of the assumption of liabilities.
123
Rev. Rul. 2007-8 – Situation 2: C Reorganization
A
B
A
2
B
2
Liquidation
Y stock
Y stock
51%
Property
1
X Assets
X
Y
Y stock
Assumption of X Liabilities
Y
X Assets
X Liabilities
Facts: A, an individual, owns all of the stock of corporation X. B, an unrelated individual, owns all of the stock of
corporation Y. X transfers its assets to Y in exchange for Y stock and the assumption by Y of X’s liabilities.
Pursuant to the plan, X liquidates and transfers its Y stock to A, and B contributes property to Y such that
immediately after the transaction, B holds 51% of the stock of Y. The Y stock issued to X along with the Y stock
issued to and held by B constitutes control (as defined under section 368(c)). At the time of the acquisition, the
amount of X liabilities assumed by Y in the transfer is greater than the X’s aggregate adjusted basis in its assets
transferred to Y, but less than the value of those assets. After the initial exchange, Y’s assets exceeds its liabilities.
The transaction qualifies as a ‘C’ reorganization and as an exchange to which section 351 applies.
Result: Pursuant to Rev. Rul. 2007-8, section 357(c)(1) does not apply to X’s transfer of assets to Y in exchange
for Y stock and assumption of X’s liabilities notwithstanding the fact that section 351 applies to such transfers.
124
Use of LLCs in Acquisitions and
Dispositions
125
Disregarded Entities In General
126
Littriello v. United States
¾
In Littriello v. United States, 2005-1 U.S.T.C. ¶ 50,385,
reconsideration denied, 96 A.F.T.R.2d 2005-5764, the U.S.
District Court for the Western District of Kentucky upheld
the validity of the check-the-box regulations.
¾
Facts – Frank Littriello was the sole member of Kentuckiana
Healthcare, LLC, which had not elected to be taxed as a
corporation. Kentuckiana failed to pay withholding and
FICA taxes, and the IRS determined that because the entity
was disregarded, Mr. Littriello was individually liable for the
taxes. Mr. Littriello argued that the check-the-box
regulations constituted an invalid exercise of the Treasury's
authority to issue interpretive regulations under section
7805(a).
AN
127
Littriello v. United States
¾
AN
The court applied the two-part Chevron analysis in upholding
the regulations’ validity.
À
First, the court concluded that the statute was ambiguous,
because sections 7701(a)(2) and 7701(a)(3) do not make a
clear distinction between an “association,” which is treated
as a corporation and a “group, pool or joint venture,” which
is treated as a partnership. The growth of different state law
entities has exacerbated this ambiguity.
À
Second, the court concluded that the check-the-box
regulations were a permissible construction of the statute,
representing a more formal version of the informally
elective regime under the old Kintner regulations.
128
Littriello v. United States
¾
In early 2007, the Court of Appeals for the Sixth Circuit affirmed the lower court ruling. See
Littriello v. United States, 484 F.3d 372 (6th Cir. 2007).
¾
In May 2007, the Court of Appeals for the Second Circuit, addressing a similar set of
circumstances, also concluded that the check-the-box regulations were valid. See McNamee
v. Department of Treasury, 488 F.3d 100 (2d. Cir. 2007).
¾
New Final Regulations – Treas. Reg. 301.7701-2(c)(2)(iv) (Aug. 15, 2007)
¾
Proposed in 2005 after the relevant tax years in Littriello and McNamee.
¾
For wages paid on or after January 1, 2009, an entity disregarded as separate from its
owner for Federal tax purposes is treated as a separate corporation for employment tax
purposes and income tax withholding purposes.
¾
Notice 99-6 will be obsoleted at such time as well.
¾
Such an entity will be subject to (with respect to the employees of that entity) income
tax withholding, FICA taxes, FUTA taxes, and employment tax deposit and reporting
obligations.
¾
The owner of such an entity will continue to be treated as self-employed (i.e., not an
employee of the entity). Thus, the earnings of the entity will continue to be included in
the owner’s net earnings from self-employment (to the extent otherwise included).
129
Multiple Disregarded Entities
P
100%
100%
LLC-1
LLC-2
50%
50%
LLC-3
Facts: Corporation P is the sole member of LLC-1 and LLC-2. LLC-1
and LLC-2 form LLC-3, with each taking a 50 percent membership
interest.
Results: The assets of LLC-1, LLC-2, and LLC-3 are treated as owned
directly by P. See Rev. Rul. 2004-77.
130
Merger of Corporation Into Single-Member LLC
P
100%
S
100%
Merger
LLC
Facts: Corporation P owns all of the stock of Corporation S and all of the
membership interests in LLC. S is merged into LLC pursuant to Delaware Law.
Results: Although this transaction could be treated as an upstream merger, S should
be treated ultimately as liquidating into P under section 332. See Treas. Reg. §§
1.332-2(d), (e) ex., 1.368-2(b)(1)(ii); see, e.g.,P.L.R. 9822037
(Feb. 27, 1998).
131
Sale of an Interest in a
Disregarded Entity
132
Sale of All of the Membership Interests
100% of LLC
P
X
Cash
100%
LLC
Facts: P owns all of the outstanding interests in LLC, which is treated as a
disregarded entity for tax purposes. P sells all of the outstanding membership
interests in LLC to X, an unrelated party.
Results: Because P is treated as owning all of the assets of LLC rather than LLC
interests, P is treated as selling all of the assets of LLC to X.
133
Sale of Less than All of the Membership Interests
P
50% of LLC
Cash
X
100%
LLC
Facts: P owns all of the outstanding interests in LLC, which is treated as a disregarded entity for tax
purposes. P sells 50 percent of the outstanding membership interests in LLC to X, an unrelated party.
Results: P is treated as having sold 50% of LLC’s assets to X, followed by a contribution by X of the
purchased assets and by P of the retained assets to a newly formed partnership. Rev. Rul. 99-5 (Sit. 1).
What are the results if, instead of P’s selling the interests to X, X contributes cash to LLC in exchange for
interests? See Rev. Rul. 99-5 (Sit. 2). What if the contributed cash is distributed to P within 2 years? See
section 707(a)(2)(B). What if P sells 50 percent of the LLC’s interests in a public offering? See section 7704.
134
Overlap Between Automatic and Elective Changes In
Classification
50% of LLC
P
50% Newco
X
P
Cash
Cash
100%
LLC
Assets &
Liabilities
X
100%
Stock
Newco
Facts: P owns all of the outstanding interests in LLC, which is treated as a disregarded entity
for tax purposes. On January 1, 1998, P sells 50 percent of the outstanding membership
interests in LLC to X, an unrelated party. P and X elect to treat the entity as an association
effective January 1, 1998.
Results: The elective classification changes preempt the automatic classification change
resulting from the change in the number of owners. Thus, P is treated as contributing all of the
assets and liabilities of LLC to Newco and selling 50% of the Newco stock to X. See Treas.
Reg. § 301.7701-3(f)(2), (4) ex. 1.
135
Sale of Membership Interests to Other Member
50% of LLC
P
X
X
Cash
50%
50%
LLC
100%
LLC
Facts: P and X each own a 50% interest in LLC. P sells its 50% LLC interest to X. After the
sale, X is the sole owner of LLC, which is disregarded as an entity separate from X.
Results: The partnership terminates under section 708(b)(1)(A) when X purchases P’s
interest. P treats the transaction as a sale of a partnership interest. However, for purposes of
determining the consequences to X, LLC is deemed to make a liquidating distribution of all of
its assets to P and X, and X is treated as acquiring the assets distributed to P. See Rev. Rul.
99-6. What if P and X are members of a consolidated group? See P.L.R. 200334037..
136
Reorganizations Involving
Disregarded Entities
137
Final Section 368 Regulations
Merger of Target into Disregarded Entity
T
P
100%
PV
c
and
k
c
o
g St
n
i
t
o
ash
ger
r
e
M
LLC
Facts: P and T are domestic corporations and LLC is a domestic limited liability company. LLC
is wholly owned by P. LLC is treated as a disregarded entity. P and T are combining entities. P
and LLC comprise a combining unit, and T is a combining unit. T merges into LLC under state
statutory merger law, with the T shareholders receiving consideration of 50% P voting stock and
50% cash.
138
Final Section 368 Regulations
Merger of Disregarded Entity into Corporation
T
P
100%
ger
M er
LLC
Facts: P and T are domestic corporations and LLC is a domestic limited liability
company. LLC is wholly owned by P. LLC is treated as a disregarded entity. P and LLC
comprise a combining unit, and T is a combining entity and combining unit. LLC merges
into T under state statutory merger law with shareholders of T receiving P stock and cash.
139
Final Regulations on Statutory Mergers
or Consolidations under Section 368
ƒ On January 23, 2006, the IRS and Treasury issued final regulations defining the term “statutory
merger or consolidation” as that term is used in the definition of an “A” reorganization under
section 368(a)(1)(A) of the Code. These final regulations were the result of several iterations of
proposed and temporary regulations and modifications made in response to comments.
ƒ The 2000 proposed regulations (May 16, 2000) provided that neither the merger of a
disregarded entity into a corporation nor the merger of a target corporation into a disregarded
entity could qualify as an A reorganization.
ƒ On November 15, 2001, the IRS and Treasury withdrew the 2000 proposed regulations and
issued new proposed regulations that permitted certain statutory mergers involving disregarded
entities to qualify as A reorganizations, if all of the assets and liabilities of the target are
transferred to the acquiror and the target goes out of existence.
ƒ On January 24, 2003, the IRS and Treasury made certain minor clarifications to the proposed
regulations and issued them as temporary regulations.
ƒ On January 5, 2005, the IRS and Treasury issued proposed regulations that would expand the
temporary regulations to include mergers involving foreign entities and mergers effected
pursuant to foreign laws within the scope of “statutory merger or consolidation.”
140
Final Section 368 Regulations
Definition of Terms
• A “statutory merger or consolidation” is defined as a transaction effected pursuant to the statute or
statutes necessary to effect the merger or consolidation, in which transaction, as a result of the
operation of such statute or statutes, the following events occur simultaneously at the effective time of
the transaction in which:
– All of the assets (other than those distributed in the transaction) and liabilities (except to the
extent such liabilities are satisfied or discharged in the transaction or are nonrecourse liabilities to
which assets distributed in the transaction are subject) of each member of one or more combining
units (each a transferor unit) become the assets and liabilities of one or more members of one
other combining unit (transferee unit), and
– The combining entity of each transferor unit ceases its separate legal existence for all purposes.
• This requirement will be satisfied even if, under applicable law, after the effective time of the
transaction, the combining entity of the transferor unit (or its officers, directors, or agents)
may act or be acted against, or a member of the transferee unit (or its officers, directors, or
agents) may act or be acted against in the name of the combining entity of the transferor unit,
provided that such actions relate to assets or obligations of the combining entity of the
transferor unit that arose, or relate to activities engaged in by such entity, prior to the
effective time of the transaction, and such actions are not inconsistent with the combination
requirement above.
• The final regulations adopt the change in the proposed regulations to permit mergers or consolidations
involving foreign entities and mergers or consolidations pursuant to foreign laws.
141
Final Section 368 Regulations
Definition of Terms
• The following terms are defined in the final regulations for purposes of
defining statutory merger or consolidation:
• Disregarded entity - Business entity (as defined in Treas. Reg. §
301.7701-2(a)) that is disregarded as an entity separate from its
owner for federal income tax purposes. Examples include domestic
single-member LLCs that do not elect to be treated as corporations,
qualified REIT subsidiaries, and qualified subchapter S subsidiaries.
• Combining entity - Business entity that is a corporation that is not a
disregarded entity.
• Combining unit - Comprised solely of a combining entity and all
disregarded entities, if any, owned by the combining entity.
142
Final Section 368 Regulations
Merger of Target into Disregarded Entity
T
P
100%
tock
S
g
otin
PV
ca
an d
sh
ger
Mer
LLC
Facts: P and T are domestic corporations and LLC is a domestic limited liability company. LLC
is wholly owned by P. LLC is treated as a disregarded entity. P and T are combining entities. P
and LLC comprise a combining unit, and T is a combining unit. T merges into LLC under state
statutory merger law, with the T shareholders receiving consideration of 50% P voting stock and
50% cash.
Result: The transaction qualifies as a tax-free A reorganization under Treas. Reg. § 1.3682(b)(1)(ii). See Treas. Reg. § 1.368-2(b)(1)(iii), ex. 2.
143
Final Section 368 Regulations
Merger of Disregarded Entity into Corporation
T
P
100%
ger
r
e
M
LLC
Facts: P and T are domestic corporations and LLC is a domestic limited liability company. LLC is wholly owned
by P. LLC is treated as a disregarded entity. P and LLC comprise a combining unit, and T is a combining entity and
combining unit. LLC merges into T under state statutory merger law with shareholders of T receiving P stock and
cash.
Result: The transaction does not qualify as a tax-free A reorganization under Treas. Reg. § 1.368-2(b)(1)(ii) because
all of assets and liabilities of the combining unit of P and LLC do not become assets of T, and LLC is not a
combining entity. See Treas. Reg. § 1.368-2(b)(1)(iii), ex. 6.
Notes: If LLC is a transitory merger subsidiary, is a recast under Rev. Rul. 67-448 available if only P shares
are used?
If LLC is not a transitory merger subsidiary, could the transaction be viewed as a section 351
transaction to the extent of the LLC assets (and possibly a “B” reorganization with respect to the rest)?
144
Final Section 368 Regulations
Merger of Target and LLC into Separate D.E.s
T
P
100%
LLC2
100%
LLC1
g
o tin
V
P
d ca
n
a
ck
Sto
sh
r
r ge
e
M
100%
LLC3
Facts: P and T are domestic corporations and LLC1, LLC2, and LLC3 are domestic limited liability companies.
LLC1 and LLC2 are wholly owned by P. LLC3 is wholly owned by T. The LLCs are treated as disregarded
entities. P, LLC1, and LLC2 comprise a combining unit, and T and LLC3 comprise a combining unit. T merges
into LLC1 under state statutory merger law, with the T shareholders receiving consideration consisting of 50%
P voting stock and 50% cash. LLC3 merges into LLC2 under state statutory merger law.
Result: The transaction qualifies as a tax-free A reorganization under Treas. Reg. § 1.368-2(b)(1)(ii). See
Treas. Reg. § 1.368-2(b)(1)(iii), ex. 2.
145
Final Section 368 Regulations
Merger of Foreign Entities Under Foreign Law
Z SHs
Z
Foreign
Y SHs
Y Shares and cash
Y
Foreign
Merger
Facts: Z and Y are entities organized under the laws of Country Q and classified as corporations
for Federal tax purposes. Z merges into Y under Country Q law. Pursuant to statutes of Country
Q the following events occur simultaneously: (i) all of the assets and liabilities of Z become the
assets and liabilities of Y, (ii) Z’s separate legal existence ceases for all purposes, and (iii) Z
shareholders receive consideration consisting of 50% Y voting stock and 50% cash.
Result: Under the final regulations, this transaction qualifies as an “A” reorganization. See
Treas. Reg. § § 1.368-2(b)(1)(ii), -2(b)(1)(iii) Ex. 13.
146
Final Section 368 Regulations
State Law Consolidation
T SHs
P SHs
T
P
T SHs
P SHs
Newco
Consolidation
Facts: Under state W law, T and P consolidate. Pursuant to such law, the following events occur at the effective time
of the transaction: all of the assets and liabilities of T and P become the assets and liabilities of Newco, an entity that is
created in the transaction, and the existence of T and P continues in Newco. In the consolidation, the T and P
shareholders exchange their stock of T and P, respectively, for stock of Newco.
Result: Under the final regulations, the consolidation qualifies as an “A” reorganization, because it is a transaction
effected pursuant to the statute or statutes necessary to effect the merger or consolidation (i.e., State W consolidation
law), all of the assets and liabilities of each member of one or more combining units (i.e., P and T) become the assets
and liabilities of one or more members of another combining unit (i.e., Newco). See Treas. Reg. § 1.368-2(b)(1)(ii).
The fact that the existence of the consolidating corporations (T and P) continues in Newco under State W law will not
prevent the consolidation from qualifying as a statutory merger or consolidation. See Preamble to Treas. Reg. § 1.3682(b); Treas. Reg. § 1.368-2(b)(1)(iii), Ex. 12.
147
Final Section 368 Regulations
Amalgamation Under Foreign Law
SH
P SHs
T
P
SH
P SHs
Amalco
Amalgamation
Facts: T, a Country Q Limited Company with a single US shareholder (SH), amalgamates with P, also a Country Q
Limited Company, pursuant to the law of Country Q. By operation of law, the assets of T and P become assets of a
new entity (“Amalco”), P and T cease their separate existence, and SH and the P shareholders receive shares of
Amalco stock as consideration. SH receives 30% of Amalco’s outstanding shares.
Result: Under the final regulations, the amalgamation qualifies as an “A” reorganization, because it is a transaction
effected pursuant to the statute or statutes necessary to effect the merger or consolidation (i.e., Country Q
amalgamation law), all of the assets and liabilities of each member of one or more combining units (i.e., P and T)
become the assets and liabilities of one or more members of another combining unit (i.e., Amalco). See Treas. Reg. §
1.368-2(b). The fact that the existence of the amalgamating corporations (T and P) continues in Amalco under
Country Q law will not prevent the amalgamation from qualifying under the final regulations as a statutory merger or
consolidation. See Preamble to Treas. Reg. § 1.368-2(b); Treas. Reg. § 1.368-2(b)(1)(iii), Ex. 14.
148
Final Section 368 Regulations
Merger of Corporation into D.E. in Exchange for
Interests in the D.E.
T SHs
P
100%
e
Inter
LLC
nL
st s i
LC
T SHs
P
T
ger
Mer
LLC
Facts: P and T are domestic corporations and LLC is a domestic limited liability company. LLC is wholly owned
by P. LLC is treated as a disregarded entity. T merges into LLC under state statutory merger law, with the T
shareholders receiving interests in LLC. After merger, LLC is not disregarded as an entity separate from P and is
treated as a partnership for federal income tax purposes.
Result: The transaction does not qualify as a tax-free A reorganization because assets of T do not become assets
of a combining unit. LLC cannot be a combining entity as a partnership and, thus, is not part of a combining unit.
See Treas. Reg. § 1.368-2(b)(1)(iii), ex. 7.
Note: What if LLC elects to be taxed as a corporation effective at the time of the merger? See Rev. Rul.76-123,
1976-1 C.B. 94; Rev. Rul. 68-349, 1968-2 C.B. 143; Rev. Rul. 68-357, 1968-2 C.B. 144.
149
Final Section 368 Regulations
Merger of Corporate Partner Into a Partnership
P
T
M
er
erg
Ps
X
n
ka
c
to
P
ash
c
d
X
Facts: P and T, both corporations, together own all of the membership interests in X, a limited liability company that is
treated as a partnership for federal income tax purposes. Under State W law, T merges into X. Pursuant to such law,
the following events occur simultaneously at the time of the transaction: all of the assets and liabilities of T become the
assets and liabilities of X, and T ceases its separate legal existence for all purposes. In the merger, the shareholders of
T exchange their T stock for consideration consisting of 50% P stock and 50% cash. As a result of the merger, X
becomes an entity that is disregarded as an entity separate from P.
Result: Under the final regulations, the transaction satisfies the requirements of a statutory merger or consolidation
because the transaction is effected pursuant to State W law and the following events occur simultaneously at the
effective time of the transaction: all of the assets and liabilities of T, the combining entity and sole member of the
transferor unit, become the assets and liabilities of one or more members of the transferee unit that is comprised of P,
the combining entity of the transferee unit, and X, a disregarded entity the assets of which P is treated as owning for tax
purposes immediately after the transaction, and T ceases its separate legal existence for all purposes. See Treas. Reg. §
1.368-2(b)(1)(iii), ex. 11. The existence and composition of the transferee unit are determined immediately after (but
not immediately before) the merger. See Preamble to Treas. Reg. § 1.368-2(b)(1).
150
Final Section 368 Regulations
Merger of Corporate Partner Into a Partnership (cont.)
P
P
T
M
er
erg
Ps
X
n
ka
c
to
a
dc
sh
X
Issues: In this transaction, X terminates as a partnership under section 708(b)(1)(A). The
preamble to Treas. Reg. § 1.368-2(b)(1) notes that this transaction “raises questions as to
the tax consequences of the transaction to the parties, including whether gain or loss may
be recognized under the partnership rules...as a result of the termination of” X. The
preamble also inquires whether the principles of Rev. Rul. 99-6 should apply to this
transaction.
151
Final Section 368 Regulations
Step Transaction Issues
T Stock
T SHs
P
100%
LLC
P
50% P Stock
50% Cash
T
LLC
T
Facts: P and T are domestic corporations. P owns all of the interests in LLC, a domestic limited liability company that
is disregarded for federal tax purposes. T’s shareholders transfer their T stock to P in exchange for 50% P stock and
50% cash. Immediately after the acquisition, T engages in one of the following alternative transactions.
(1) T merges into P = A reorganization
(2) T merges into LLC = A reorganization
(3) T files a form in Delaware to become an LLC = Not an A reorganization
(4) T checks the box to be treated as a disregarded entity = Not an A reorganization
(5) T liquidates into P = Not an A reorganization
(6) T dissolves = Not an A reorganization if remaining property does not vest in parent upon dissolution
Does the form of the second step determine the characterization of the transaction? Under what circumstances could
a state law liquidation be treated as a consolidation treated as an A reorganization?
See King Enterprises, Inc. v. United States, 418 F. 2d 511 (Ct. Cl. 1969); Rev. Rul. 67-274; Rev. Rul. 72-405; Rev.
Rul. 2001-46, 2001-2 C.B. 321; Rev. Rul. 90-95, 1990-2 CB 67; P.L.R. 9539018 (June 30, 1995); Preamble to Treas.
Reg. § 1.368-2(b)(1).
152
B Reorganization
P
100%
LLC
o
V
P
ck
o
t
gS
tin
ck
o
t
TS
T
Shareholders
T
Facts: P would like to acquire the stock of T in a tax-free reorganization.
Accordingly, P forms a wholly owned LLC, which is treated as a disregarded entity.
LLC acquires the T stock from T’s shareholders in exchange for P voting stock.
Result: The transaction should qualify as a tax-free B reorganization.
153
C Reorganization
T
Shareholders
P
P Voting
Stock
100%
P Voting Stock
LLC
T
T Assets &
Liabilities
Facts: P would like to acquire the assets and operating liabilities of T in a tax-free
reorganization, but T has certain liabilities that P wants to leave behind. Accordingly,
P forms a wholly owned LLC, which is treated as a disregarded entity. T transfers
its assets and operating liabilities to LLC in exchange for P voting stock and distributes
the P stock to its shareholders in complete liquidation (subject to satisfaction of any
remaining liabilities).
Result: The transaction should qualify as a tax-free C reorganization, with P as the
acquiring corporation. See Rev. Rul. 70-107; cf. G.C.M. 39,102.
154
D Reorganization
P
P
T Stock
100%
T
100%
100%
A
A
100%
T
Merger
LLC
Facts: P owns all of the stock of two corporations, T and A. P contributes all of its T stock to A. Immediately
thereafter, A forms a wholly owned LLC, and T merges into LLC.
Result: The contribution of T stock and the subsequent merger of T into LLC should be integrated and treated
as if T transferred all of its assets directly to A in exchange for A stock and then distributed the A stock to P in
complete liquidation. The transaction, as recharacterized, should qualify as a tax-free acquisitive D
reorganization. See P.L.R. 200445016 (Jul. 20, 2004); see also Rev. Rul. 2004-83 (taxable sale of subsidiary
stock to another subsidiary followed by an actual liquidation treated as a D reorganization); P.L.R. 200430025
(Apr. 2, 2004) (transfer of stock followed by a QSub election treated as a D reorganization).
Note that, as a result of the AJCA, section 357(c) no longer applies when T’s liabilities exceed T’s aggregate
155
basis in its assets as long as the D reorganization is acquisitive. See section 357(c)(1)(B).
F Reorganization
T
Shareholder
2) Merger
T
3) LLC
Interests
T
Shareholder
HC
1) Business A
HC
4)
Sto P Vo
t
ck
& C ing
ash
Bus. A
4) Merger
P
100%
LLC
100%
Bus. B/Cont. Liab.
LLC
Facts: T conducts two businesses, Business A and Business B. P would like to acquire Business A in a tax-free
reorganization in exchange for 80% P stock and 20% cash. T has contingent liabilities that P wants to leave behind.
Further, assume for simplicity that the Business B assets have little or no built-in gain and T has a single shareholder.
Accordingly, T forms a new corporation, HC, which in turn forms a wholly owned LLC treated as a disregarded
entity. T transfers Business A to HC and then merges into LLC. HC then distributes the LLC interests to its
shareholder in a taxable distribution. HC then merges into P, with the T shareholder receiving P stock and cash.
Result: Steps 1 and 2 should qualify as a tax-free F reorganization; step 3 should be treated as a taxable distribution
of LLC’s assets to T’s shareholder; step 4 should qualify as a tax-free A reorganization. See Prop. Reg. § 1.3682(m)(3)(ii); Rev. Rul. 96-29; PLRs 199902004, 199939017. What if, instead of a merger, the T shareholder sells the
HC stock to P? See Prop. Reg. § 1.368-2(m)(2).
156
Use of LLCs in Section 355
Transactions
157
Use of LLC to Avoid Section 355
P
P
C Stock
100%
D
C
Merger
LLC
LLC
C
Facts: P owns all of the stock of D. D owns all of the stock of C. D wants to distribute
the C stock to P, but the distribution would not satisfy the requirements of section 355.
Accordingly, P forms a wholly-owned LLC, which is treated as a disregarded entity, and D
merges into the LLC. LLC then distributes the stock of C to P.
Results: D should be treated as liquidating into P in a tax-free section 332 liquidation.
Because the LLC is treated as a division of P, the distribution of the C stock should be
ignored. See PLR 200035031.
158
Use of LLCs in Spin-Offs
P
(Holding)
S1
(5 years)
S2
(5 years)
S3
(3 years)
S4
(3 years)
Facts: P, a holding company, has four wholly owned subsidiaries: S1, S2, S3, and S4.
The subsidiaries are each actively engaged in a trade or business for purposes of section
355. S3 and S4, however, were acquired in taxable transactions during the past five years.
As a result, S3 and S4 are not engaged in qualifying active businesses under section
355(b). S2 merges into an LLC. P then distributes the stock of S1 to its shareholders.
159
Use of LLCs in Spin-Offs (cont.)
Shareholders
2. Spin-off of S1
to
P shareholders
S1
P
(Holding)
S2
LLC
S3
S4
1. Merger
Results: The merger of S2 into LLC should be treated as a section 332 liquidation. Thus, P is considered to be
directly conducting an active trade or business within the meaning of section 355(b).
The Tax Increase Prevention and Reconciliation Act of 2005 added new section 355(b)(3) to the Code to simplify
the active trade or business requirement. Section 355(b)(3) treats all members of the distributing and controlled
corporations’ separate affiliated groups as one corporation for purposes of the active trade or business requirement.
Thus, P is now treated as conducting the businesses of S2, S3, and S4, which eliminates the need for the
restructuring illustrated by this example. However, section 355(b)(3) is set to sunset on December 31, 2010. 160
Insolvency and
Bankruptcy Issues
161
Consequences of Check-the-Box Election
Election to be a Disregarded Entity
P
Convert
S
LLC
Assets = $50
Liabilities = $300
Facts: In year 1, P formed S and capitalized it with $100 of equity and $300 of debt. S
loses $350, rendering it insolvent. In year 2, S converts into an LLC under applicable state
law.
Result: The conversion does not qualify as a tax-free section 332 liquidation. Instead, P is
entitled to a worthless stock deduction under section 165(g)(3). See Treas. Reg. §§
301.7701-3(g)(1)(iii), (g)(2)(ii); Rev. Rul. 2003-125; see also Prop. Treas. Reg. § 1.332-2(b).
162
Consequences of Check-the-Box Election
Election to be Taxed as a Corporation
P
Bank
LLC
Check the Box
$300 Debt
LLC
Assets = $50
Liabilities = $300
Facts: In year 1, P formed LLC and capitalized it with $100 of equity. LLC borrowed $300
from Bank. LLC loses $350, rendering it insolvent. In year 2, LLC checks the box to be taxed
as a corporation.
Result: P is treated as contributing all of LLC’s assets and liabilities to a newly formed
corporation in a transaction that may not qualify under section 351. See Treas. Reg. §§
301.7701-3(g)(1)(iv), (g)(2)(ii). Compare Rosen v. Commissioner, 62 T.C. 11 (1974), Focht v.
Commissioner, 68 T.C. 223 (1977), and G.C.M. 33,915 (Aug. 26, 1968) with DeFelice v.
Commissioner, 386 F.2d 704 (10th Cir. 1967); Meyer v. United States, 121 F. Supp. 898 (Ct.
Cl. 1954); Prop. Treas. Reg. § 1.351-1(a)(1)(iii).
163
No Net Equity Partnership Analogue
P
Q
LLC
Bank
$300 Debt
Assets = $50
Liabilities = $300
Facts: In year 1, P formed LLC and capitalized it with $100 of equity. LLC borrowed $300
from Bank. LLC loses $350, rendering it insolvent. In year 2, Q contributes $250 in
exchange for an interest in LLC.
Result: P is treated as transferring all of LLC’s assets and liabilities to a newly formed
partnership in exchange for an interest in LLC. See Rev. Rul. 99-5 (Sit. 2). Query whether
such an exchange should be tax-free to P pursuant to section 721. Compare section 351(a)
with section 721(a); see also section 752(c); Cf. Prop. Treas. Reg. § 1.351-1(a)(1)(iii).
164
Bankruptcy of Disregarded LLC
X Corp. forms LLC by contributing cash of
$5,000,000 and LLC borrows $8,000,000 more. The
business washes out, with LLC losing everything.
LLC files for bankruptcy, triggering $8,000,000 of
COD ordinary income. Does section 108(a)(1)(A)
apply? See sections 108(d)(2), 7701(a)(1), (14).
X
Corp.
If section 108(a)(1)(A) applies, what tax attributes
are reduced? See section 108(b)(1), (2).
LLC
165
Bankruptcy of Regarded LLC
X and Y form XY LLC by
contributing cash of $5,000,000 and
XY LLC borrows $8,000,000 more.
The business washes out, with XY
LLC losing everything. XY LLC
files for bankruptcy, triggering
$8,000,000 of COD ordinary
income. How does section 108
apply? See section 108(d)(6).
X
Corp.
Y
Corp.
XY
LLC
166
Debt and Entity Conversion
LLC, taxable as a corporation and
consolidated with X Corp., borrows
$5,000,000 from a third party on a
recourse basis. Sometime thereafter,
LLC elects to be taxed as a
disregarded entity. The change in
classification is treated as a
liquidation. How does the change in
classification affect the debt? See
P.L.R. 200315001 (Sept. 19, 2002);
P.L.R. 199904017 (Oct. 29, 1998);
Prop. Treas. Reg. § 1.752-2(k).
X
Corp.
Third
Party
LLC
Debt of $5,000,000
167
Taxable Transactions
Sections 1060, 338, and 338(h)(10)
168
Asset Purchase
T S/H’s
P S/H’s
T S/H’s
P S/H’s
T
P
$
P Assets T Assets
$
T
T Assets
•
•
•
T Assets
P
P Assets
T recognizes gain or loss equal to difference between the purchase price and the
basis of the T assets.
P takes a basis in the T assets equal to the fair market value of the consideration it
pays to acquire them (“cost” basis).
Under section 1060, the consideration is allocated to 7 classes of assets (the residual
method of allocation).
169
Stock Purchase
P S/H’s
T S/H’s
P S/H’s
$
T
T Stock
P
P
T
T Assets
•
•
•
•
•
T Assets
T does not recognize any gain or loss (unless P makes a § 338 election).
T shareholders recognize gain or loss on the sale of their stock
T’s basis in the T assets (referred to as “inside basis”) is unaffected (unless P
makes a § 338 election).
P takes a basis in the T stock equal to the fair market value of the consideration
paid to acquire it.
P may make an election under section 338 to treat the stock purchase as an asset
purchase. This election has consequences for both P and T.
170
Section 1060
•
Section 1060 applies to any "applicable asset acquisition." Section 1060(a).
–
An applicable asset acquisition is any transfer of assets constituting a trade or business
if the purchaser's basis in the acquired assets is determined wholly by reference to the
consideration paid for such assets. Section 1060(c).
–
Regulations broadly define "assets constituting a trade or business" as consisting of
any group of assets (i) the use of which would constitute an active trade or business for
purposes of section 355, or (ii) to which goodwill or going concern value could under
any circumstances attach. Treas. Reg. § 1.1060-1(b)(2)(i).
–
Prior to the enactment of section 1060 as part of the 1986 Act, taxpayers and the
government had frequently skirmished over purchase price allocations.
•
If section 1060 applies to a transaction, the "consideration received" for the acquired assets
must be allocated among the assets in accordance with regulations under section 338(b)(5).
Section 1060(a). See also Treas. Reg. § 1.1060-1(c)(2).
–
The regulations require that the consideration be allocated among the assets under the
"residual method."
If the transaction is an applicable asset acquisition, each party must satisfy certain reporting
requirements. Section 1060 also imposes certain reporting requirements with respect to
specific transactions that are not applicable asset acquisitions.
•
171
Section 1060 Regulations
•
•
•
Regulations were issued to clarify the treatment of, and provide consistent rules (where possible) for, both
deemed and actual asset acquisitions under sections 338 and 1060.
Treas. Reg. § 1.1060-1(c)(2) incorporates the residual method by cross reference to the final section 338
regulations (Treas. Reg. §§ 1.338-6 and 1.338-7).
The regulations provide:
– A trade or business is present if goodwill or going concern value could attach to the group of assets,
regardless of whether any value will eventually be allocated to the residual class (Class VII). Treas.
Reg. § 1.1060-1(b)(2)(iii).
– The presence of section 197 intangibles is a factor to be considered in determining whether goodwill
or going concern value could attach. Treas. Reg. § 1.1060-1(b)(2)(iii)(A).
– A purchaser is subject to section 1060 even if the seller in the transaction is treated as selling
something different than the purchaser is treated as purchasing. Treas. Reg. § 1.1060-1(b)(4).
– In determining whether a group of assets constitute a trade or business, all transfers from the seller to
the purchaser in a series of related transactions are aggregated. Treas. Reg. § 1.1060-1(b)(5).
– As long as any part of the assets are a trade or business, all of the assets are to be treated as a single
trade or business for purposes of applying the residual method. Treas. Reg. § 1.1060-1(b)(6).
– If, in connection with the applicable asset acquisition, the seller enters into a covenant not to compete
with the purchaser, that covenant is treated as an asset transferred as part of a trade or business. Treas.
Reg.§ 1.1060-1(b)(7).
– The regulations allow the buyer and seller to adjust their allocation of consideration to particular
assets for costs incurred which are specifically identified with those assets. Thus, the total amount the
seller allocates to an asset for which it incurs specifically identifiable costs would be less than its fair
market value and, for the purchaser, greater than its fair market value. Treas. Reg. § 1.1060-1(c)(3).
172
Section 1060 Regulations
•
Seven asset classes under the final section 338 regulations (cross-referenced in the 1060 regulations).
•
Class I -- cash and general deposit accounts (including savings and checking accounts)
other than certificates of deposit held in banks, savings and loan associations, and
other depository institutions.
•
Class II -- actively traded personal property within the meaning of section 1092(d)(1)
and Treas. Reg. § 1.1092(d)-1, certificates of deposits, and foreign currency. Class II
assets do not include stock of target affiliates, other than actively traded stock described
in section 1504(a)(4)).
•
Class III -- assets that the taxpayer marks to market at least annually for Federal income
tax purposes and debt instruments (including accounts receivable but excluding certain
other debt instruments).
•
Class IV -- stock in the trade of the taxpayer or other property of a kind which would
properly be included in the inventory of taxpayer if on hand at the close of the taxable
year, or property held by the taxpayer primarily for sale to customers in the ordinary
course of its trade or business.
•
Class V -- all assets other than Class I, II, III, IV, VI, and VII assets.
•
Class VI -- all section 197 intangibles, as defined in section 197, except goodwill and going
concern value.
•
Class VII -- goodwill and going concern value (whether or not the goodwill and going concern
value qualifies as a section 197 intangible).
173
Example Allocation
T S/H’s
P S/H’s
$
T
•
P
T Assets
T Assets
•
•
Purchase Price = $1000
T Assets include:
–
–
–
–
–
–
Cash:
Stock portfolio
Accounts Receivable
Inventory
Land
Building
$100
$125
$100
$150
$150
$200
P Assets
Allocation using Residual Method:
– Class I (cash)
– Class II (stock)
– Class III (accounts receivable)
– Class IV (inventory)
– Class V (land + building)
= $100
= $125
= $100
= $150
= $350
–
Total FMV of Assets in classes I-V
= $825
–
Class VII (goodwill and going concern) = $1000 - $825
= $175
174
Basis Allocation in a Bargain Purchase
Facts
Corporation S owns all of the stock of Corporation T ("T"). Because of poor management, T is
under strong pressure from S to dispose of its business and liquidate. P is interested in acquiring T's
business, but realizes the pressure that T is under, and hence will only pay 75 cents on the dollar for
T's assets. T’s assets include cash, equipment and the stock of T1, and have a combined fair market
value of $2,000. P purchases the T stock from S for $1,500 and the parties make joint section
338(h)(10) elections for T and T1.
T stock
Asset
FMV
Cash
$1000
Equipment $500
T1 Stock
$500
Cash
$300
U.S. Gov’t
Securities $100
Equipment $100
S
$1500
P
T
T1
Questions
1. How will basis be allocated among T and T1's assets under the temporary regulations?
2. Does the basis allocation follow the class system described in Temp. Treas. Reg. § 1.338-6T
(i.e., do all Class I and Class II assets receive basis before Class V assets?).
175
Basis Allocation in a Bargain Purchase Continued
Result
Under Temp. Treas. Reg. § 1.338-6T, basis is allocated under the residual method. Consideration is first allocated to
Class I assets, then to Class II, then to Class III assets, then to Class IV assets, then to Class V assets, then to Class VI
assets, and finally to Class VII assets. Basis is allocated to each class up to its fair market value and then to the next
class of assets. Basis is allocated to the assets within a Class up to their fair market value (and in proportion to their
fair market value, if the total consideration is less than their fair market value).
T Assets -- Total basis to be allocated $1500
FMV of Individual Asset x
FMV of all assets in Class
Class I $1000
FMV
Cash
$1000
Amt. to be allocated
to the Class
= Basis of Individual Asset
Basis
$1000
Classes II, III, and IV $0
None
Class V $500
Equipment
T1 Stock
$500 x
$1000
$500 x
$1000
$500 =
Basis
$250
$500 =
$250
176
Basis Allocation in a Bargain Purchase Continued
T1 Assets -- Total basis to be allocated $250
Class I $250
FMV
Cash
$300
Basis
$250
Class II $0
U.S. Gov’t
Securities $100
$0
Class V $0
Equipment $100
$0
177
Reporting Requirements
•
•
•
•
•
Form 8594. The parties to an applicable asset acquisition are each required to file an information statement:
Who Must File
– Both the purchaser and seller are required to file Form 8594.
– The Form 8594 must be attached to each filer’s timely filed Federal income tax return.
– Taxpayers are not required to file Form 8594 if, pursuant to section 1031, the assets of a trade or business are exchanged for the
assets of another trade or business.
When and Where to File
– The seller and purchaser must file Form 8594 as an attachment to their respective income tax return for the year in which the sale
date occurred.
– If any amount allocated to an asset is either increased or decreased in a subsequent year, the seller and/or purchaser (whoever is
effected by the increase or decrease) must complete Parts I and III of Form 8594 and attach the Form to the income tax return for
the year in which the increase or decrease is taken into account.
Required Information
– Form 8594 requires the following information:
• The name, address, and taxpayer identification number of the seller and the purchaser, and the date of the sale/purchase.
• The total amount of consideration for the assets.
• The actual amount of Class I assets, and the aggregate fair market value of the assets included in each of Class II, III, IV, V,
and VI and VII; Class VI and VII are grouped together on Form 8594.
• The sum of the aggregate fair market values of all of the Class I - VII assets.
• The amount of the sales price allocated to each asset Class (i.e., Class I - VI and VII).
• Whether the allocation of purchase price was provided for in a sales contract or other written document signed by both
parties; if the answer is yes, whether the aggregate fair market values for each asset class as listed on Form 8594 are same
as the amounts agreed upon in the sales contract or other written document.
• Whether there is a related covenant not to compete, employment or management contract, or similar arrangement with the
seller (or managers, directors, owners, or employees of the seller); if so, the parties must attach a schedule specifying the
type of agreement and the maximum consideration (exclusive of interest) to be paid pursuant to such agreement.
Other Specified Transactions
– The reporting requirements also apply to certain transactions that ordinarily are not applicable asset acquisitions. These
transactions include:
•
•
A distribution of partnership property or a transfer of a partnership interest where section 755 applies (section 1060(d)(2)); and
A transfer by a 10-percent (by value) owner of an entity of any interest in such entity if, in connection with the transfer, the owner (or a related
person) enters into an employment contract, covenant not to compete, royalty or lease agreement, or other agreement with the transferee (section
1060(e)(1)); the information to be provided in a section 1060(e) transaction is to be set forth in regulations, which have yet to be issued.
178
Section 338
T S/H’s
T S/H’s
P S/H’s
P S/H’s
P
$
T
T Stock
T Assets
•
•
P
Old
T
Asset Sale
New
T
T Assets
Requirements: To make a § 338 election, the purchasing corporation (A) must make a
“qualified stock purchase” (QSP) of T. To make a QSP, A must purchase at least 80% of the
total voting power and at least 80% of total value of T stock during a 12 month acquisition
period.
Tax Consequences: If A makes a § 338 election, the original target corporation (old T) is
deemed to sell its assets to a new corporation (new T).
– This results in a double tax
• T recognizes gain or loss as if it had sold the assets to New T.
• Selling shareholders (T S/H’s) pay tax on gain from sale of T stock.
– New T takes a basis in the T assets determined by reference to the purchase price.
179
Section 338(h)(10)
P S/H’s
P S/H’s
$
S
P
T Stock
T
T Assets
•
•
P
S
§ 332
liquidation
Old
T
Asset Sale
New
T
T Assets
Requirements: If P purchases the stock of T from a member of T’s affiliated group (S), then a
joint §338(h)(10) election may be made to treat the stock purchase as an asset purchase.
Tax Consequences: If a § 338(h)(10) election is made, the stock purchase is recharacterized as
an asset sale followed by a liquidation. The original target corporation (old T) generally is
deemed to sell its assets to a new corporation (new T) and then liquidate into S under § 332 .
– T recognizes gain or loss as if it had sold the assets to New T.
– S does not recognize gain or loss on the sale of T stock.
– New T takes a basis in the T assets determined by reference to the purchase price.
180
Section 338 Regulations: Organization
•
§ 1.338-1 General principles; status of old and new T
•
§ 1.338-2 Nomenclature and definitions; mechanics of
the section 338 election.
•
§ 1.338-3 Qualification
•
§ 1.338-4 Seller’s side; ADSP
•
§ 1.338-5 Buyer’s side; AGUB
•
§ 1.338-6 Allocation
•
§ 1.338-7 Redeterminations
•
§ 1.338-8 Consistency
•
§ 1.338-9 International
•
§ 1.338-10 Returns
•
§ 1.338(h)(10)-1 Section 338(h)(10)
181
Section 338 Regulations: Accounting Rules
•
•
•
•
•
•
•
•
•
Under the regulations, aggregate deemed sales price (“ADSP”) is the sum of:
(1) the grossed-up amount realized on the sale to P of P's recently purchased T stock;and
(2) the liabilities of old T.
The amount realized is determined as if old T itself were the selling shareholder. Old T may use the
installment method of section 453 in the calculation of the first element of ADSP.
General principles of tax law apply in determining the timing and amount of the elements of ADSP.
ADSP is redetermined at such time and in such amount as an increase or decrease would be required, under
general principles of tax law, to the individual elements of ADSP.
The same rules apply for purposes of determining (and redetermining) aggregate grossed up basis
(“AGUB”).
The regulations make clear that, old T's tax liability incurred on its deemed asset sale is deemed assumed
unless the parties have agreed (or the tax or non-tax rules operate such that) the seller, and not T, will bear
the economic cost of that tax liability.
The amount of liabilities of old T taken into account to calculate ADSP is determined as if old T had sold
its assets to an unrelated person for consideration that included the unrelated person’s assumption of, or
taking assets subject to, the liability.
In order to be taken into account in AGUB, a liability must be a liability of T that is properly
taken into account under general principles of tax law that would apply if new T had acquired its assets
from an unrelated person for consideration that included the assumption of, or taking subject to, the
liability.
182
Section 338 Regulations
•
•
•
Definition of “Purchase”
•
The regulations include a single definition of purchase applicable to both targets and target affiliates. Under this definition,
stock in a target (or target affiliate) may be considered purchased if, under general principles of tax law, the purchasing
corporation is considered to own the stock of the target (or the target affiliate) meeting the requirements of section
1504(a)(2), notwithstanding that no amount may be paid for (or allocated to) the stock.
–
Section 338(h)(3)(A) defines the term "purchase" as "any acquisition of stock," subject to the following conditions:
• The basis of the T stock in the hands of P is not determined (i) in whole or part by reference to the adjusted basis of
such stock in the hands of T's former shareholders, or (ii) under section 1014(a) (property acquired from a decedent);
• The T stock is not acquired in an exchange to which section 351, 354, 355 or 356 applies or in any other transaction
described in the regulations in which the transferor recognizes less than all of its realized gain or loss; and
• The T stock is not acquired from a person the ownership of whose stock would, under section 318(a) (other than
paragraph (4) -- the option attribution provision), be attributed to P. The regulations provide that the relationship
between the purchaser and seller is tested immediately after the transaction. See Treas. Reg. § 1.338-3(b)(3)(ii).
Allocation Rules
•
The regulations use the top-down allocation method.
•
The scope Class II assets does not include stock of target affiliates, whether or not of a class that is actively traded, other
than actively traded stock described in section 1504(a)(4).
First Year Price Adjustments
•
•
The regulations do not include rules providing special treatment for changes in ADSP or AGUB occurring before the close
of new target’s first taxable year and instead apply the general rule that governs the allocation of all changes in ADSP or
AGUB after the acquisition date.
Reporting Requirements: Forms 8023 and 8883
•
Elections under section 338 are made by filing IRS Form 8023.
•
In addition, both old target and new target must file IRS Form 8883.
183
Treas. Reg. § 1.338(h)(10)-1
Deemed Asset Sale and Liquidation
• Treas. Reg. § 1.338(h)(10)-1 describes the model on which taxation of the section 338(h)(10) election is
based. Under the regulations:
(1)
Old T is treated as transferring all of its assets by sale to an unrelated person.
(2)
Old T recognizes the deemed sale gain while a member of the selling consolidated group, or
owned by the selling affiliate, or owned by the S corporation shareholders (both those who
actually sell their shares and any who do not).
(3)
Old T is then treated as transferring all of its assets to members of the selling consolidated
group, the selling affiliate, or S corporation shareholders and ceasing to exist.
(4)
If T is an S corporation, the deemed asset sale and deemed liquidation are considered as
occurring while it is still an S corporation.
• The preamble to the proposed regulations indicates the regulations were intended to treat all parties
concerned as if the transactions that are deemed to occur under section 338(h)(10) actually did occur, or as
closely thereto as possible.
• Old T generally may not obtain any tax benefit from the section 338(h)(10) election that it would not
obtain if it actually sold the assets and liquidated. Treas. Reg.§ 1.338(h)(10)-1(d)(9).
184
Treas. Reg. § 1.338(h)(10)-1
Deemed Asset Sale and Liquidation Continued
•
In the case of parent-subsidiary chains of corporations making section 338(h)(10) elections, the
deemed asset sale at the parent level is considered to precede that at the subsidiary level.
Treas. Reg. § 1.338(h)(10)-1(d)(3)(ii).
•
However, the deemed liquidation of the subsidiary is considered to precede the deemed liquidation of
the parent. Treas. Reg. § 1.338(h)(10)-1(d)(4)(ii).
•
Under the regulations, the section 453 installment method is available to old T in its deemed
asset sale, as long as the deemed asset sale would otherwise qualify for installment sale reporting.
Treas. Reg. § 1.338(h)(10)-1(d)(8).
•
The regulations extend the use of the term "aggregate deemed sales price" or "ADSP" generally
applicable to section 338 transactions to section 338(h)(10).
185
Section 338 -- Purchase
Has a Corporation Made the Purchase
•
Section 338(d)(3)
– “The term ‘qualified stock purchase’ means any transaction or series of transactions in
which stock (meeting the requirements of section 1504(a)(2)) of 1 corporation is
acquired by another corporation by purchase during the 12-month acquisition period.”
•
Treas. Reg. § 1.338-3(b)(1)
– “An individual cannot make a qualified stock purchase of target. Section 338(d)(3)
requires, as a condition of a qualified stock purchase, that a corporation purchase the
stock of target. If an individual forms a corporation (new P) to acquire target stock, new
P can make a qualified stock purchase of target if new P is considered for tax purposes to
purchase the target stock. Facts that may indicate that new P does not purchase the target
stock include new P's merging downstream into target, liquidating, or otherwise
disposing of the target stock following the purported qualified stock purchase.”
186
Section 338 -- Purchase
Has a Corporation Made the Purchase
S
T
$
TS
t oc
k
P
P
332
liquidation
Newco
Newco
T
1. Newco buys T stock from S.
2. Newco is liquidated into P.
187
Section 338 -- Purchase
Has a Corporation Made the Purchase Continued
P
P
T Stock
X
X
GP
$
T
GP
Liquidate
T
T
3. P and X form a partnership. P transfers the
T stock to the partnership.
4. T is liquidated.
188
Section 338 -- Purchase
Has a Corporation Made the Purchase
X
A
P
T1 Stock
T Shareholders
$
T
T Stock
N
T1
Facts: Corporation X and Individual A own Partnership P. Corporation T’s only significant asset is 100% of the stock
of T1. T1 owns intellectual property. P wishes to acquire the stock of T1 and achieve a step-up in the basis of T1’s
assets. P forms Newco N, which acquires 100% of the T stock in a QSP. A section 338 election is made for both T and
T1. Immediately thereafter, T distributes the T1 stock to N, who in turn distributes the T1 stock to P.
Question: Has a “purchase” been made? See FSA 200122007 (Feb. 13, 2001); Treas. Reg. section 1.338-3(b)(1).
189
Section 338 -- Purchase
Contemporaneous Sale of Affiliate Stock
T shareholders
$
P
T Stock
T
T1 stock
$
T
T1
T1
Facts: P purchases 100% of the stock of T and makes a section 338 election for T. Before the
close of the day, P causes T to sell all of the T1 stock to a third party.
Question: Is T considered to have purchased the stock of T1 prior to the sale of T1 stock? See
Treas. Reg. section 1.338-1(d); Former Temp. Treas. Reg. section 1.338-3T(b)(4)(ii) Ex. 2;
Treas. Reg. 1.338-3(b)(1).
190
Section 338 -- Purchase
Common Ownership of S and P
A
B
C
D
A
25%
25% 25% 25% 25%
B
C
D
25% 25% 25%
T Stock
S
P
$
T
Has P purchased the T stock?
191
Section 338 -- Purchase
Cash Investment
A
P
%
90
of
T
k
oc
t
S
$
T
1. A owns all T stock.
2. P transfers cash to T for 90% of T stock.
3. Has P purchased the T stock?
4. What if T also has non-voting preferred stock
that is not bought?
192
Section 338 -- Purchase
Cash Investment Followed by Redemption
A
T Stock
P
$
1
ar
h
S
fT
o
e
ck
o
t
S
$
T
1. A owns all T stock.
2. P transfers cash to T for 1 share of T stock.
3. A is redeemed by T (using funds other than those provided by P.)
4. Has P purchased the T stock?
193
Section 338
Deemed Purchase Rule
•
Section 338(h)(3)(B)
– “The term "purchase" includes any deemed purchase under subsection (a)(2).”
– “Purchase" includes new T's deemed purchase of all the assets of old T under section
338(a)(1), including all of the stock held by old T on the acquisition date.
– Thus, if P purchases 80 percent of T's stock and makes an election, new T is deemed to
"purchase" 100 percent of the stock held by old T in its subsidiary X on the acquisition
date.
– If old T held 80 percent of the stock of X, then new T is deemed to have made a QSP of
the same 80 percent, thereby entitling T to make an election with respect to X.
194
Section 338 Election Rules -- Chain of Corporations
$
S
T stock
P
T
X
Y
Z
1. P purchases the stock of T from S and makes a section 338 election for T.
2. May P make a section 338 election for X, Y and Z?
3. May P make a section 338(h)(10) election for X, Y and Z?
195
Effect of Section 351
196
Qualified Stock Purchase -- Effect of Section 351
I
S
(3)
(2 )
$&
5%
$
(1)
T st
ock
P st
ock
T
P
1. Investor (“I”) transfers cash to Newco (“P”)
2. S transfers T stock to P.
3. P transfers cash and 5% of P stock to S.
197
Qualified Stock Purchase -- Effect of Section 351
Continued
I
S
95%
5%
P
T
Variations
•
S is several individuals, some shareholders sell P stock, while others do not.
•
The transaction is leveraged.
198
Participation by T Management - Section 351
95%
SH
5%
M
X
cash
T
oc
St
k
P
T
merger
S
Bank
$80
1. P is formed.
2. Management contributes 5% of T stock and X contributes $15 in cash, in exchange for
25% and 75% interest in P, respectively.
3. P forms S.
4. $80 is borrowed, secured by the T assets, to acquire the T stock.
5. S is merged into T with T surviving.
6. Acquisition of T stock with borrowed funds constitutes a redemption.
7. T stock from management -- section 351 -- is not purchased.
8. Section 338 will not apply unless X contributes cash equal to four times the value of
management’s stock and that cash is used to purchase T stock.
199
Sale by T Management to P -- Newly Formed P
95%
SH
5%
M
X
$15 cash
$5 cash
P
T
S
1.
2.
3.
4.
5.
6.
P is formed.
Management (M) contributes $5 in cash and X contributes $15 in cash.
P forms S.
$80 is borrowed, secured by the T assets, to acquire the T stock.
S is merged into T with T surviving. M receives $5 in the transaction.
The Service might ignore the $5 contribution by M and treat the transaction as if M
transferred its T stock to P in a section 351 exchange. Alternately, the Service could
treat the transaction as if M contributed its T stock and $5 in cash to P in exchange for P
stock and $5 in cash (boot).
7. The result is the same as the prior example -- section 338 is not available.
200
Section 338(h)(10) and “Busted 351” Transaction
P
X
Y
Z
Facts
1. P, X, Y, and Z file a consolidated return.
2. P wishes to sell X and Y to the public and to step up the basis of the X and Y assets.
56
201
Section 338(h)(10) and “Busted 351” Transaction Continued
PUBLIC
(3)
ock
t
s
N
P
Z
(1) Newco formed
(2)
X&Y
Stock
N
X
3. P forms Newco (N) and P transfers the X and Y stock to N.
Pursuant to a prearranged plan, P sells the N stock to the Public.
Y
57
202
Section 338(h)(10) and “Busted 351” Transaction Continued
Results
1. The transfer of the X and Y stock to N should not qualify as a section 351 transaction. P is not in control of N
immediately after the transfer. See Rev. Rul. 79-194, 1979-1 C.B. 145; TAM 9747001 (July 1, 1997); PLR 9541039
(July 20, 1995), as modified by PLR 9549036 (Sept. 12, 1995); PLR 9142013 (July 17, 1991).
2. Thus, N is deemed to purchase the X and Y stock.
3. In this event, P and N can file a section 338(h)(10) election to treat the transaction as a sale of assets by X and Y
followed by section 332 liquidations.
4. The recently regulations contain a similar example. See Treas. Reg. § 1.338-3(b)(3)(iv), Ex. 1.
5. How much stock does P have to sell?
•
P must sell more than 20% of N stock for section 351 not to apply. See section 351(a) and 368(c).
•
P must sell at least 50% of the N stock so that P and N are not related for purposes of section 338(h)(3)(A)(iii).
•
P must sell more than 80% of the N stock to avoid the application of the anti-churning rules of section 197(f)(9).
•
Prior to the effective date of recently finalized Treas. Reg. § 1.197-2 it was possible that the antichurning rules could have applied even if P sold all of the N stock because of the momentary relationship
between P and N. See Old Prop. Treas. Reg. § 1.197-2(h)(6)(ii).
203
PLR 200427011
Newco Stock, Convertible
Instruments & Non-Cash
Consideration
30% Newco
Common Stock
S1, S2, and
S3 Stock
Newco
P
S1
Public
S2
S3
Facts: P forms Newco with a minimal amount of capital. P executes a “firm commitment”
underwriting agreement to sell Newco stock and convertible instruments in an IPO. P then
contributes the shares of subsidiaries S1, S2, and S3 to Newco in exchange for all of the outstanding
Newco common stock, Newco convertible instruments, and other non-stock consideration (e.g., shortterm promissory notes or cash). Pursuant to the underwriting agreement, P sells 30% of the common
stock to the public. P also represents that, although not legally obligated to do so, it fully intends to
reduce its interest in Newco below 50% within two years of completing the sale of the 30% of the
common stock to the public.
Issue: Can P and Newco make a section 338(h)(10) election with respect to the contributed
subsidiaries? See P.L.R. 200427011 (October 6, 2003); Merril Lynch & Co., Inc. v. Commissioner.
204
Application of Section 338 to the Purchase of an Insolvent
Corporation -- Insolvent Target Corporation
A
T
T stock
P
$
Assets
1,000,000
Liabilities 1,000,001
Facts
Corporation T owns assets with a value of $1,000,000 and has liabilities of $1,000,001.
P purchases all the stock of T from individual A for $1 and attempts to make a section 338(g) election with respect to T.
Questions
1. What are the results of this election?
2. Would the results be different under the section 338 regulations?
References
Section 338(h)(3)(A)
Treas. Reg. § 1.332-2(b)
New Treas. Reg. § 1.338-3(b)(2)
Rev. Rul. 56-387, 1956-2 C.B. 189
205
Step Transaction Issues
206
Rev. Rul. 2001-46 - Situation 1
Step 2
Step 1
100% T stock
T Shareholders
70% P voting
stock and
30% cash
P
P
100%
T
Merge
S
Merge
T
Facts: P owns all of the stock of S, a newly formed wholly owned subsidiary. Pursuant to an integrated plan,
P acquires all of the stock of T, an unrelated corporation, in a statutory merger of S into T, with T surviving.
In the merger, the T shareholders exchange their stock for consideration of 70% P voting stock and 30%
cash. Immediately thereafter, T merges upstream into P.
Result: If the acquisition were viewed independently from the upstream merger of T into P, the result should
be a QSP of T stock followed by a section 332 liquidation. See Rev. Rul. 90-95, 1990-2 C.B. 67. However,
because step transaction principles apply, see King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl.
1969), the transaction is treated as a single statutory merger of T into P under section 368(a)(1)(A). P
acquires the T assets with a carry-over basis under section 362, and P may not make a section 338 election
for T.
Note: On July 8, 2003, the Service issued new final and temporary regulations that permit taxpayers to turn
207
off the step transaction doctrine and to make a section 338(h)(10) election in the transaction
described above. See Treas. Reg. § 1.338-3(c)(1)(i), (2) and Temp. Treas. Reg. § 1.338(h)(10)-1T.
Rev. Rul. 2001-46 - Situation 2
Step 1
Step 2
T Shareholders
100% T stock
100% P voting
stock
P
P
100%
Merge
Merge
T
S
T
Facts: Same facts as in Situation 1, except that the T shareholders receive solely P
stock in exchange for their T stock, so that the merger of S into T, if viewed
independently of the upstream merger of T into P, would qualify as a reorganization
under section 368(a)(1)(A) by reason of section 368(a)(2)(E).
Result: Step transaction principles apply to treat the transaction as a merger of T
directly into P.
Note: The taxpayers cannot not change this result under the new section 338
regulations because, standing alone, P’s acquisition of T does not constitute a
qualified stock purchase.
208
Final Treas. Reg. § 1.338(h)(10)-1(c)(2), (e)
•
The IRS issued final regulations on July 3, 2006, which adopted the substance of temporary and proposed
regulations issued in 2003.
•
The final regulations provide that “a section 338(h)(10) election may be made for T where P’s acquisition
of T stock, viewed independently, constitutes a qualified stock purchase and, after the stock acquisition, T
merges or liquidates into P (or another member of the affiliated group that includes P) . . . ” Treas. Reg. §
1.338(h)(10)-1(c)(2).
–
This rule applies regardless of whether, under the step transaction doctrine, the acquisition of T stock and
subsequent merger or liquidation of T into P (or P affiliate) qualifies as a reorganization under section 368(a). Id.
–
If a section 338(h)(10) election is made under these facts, P’s acquisition of T stock will be treated as a qualified
stock purchase (a “QSP”) for all Federal tax purposes and will not be treated as a reorganization under section
368(a). See Treas. Reg. § 1.338(h)(10)-1(e), Ex. 12 & 13.
–
However, if taxpayers do not make a section 338(h)(10) election, Rev. Rul. 2001-46 will continue to apply so as to
recharacterize the transaction as a reorganization under section 368(a). See id. at Ex. 11.
•
In issuing the final regulations, the IRS rejected a recommendation that the final regulations allow section
338(g) elections, as well as section 338(h)(10) elections, to turn off the step transaction doctrine, because
extending the election as such would allow the acquiring corporation to unilaterally elect to treat the
transaction, for all parties, as other than a reorganization under section 368(a).
•
The IRS stated in the Preamble to the final regulations that it would continue to study whether the
corporate purchaser requirement of -3(b) should be amended (e.g., an individual cannot make a QSP,
although an individual can form a corporation to satisfy the QSP requirement if that corporation is treated
as purchasing the target stock, which it may not be if that corporation liquidates following the stock
purchase).
•
The final regulations are effective for stock acquisitions occurring on or after July 5, 2006.
209
Section 197
210
Section 197 Overview
•
•
•
Section 197 has a profound effect on acquisition transactions. By its terms, the 15-year
amortization period applies to any "amortizable section 197 intangible" that (i) is acquired after
August 10, 1993, and (ii) "is held in connection with the conduct of a trade or business or any
activity described in section 212." Section 197(c)(1).
An "Amortizable Section 197 Intangible.“ Section 197(c) defines the term "amortizable section
197 intangible" as referring to a section 197 intangible that is
– acquired after the date of enactment of the statute (except for the special elections noted
below), and
– held in connection with the conduct of a trade or business or an activity described in section
212. See Treas. Reg. § 1.197-2(d)(1).
The term does not include certain section 197 intangibles created by the taxpayer (self-created
intangibles). See Section 197(c)(2); Treas. Reg. § 1.197-2(d)(2)(i).
– An intangible is self-created to the extent the taxpayer makes payments or otherwise incurs
costs for its creation or improvement, whether the actual work is done by the taxpayer or by
another person under a contract with the taxpayer. Treas. Reg. § 1.197-2(d)(2)(ii).
– The following self-created intangibles are excluded from the definition of amortizable Section
197 intangibles:
• goodwill;
• going concern value;
• workforce in place;
• information-based intangibles;
• know-how intangibles;
• customer-based intangibles;
• supplier-based intangibles; and
• any similar items.
• Section 197(c)(2), (d)(1).
211
Section 197 Regulations
•
On January 20, 2000, the Internal Revenue Service issued final regulations under section 197. 65
Fed. Reg. 3,820 (Jan. 25, 2000).
•
The exception for self-created intangibles does not apply if the intangible is created in connection
with a transaction involving the acquisition of assets constituting a trade or business or a
substantial portion thereof. Section 197(c)(2); see Treas. Reg. § 1.197-2(d)(2)(iii)(B). Thus,
intangibles created in connection with such an acquisition will be treated as amortizable section
197 intangibles.
•
•
The final regulations define a trade or business as it is defined in section 1060 (i.e.,
one to which goodwill or going concern value could, under any circumstances,
attach).
•
Whether acquired assets constitute a "substantial portion" of a trade or business is
based on all the relevant facts and circumstances. Treas. Reg. § 1.197-2(e)(4).
A qualified stock purchase treated as an asset purchase under section 338 constitutes the
acquisition of a trade or business or a substantial portion thereof only if the direct acquisition of
the assets of the corporation would have been treated as the acquisition of assets constituting a
trade or business. Treas. Reg. § 1.197-2(e)(5).
212
Section 197 Intangibles: In General
•
For purposes of section 197, acquired intangible assets generally can be grouped
into three categories:
– Intangibles that will always be treated as a "section 197 intangible"
• Examples: goodwill; going concern value; workforce intangibles; information-based
intangibles; know-how intangibles, customer-based intangibles, supplier-based
intangibles, licenses, permits, or other rights granted by a governmental unit; and
franchises, trademarks, or trade names
– Intangibles that will be treated as a section 197 intangible if there is a related
direct or indirect acquisition of a trade or business or substantial portion thereof
• Examples: a covenant not to compete; specialized computer software; any interest in
a film, sound recording, video tape, book, or similar property; a contractual right to
receive tangible property or services; any interest in a patent or copyright; any right
to service mortgage indebtedness secured by residential real property; and insurance
contracts acquired in assumption reinsurance transactions)
– Intangibles that will never be treated as a section 197 intangible
• Examples: a financial interest; an interest in land; off-the-shelf computer software;
an interest in a tangible property lease or a debt instrument; a professional sports
franchise; and certain transactional costs. See Section 197(d), (e).
213
Section 197 Regulations: Anti-churning Rules
•
The amortization rules described above do not apply to goodwill, going concern value or any other section
197 intangible that would not be amortizable but for Code Sec. 197, if acquired by a taxpayer after August
10, 1993, and:
•
(1) the taxpayer or a related person held or used the intangible at any time on or after July 25, 1991,
and on or before August 10, 1993;
•
(2) the taxpayer acquired the intangible from a person who held it at any time on or after July 25,
1991, and ending on or before August 10, 1993, and, as part of the transaction, the user of the
intangible does not change; or
•
(3) the taxpayer grants the right to use the intangible to a person (or a person related to such person)
who held or used the intangible at any time on or after July 25, 1991, and on or before August 10,
1993 (Code Sec. 197(f)(9)(A)).
•
The regulations expressly state the purpose of the anti-churning rules and provide that the anti-churning
rules are to be applied in a manner that carries out their purpose.
•
The final regulations modify the definition of a related person for purposes of the anti-churning rules in the
case of a series of related transactions. The final regulations test relatedness for purposes of the antichurning rules only immediately before the first transaction and immediately after the last transaction, not
during the period in between as in the proposed regulations. The final regulations also apply this rule to a
series of transactions that together comprise a qualified stock purchase within the meaning of section
338(d)(3).
–
The regulations also provide that any relationship created as part of a series of related transactions in
which a person acquires stock of a corporation constituting 80 percent followed by a liquidation of the
corporation under section 331 is generally disregarded.
214
Section 197 -- Anti-Churning Rules
Series of Transactions
A
T Stock
P
$
100%
T
Facts
1. A owns all of T’s stock.
2. P purchases 25 percent of the T stock from A in January of Year 1.
3. P purchases the remaining 75 percent of the T stock in June of Year 1 and makes a section 338
election.
Questions
1. Are P and T considered related for purposes of the anti-churning rules?
215
Section 197 -- Anti-Churning Rules
Series of Transactions
60% T Stock
A
40 %
100%
T Sto
ck
X
$
$
Y
60%
T
40%
Facts
1. A owns all of T’s stock.
T
2. A sells all of T’s stock -- 60 percent to X and 40 percent to Y.
3. X and Y liquidate T under section 331.
Questions
1. Do the anti-churning rules apply to this transaction?
216
Contingent Liabilities
217
Contingent Liabilities in Taxable Asset Acquisitions
•
Unfortunately almost every deal involves contingent liabilities
– Examples
• Environmental liabilities
• Tort liabilities
• Warranty claims
• Retiree medical expenses
– Complex area with very few answers
– Conflicting authority
•
Issue arises when a buyer purchases assets of a business and after the acquisition
the buyer pays or incurs a liability that is attributable to the acquired business
– It is not clear whether that liability is a liability of the seller that is assumed by the buyer;
OR
– Whether it is simply a liability that arose after the acquisition and is properly treated as
the buyer’s liability
218
Contingent Liabilities in Taxable Asset Acquisitions
•
Whose liability is it?
– Is it a seller liability assumed by the buyer?
– Or a liability of the buyer arising after closing?
•
If the buyer is not assuming a debt of the seller
– Buyer should get a deduction on the payment of the liabilities. (Under normal rules of
the all events test and economic performance. See section 461(b).
– Ability to get a deduction is subject to the capitalization rules.
•
If the liability is the seller’s liability assumed by the buyer, there are numerous
issues
– Income to the seller
– Offsetting deduction to the seller
– Basis to the Buyer
•
Threshold question is when will contingent liability be treated as a seller liability
assumed by the buyer and when will it be treated as the buyer’s liability
– Each case decided on its own facts and circumstances
– Cases and rulings provide some guidance on factors as to when a liability will be treated
as assumed by the buyer
219
Contingent Liabilities: Assumed Obligation?
Factors
•
Results from Buyer’s Operation
•
Arises Out of Post-Acquisition Events
•
Buyer Aware of Liability
•
When Did Legal Liability Arise
•
Reflection in Price
•
Express Assumption by the Buyer
•
Balance Sheet Reserve
220
Contingent Liabilities: Assumed Obligation?
•
First factor – Results from Buyer’s Operation
–
Whether the liability relates to
•
•
•
•
–
–
–
Goal is to separate the occurrence of the liability from the seller and the acquisition (i.e., not a seller liability)
If it does not relate to the seller’s operation of the business, then the Buyer can deduct the payment
Holdcroft Transportation Co. v. Commissioner, 153 F.2d 323 (8th Cir. 1946)
•
•
•
–
Buyer’s operation of the business
Activity performed by the buyer
Events under the buyer’s control
Liability arising from buyers decision
Corporation acquires assets of partnership in exchange for stock and assumption of liabilities—including two tort claims
filed against the partnership
Corporation pays on the claims and deducts the payments
– Corporation argues it should be treated as stepping into the shoes of the partnership and therefore should be able to
deduct the payments
– Corporation also argues it should be able to deduct the payments because the claims were contingent
Court holds: (i) claims did not arise out of buyer’s business; (ii) rather, expenses related to the seller’s business; (iii) buyer
cannot deduct costs relating to seller; (iv) fact that liability was liability was contingent did not matter; (v) buyer assumed the
liability as part of the costs of the assets; (vi) section 381 – step into the shoes.
Other authorities
•
•
•
•
Albany Car Wheel v. Commissioner, 333 F.2d 653 (2nd Cir. 1964) – liability arose after acquisition due to buyer’s decision
to close plant
Rev. Rul. 76-520 – buyer acquired a newspaper business
– Costs of filling prepaid subscriptions was assumed liability because it relates to sellers operation
– Costs incurred to sell newspapers at newsstand were deductible because they related to the buyer’s operation
TAM 9721002 – acquisition and severance pay
– “[A]lthough severance payments here were coincidental with Buyer's acquisition of Target, the severance payments
had their origin in Buyer's termination of Target employees. While the acquisition may have been the catalyst for the
employees' receipt of the severance payments, the acquisition was not itself the basis for the payments. Accordingly,
the severance payments need not be capitalized and added to the basis of the stock purchased.”
Illinois Tool Works v. Commissioner, 355 F.3d 997 (7th Cir. 2004)
– Because the taxpayer knew of the pending patent infringement lawsuit, and agreed to pay that contingent liability in
exchange for purchasing the company, the taxpayer was not entitled to currently deduct the judgment as a business
expense.
221
Contingent Liabilities: Assumed Obligation?
•
Second factor – Arises Out of Post-acquisition Events
– A closely related factor is whether the liability arises out of post-acquisition events
– For example, employee benefit cases
• Where there is a contract in place at the time of the acquisition to pay death benefits when
an employee dies
• If employee dies after closing, then the liability should be a buyer liability
– Even though contract in place, it’s contingent because you know he will die
eventually
• If employee has already died and seller is obligated to pay, the buyer assumes the
obligation—No deduction.
– M. Buten & Sons, Inc. v. Commissioner, 31 T.C.M. (CCH) 178 (1972)
• Corporation agreed to assume liabilities of partnership in section 351 transaction,
including death benefits to surviving widows
– Court held no deduction for payments to widow of employee who died before the
acquisition; Payments were deductible if employee died after the acquisition
– David R. Webb Compay, Inc. v. Commissioner, 708 F.2d 1254 (7th Cir. 1983)
• Buyer assumed sellers obligation to make pension payments to wide of previously deceased employee
• Court no deduction to buyer
222
Contingent Liabilities: Assumed Obligation?
•
Third factor – Buyer Aware of Liability
– The third factor is whether the buyer was aware of the liability.
– In Pacific Transport v. Commissioner, 29 T.C.M. 133 (1970), rev’d per curiam 483 F.2d 209
(9th Cir. 1973), a parent corporation liquidated its subsidiary (section 334(b)(2) and took assets
and assumed the liabilities of the subsidiary, including a lawsuit that was asserted against the
subsidiary.
• The parent corporation believed its risk exposure on the claim was remote.
• The parent corporation’s risk assessment was wrong and it ultimately had to pay the
claim.
• Tax court held that a deduction should be allowed because the claim was speculative and
remote.
• Appeals court reversed and held that contingency was irrelevant. Because the buyer was
aware of the liability, payment of the claim was a cost of acquiring the assets.
– No exception to capitalization for bad bargains.
– Therefore, if buyer is aware of the claim at the time of the acquisition, there is no
deduction for payment of the claim
– On the other hand, if buyer is not aware of the claim, then the court might permit the
buyer to deduct
– But see Holdcroft Transportation v. Commissioner. Court might not care whether
the buyer knew of the liability and may instead look to when the liability arose. If
the liability relates to the seller, then no deduction
223
Contingent Liabilities: Assumed Obligation?
•
Fourth Factor: When did legal liability arise?
– The fourth factor used by some courts to determine if a liability has been assumed is
when the legal liability arose.
– This factor can be used to explain the tort cases. Courts have stated that legal
liability for a tort arises when the tort occurs.
• Therefore using this factor would lead a court to conclude that a pre-closing cause of
action is a liability of the seller. If the buyer pays the liability, there is no deduction.
• Holdcroft and Pacific Transport support the notion that the contingent nature of the tort is
not relevant
– Compare this result to the contract cases where the liability represents a contractual
claim, not a tort.
– Albany Car Wheel Co. v. Commissioner, 40 T.C. 831 (1963), aff’d 333 F.2d 653
(2nd Cir. 1964)
• There was a collective bargaining agreement that required payment of severance wages to
employees upon a plant shutdown.
• The purchase agreement called for an express assumption of the severance pay liabilities.
• After the assets were transferred, the plant was shut down and severance payments were
made by the buyer.
• Court held that the liability did not arise until after the closing when the plant shut down.
Therefore the liability arose on the buyer’s side.
– Contract required payment upon certain contingent, future events. Liability arose when the
event occurred.
– Event was post-closing.
224
Contingent Liabilities: Assumed Obligation?
•
Fifth Factor: Liability Reflected in Price
–
–
–
–
The next factor is whether the contingent liability is reflected in the price
Courts look to see if the purchase price was reduced on account of the contingent liability.
If the purchase price was reduced, then the liability looks lie an assumed liability
This factor comes up often where
• Purchase price based on balance sheet
• Reserve on balance sheet (e.g., for employee medical benefits)
– Allows IRS to argue that the liability was reflected in the price
•
Sixth Factor: Liability Expressly Assumed by the Buyer
– The sixth factor is whether the buyer expressly assumed the liability.
– If the buyer expressly assumes a liability of the seller, courts generally conclude that the buyer
is assuming the liability
– However, this factor alone is not fatal. In Albany Car Wheel the buyer expressly assumed a
collective bargaining liability (severance pay in the event of a plant shutdown). However, the
court said that the liability in fact was assumed
225
Consequences of an Assumed Liability
To the Seller:
•
Income Inclusion – When
What Amount
•
Installment Reporting
•
Offsetting Deduction
•
Imputed Interest Income
To the Buyer
•
Capitalize Payment
•
Deduct Payment
•
Report Income
•
Imputed Interest Expense
226
Consequences of an Assumed Liability: To the Seller
•
First Issue: Income Inclusion
– Seller is being relieved of a liability
– Seller’s amount realized is increased
• Not clear when amount realized increased and by how much
• One approach is to value the liability at closing and increase the amount realized by
that amount
• Second approach is to increase seller’s amount realized only when the contingency
becomes fixed and determinable (however that standard is defined). This is
sometimes referred to as the “Wait and See” approach.
•
Second Issue: Installment Reporting
– If the “wait and see” approach is taken, then the issue arises as to whether the sale is
converted to an installment sale because of the possible future payment when liability
becomes fixed
• Section 453 regulations (relating to installment sales) do not discuss assumption of
contingent liabilities
• However, if you treat the payment of the liability as a payment of the purchase
price, then the sale literally falls within the definition of contingent payment
installment sale.
227
Consequences of an Assumed Liability: To the Seller
•
Third Issue: Does the Seller get an offsetting deduction against the amount realized
resulting in no net income?
– Most practitioners would conclude the seller should get a deduction under James M. Pierce
Corp. v. Commissioner, 326 F.2d 67 (1964) and Commercial Security Bank v.
Commissioner, 77 T.C. 145 (1981).
– In Pierce, the seller operated a newspaper business.
• Seller received prepaid subscription fees
• Seller initially set up a reserve and deferred the income under section 453
• Court said that when seller sold the business the seller must accelerate the reserve into
income
• But, the court also gave the seller a deduction
– Buyer paid cash for reserve
– Seller turned around and paid buyer for assuming the liability to fill newspaper
subscriptions
– Thus income was offset with a deduction
– In Commercial Security Bank there was a slightly different rationale.
• Court said that liability assumed by the buyer reduced the cash received by the seller
• Such reduction in cash received treated as if seller actually paid the liability
• Seller gets a deduction to offset income
228
Consequences of an Assumed Liability: To the Seller
•
Third Issue (continued): Does the Seller get an offsetting deduction against the
amount realized resulting in no net income?
– Problem arises because a seller can have all kinds of liabilities and the timing rules for
deductions must be considered.
• For example, if the all events test is satisfied but there is no economic performance, does the
seller still get a deduction?
• Section 461(h) regulations reserve treatment of contingent liabilities. See Treas. Reg. § 1.4614(j).
• Section 461 regulations do provide that in a sale of a business if the buyer “expressly assumes” a
fixed liability then economic performance occurs as the liability is included in the seller’s
amount realized.
• Problem is that the regulation is too narrow because it requires an express assumption.
• If the regulation test is failed, then the seller may have income without a matching deduction.
–
Presumably the deduction is deferred until the buyer makes payment
» This is the wrong answer – in the acquisition context the seller should not be subject to economic
performance.
» Section 461(h) was intended to prevent premature accrual. If the seller has income recognition,
then accrual is not premature.
» If the seller doesn’t get a deduction at the time of the acquisition, then there is not a clear
reflection of income.
» Query whether Pierce and Commercial Security Bank apply if the requirements of section 461(h)
are not met.
– Similar problem arises where the liability is to make payment to nonqualifying deferred
compensation plan
• Section 404(a)(5) – employer gets deduction when employee has income
• IRS position in TAM 8939002 is that deemed payment found in Commercial Security Bank,
Pierce, etc. doesn’t support a deduction without income to the employee
229
Consequences of an Assumed Liability: To the Seller
•
Fourth Issue: Whether Interest Imputed on Deemed Payment
– This issue should only apply to the “wait and see” approach
• Arguably there is no imputed interest because section 1274 does not apply to
assumed debt. See section 1274(c)(4).
230
Consequences of an Assumed Liability: To the Buyer
•
First Approach: Capitalization
– Treat liability as cost of the assets.
– Add to the assets’ basis when the liability becomes fixed.
– Capitalization approach has the greatest support in the case law
• See Webb v. Commissioner, 77 T.C. 1134 (1981), aff’d, 708 F.2d 1254 (7th Cir.
1983).
– Unfunded pension liability assumed in asset acquisition
– Payments treated as cost of acquired assets
• See also Holdcroft, Pacific Transport, M. Buten & Sons.
– Uncertain whether buyer can treat a portion of the payments as interest
231
Consequences of an Assumed Liability: To the Buyer
•
Second Approach: Deduction
– This method says that even if the liability is assumed by the buyer the buyer should still
get a deduction when the liability is fixed
– There is some support for this approach in the case law
• Albany Car Wheel, 333 F.2d 653 (2d Cir. 1964)
– Agreement specifically said liability to pay severance pursuant to collective
bargaining agreement in the event of a plant shutdown was assumed
– But court said that facts showed that the liability was not assumed and the
buyer had made a decision that resulted in the liability to pay severance (i.e.,
shutting down the plant).
• United States v. Minneapolis and St. Louis Railway Co., 260 F.3d 663 (8th Cir.
1958)
– Suggests deductibility method
– But case can also be read as saying nothing was assumed
• F&D Rentals, Inc., 365 F.2d 64 (7th Cir. 1966)
– Court said in dicta that taxpayer could deduct if payment had been made
– ABA and NYSBA support the deductibility approach.
232
Consequences of an Assumed Liability: To the Buyer
•
Third Approach: Income Approach
– The third approach is the income approach. This approach comes from the Pierce case.
• Seller sold a newspaper
• Court required seller to include reserve for prepaid subscriptions in income on sale
• Court permitted seller an offsetting deduction
• Court’s theory was to construe a deemed payment from seller to buyer in an amount
equal to the reserve
– The income approach has not received much support outside of the publication industry
• Doesn’t make sense to say buyer has income on a purchase
233
Contingent Liabilities: Section 338(h)(10)
Result under the Section 338 Regulations
SELLER’S ADSP
ADSP = G + L
•
•
•
Regulations eliminate the “Fixed and Determinable” standard for determining the
Liabilities of Old T.
General principles of tax law apply in determining the timing and the amount of
liabilities to be included in ADSP.
ADSP is redetermined at such time and in such amount as an increase or
decrease would be required, under general principles of tax law, for the
elements of ADSP.
BUYER’S BASIS
•
•
Use AGUB Formula
Regulations eliminate the “Fixed and Determinable” standard.
•
In order to be taken into account for AGUB, a liability must be a liability of T that
is properly taken into account in basis under general principles of tax law.
234
Section 355 Transactions
235
Section 355 – Overview
•
Section 355 provides for the tax-free distribution of the stock of a
controlled corporation (“Controlled”) by a corporation (“Distributing”) to
its shareholders.
•
A section 355 transaction can be structured in one of three ways – a spinoff, a split-off, and a split-up.
•
A spin-off is the pro rata distribution of the stock of Controlled.
•
A split-off is the distribution of the stock of Controlled generally to
some (but not all of the shareholders) who surrender stock of
Distributing.
•
A split-up is the distribution of stock of two or more controlled
corporations in complete liquidation of Distributing.
236
Section 355 – Basic Requirements
1. Distributing must be in control of Controlled (i.e., at least 80 percent
of the total combined voting power of all classes of voting stock and at
least 80 percent of each class of nonvoting stock) immediately before
the distribution.
2. Distributing must distribute all the stock of Controlled owned by
Distributing.
3. The distribution must be motivated by a corporate business purpose
of Distributing or Controlled.
4. The distribution must not be principally a device for converting what
otherwise would be a dividend into capital gain.
5. Both Distributing and Controlled must be actively engaged in a
qualifying 5-year trade or business immediately after the distribution.
6. Pre-distribution shareholders of Distributing must have a continuing
interest in Distributing and Controlled after the distribution.
237
Section 355 – Basic Requirements (Continued)
7. No person may have purchased stock of Distributing or Controlled
within five years prior to the distribution that results in that person
owning 50 percent or more of the stock in either Distributing or
Controlled immediately after the spin-off.
8. There can not be a plan pursuant to which one or more persons acquire
directly or indirectly stock representing a 50 percent or greater interest
in Distributing or Controlled within 2 years of the distribution.
9. In a split-off, the fair market value of investment-type assets held by
Distributing and Controlled generally must be less than 2/3 of the fair
market value of all of the assets of Distributing and Controlled,
respectively.
238
Section 355: Active Trade or Business
-
Section 355(b)(3) – Separate Affiliated Group Rules
Expansion Doctrine
Partnerships
239
Active Trade or Business Requirement – SAG Rule
•
Sections 355(a)(1)(C) and (b)(1) generally require that Distributing and Controlled must each be
engaged in the active conduct of a trade or business (an “ATB”) immediately after the distribution.
•
Section 355(b)(2)(A) provided that a corporation satisfies the ATB requirement if and only if (i) it is
engaged in an ATB or (ii) substantially all of its assets consist of stock of a corporation controlled by it
(immediately after the distribution) which is so engaged.
•
The Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”) amended section 355(b) to
provide that a corporation can meet the ATB requirement only if it conducts an ATB. However, for
such purposes, all members of such corporation’s separate affiliated group (a “SAG”) shall be treated as
one corporation. See section 355(b)(3).
•
A SAG is defined as the affiliated group which would be determined under section 1504(a) if such
corporation were the common parent and section 1504(b) did not apply.
•
The TIPRA change applies to distributions occurring after the date of enactment (May 17, 2006).
•
•
Under TIPRA, section 355(b)(3) was to sunset with respect to transactions occurring before December 31,
2010.
On December 9, 2006, Congress enacted the Tax Relief and Health Care Act of 2006, which contained a
provision that made the TIPRA amendment to section 355(b)(3) permanent.
240
Section 355(b)(3) — Example
D
Spin-off
C
S1
Qualified T/B
Holding Co.
S2
S3
Nonqualified T/B
Facts: D is a holding company that wholly owns C, S1, S2, and S3, each of which is of equal value. C and S1
each engage in a qualifying 5-year active trade or business, but S2 and S3, having been acquired in taxable
transactions within the past 5 years, do not. D wants to spin-off C to its shareholders.
Analysis: Under prior law, D would not have satisfied the active trade or business requirement, because
substantially all of its assets are not stock or securities in subsidiaries that are so engaged. See Section 355(b)(2).
However, under section 355(b)(3)(B), D, S1, S2, and S3 will now be treated as one corporation engaged in S1’s
qualifying active trade or business.
241
Would the answer change if S1 were a foreign corporation?
Section 355(b) – Proposed Legislative Change
•
•
The Tax Technical Corrections Act of 2006 (the “Proposed Corrections
Act”) was introduced in the Senate (S. 4026) and the House (H.R. 6264) on
September 29, 2006.
The Proposed Corrections Act would modify the affiliated group ATB in
TIPRA, enacted as section 355(b)(3).
– As discussed above, section 355(b)(3) provides that all members of a corporation’s
separate affiliated group (determined under section 1504(a) as if section 1504(b) did not
apply) are treated as one corporation for purposes of applying the ATB requirement of
section 355(b).
– The Proposed Corrections Act would redefine the term “separated affiliated group” not to
include those corporations which became a member of such separate affiliated group (or of
any other separate affiliated group to which the active business rule of the provision
applies with respect to the same distribution) during the 5-year period ending on the date of
distribution by reason of one or more transactions in which gain or loss was recognized in
whole or in part.
– Also, a business conducted by such a corporation at the time it became an otherwise
qualifying member would not be included.
•
•
The legislative change to section 355(b) proposed by the Proposed
Corrections Act would apply as if it had been included in TIPRA.
The proposed legislative change has not been enacted.
242
Active Trade or Business Requirement -Sections 355(b)(2)(C) & (D)
•
Sections 355(b)(2)(B) requires that the ATB be conducted throughout the fiveyear period ending on the date of distribution (the pre-distribution period)
•
Section 355(b)(2)(C) provides that the ATB must not have been acquired in a
transaction in which gain or loss was recognized, in whole or in part, during
the pre-distribution period.
•
Section 355(b)(2)(D) provides that control over a corporation which (at the
time of acquisition) was conducting an ATB must not have been directly or
indirectly acquired by any distributee corporation or distributing corporation
during the pre-distribution period in a transaction in which gain or loss was
recognized, in whole or in part.
•
•
Control means control under section 368(c) (i.e., 80% of voting power in
voting stock and 80% of all other stock.)
The IRS published proposed regulations on May 8, 2007 that provide guidance
on the application of the SAG rule of section 355(b)(3) to the acquisition rules
of sections 355(b)(2)(C) and (D).
243
Proposed Regulations -- Sections 355(b)(2)(C) & (D)
•
The proposed regulations introduce the terms “DSAG” and “CSAG”, which refer to
the SAG of Distributing and Controlled, respectively.
•
The proposed regulations clarify that the SAG rule applies throughout the predistribution period. Accordingly, Distributing or Controlled may satisfy the ATB
requirement if a member of the DSAG or CSAG satisfied the requirement.
•
The proposed regulations confirm that asset transfers between SAG members are
disregarded for purposes of determining whether there has been an impermissible
acquisition under section 355(b)(2)(C).
•
The proposed regulations generally treat stock acquisitions that result in the acquired
corporation becoming a SAG member as asset acquisitions, thereby limiting the
effect of section 355(b)(2)(D).
•
If the acquired corporation becomes a SAG member, then the applicable code
provision is section 355(b)(2)(C) because the acquisition is treated as an asset
acquisition.
244
Section 355(b)(2)(C) vs. 355(b)(2)(D)
Case 1
Case 2
1504 stock
368(c) stock
Sh.
D
Sh.
D
$
$
ATB 1
ATB 1
C
ATB 2
C
ATB 2
C
ATB 2
C
ATB 2
Facts: For five years, D has conducted ATB 1, and unrelated C has conducted ATB 2. In Year 6, D
purchases C stock. In Year 8, D distributes all of the C stock in a section 355 transaction. In Case 1,
D purchases C stock in Year 6 that satisfies the requirements of section 1504(a)(2). In Case 2, D
purchases C stock in Year 6 that satisfies the requirements of section 368(c), but not section
1504(a)(2).
Result: In Case 1, D is treated as acquiring the assets of C in violation of section 355(b)(2)(C). In
Case 2, D is treated as acquiring the stock of C in violation of section 355(b)(2)(D). See Prop. Reg. §
1.355-3(b)(1)(ii), -3(b)(4)(i)(B).
245
Section 355(b)(2)(C) vs. 355(b)(2)(D)
Year 6
Remaining C Stock
D
ATB 1
Sh.
368(c) stock
C
ATB 2
C
ATB 2
Facts: For five years, D has conducted ATB 1 and C has conducted ATB 2. ATB 1 and ATB 2 are
not in the same line of business. Throughout this period, D has owned C stock that satisfies the
requirements of section 368(c), but not section 1504(a)(2). In Year 6, D purchases the remaining C
stock in a taxable transaction. In Year 8, D distributes all of its C stock in a section 355 transaction.
Result: Under the proposed regulations, the Year 6 acquisition would be in violation of section
355(a)(2)(C) because D’s acquisition of control under section 1504(a)(2) in Year 6 would be treated as
an asset acquisition. Under existing regulations, the Service had taken the position that acquisitions
between affiliated members would not implicate section 355(a)(2)(C) or (D). The Service has issued
guidance stating that it will not challenge such transactions if effected prior to the date the proposed
246
regulations are issued in temporary or final form. See Notice 2007-60.
Affiliation – SAG vs. non-SAG Members
Case 1
Case 2
P
P
D
D
S1
$
ATB 1
$
S2
S2
ATB 1
S3 Stock
S3
ATB 1
S3
ATB 2
ATB 1
S3 Stock
ATB 2
ATB 2
ATB 2
S1
S3
S3
Facts: For five years, the P consolidated group has consisted of D, S1, S2, and S3. During this period, S1 and S3 have
conducted ATB 1 and ATB 2, respectively. In Year 6, S2 purchases ATB 1 and the stock of S3 from S1. In Year 8, D
spins-off S2. In Case 1, S1 is a brother-sister corporation of D. In Case 2, S1 is a wholly-owned subsidiary of D.
Result: In Case 1, S1 is not a member of D’s separate affiliated group (the “DSAG”). Therefore, the acquisition of ATB
1 and ATB 2 violates section 355(b)(2)(C), and D cannot rely on ATB 1 or ATB 2 to satisfy the ATB requirement for the
Year 8 spin-off. In Case 2, S1 is a member of the DSAG. Accordingly, the acquisition of ATB 1 and ATB 2 is
247
disregarded. See Prop. Reg. § 1.355-3(b)(1)(ii), -3(d)(2), ex. 26.
Proposed Regulations -- Sections 355(b)(2)(C) & (D)
•
The Preamble to the proposed regulations provides that sections 355(b)(2)(C) and (D) have been and
should be applied in a manner consistent with the overall purposes of section 355. See C.I.R. v.
Gordon, 382 F.2d 499 (2d Cir.1967), rev’d on other grounds, 391 US 83 (1968); Rev. Rul. 69-461
(1969-2 CB 52); Rev. Rul. 78-442 (1978-2 CB 143); §1.355-3(b)(4)(iii); §1.355-3(b)(4)(i).
•
Accordingly, the proposed regulations may depart from the literal language of section 355(b)(2)(C) and
(D) in order to carry out the common purpose underlying section 355(b)(2)(C) and (D).
•
The common purpose of section 355(b)(2)(C) and (D) is to prevent the direct or indirect acquisition of
the trade or business to be relied on by a corporation in exchange for assets in anticipation of a
distribution to which section 355 would otherwise apply.
•
The proposed regulations provide that -•
certain transactions in which there is gain or loss actually recognized are not treated as recognition transactions
because they do not violate the common purposes of sections 355(b)(2)(C) and (D).
•
certain tax-free acquisitions are treated as transactions in which gain or loss is recognized even though no gain
or loss is actually recognized because they violate the common purpose of sections 355(b)(2)(C) and (D).
248
Proposed Regulations -- Sections 355(b)(2)(C) & (D)
•
The proposed regulations provide that certain tax-free transactions made in exchange for DSAG’s
assets are treated as transactions in which gain or loss was recognized for purposes of sections
355(b)(2)(C) and (D).
•
The proposed regulations explicitly provide that the following acquisitions constitute impermissible
acquisitions under sections 355(b)(2)(C) and (D) --
•
•
The DSAG or CSAG acquires an interest in a partnership engaged in the trade or business to be
relied on by contributing assets not constituting the trade or business to be relied on to the
partnership. See Prop. Reg. § 1.355-3(b)(4)(ii)(A).
•
The DSAG or CSAG acquires stock of a corporation engaged in the trade or business to be
relied on by transferring assets not constituting the trade or business to be relied on to such
corporation in exchange for stock of such corporation. See Prop. Reg. § 1.355-3(b)(4)(ii)(A).
•
The DSAG or CSAG acquires stock of a corporation engaged in the trade or business in an
exchange to which section 304(a)(1) applies. See Prop. Reg. § 1.355-3(b)(4)(ii)(A).
•
Distributing acquires a trade or business in exchange for its stock and assets in a transaction in
which no loss is recognized by virtue of section 351(b). See Prop. Reg. § 1.355-3(b)(4)(ii)(A).
Acquisitions consisting of a distribution from a partnership are generally treated as an acquisition
paid for with DSAG assets. See Prop. Reg. § 1.355-3(b)(4)(ii)(B).
249
Proposed Regulations -- Sections 355(b)(2)(C) & (D)
•
The proposed regulations provide that certain exchanges are not treated as made in exchange for DSAG
assets and, accordingly, are not subject to recognized gain or loss treatment.
•
The assumption by the DSAG or CSAG of liabilities of a transferor shall not, in and of itself, be treated
as the payment of assets if the assumption is not treated as the payment of money or other property
under any other applicable provision. See Prop. Treas. Reg. § 1.355-3(b)(4)(ii)(A).
•
The following acquisitions are also not treated as made in exchange for DSAG assets –
•
A pro rata distribution to which section 355 applies (to the extent the stock with respect to which the distribution
is made was not acquired during the pre-distribution period in a transaction in which gain or loss was
recognized).
•
A reorganization described in section 368(a)(1)(E) or (F).
•
An exchange to which section 1036 applies.
•
An acquisition consisting of a pro-rata distribution from a partnership of stock or an interest in a lower-tier
partnership to the extent the distributee partner did not acquire the interest in the distributing partnership during
the pre-distribution period in a transaction in which gain or loss was recognized and to the extent the distributing
partnership did not acquire the distributed stock or partnership interest within such period.
See Prop. Treas. Reg. § 1.355-3(b)(4)(ii)(A).
250
Proposed Regulations -- Sections 355(b)(2)(C) & (D)
•
The proposed regulations also disregard recognized gain or loss with respect to certain transactions for
purposes of applying sections 355(b)(2)(C) and (D).
•
The proposed regulations identify the following transactions as those in which any gain or loss will be
disregarded –
•
An acquisition by the CSAG from the DSAG provided the DSAG controls Controlled
immediately after the acquisition. See Prop. Treas. Reg. § 1.355-3(b)(4)(iii)(A).
•
An acquisition that would be tax-free but for the payment of cash to shareholders for fractional
shares in the transaction, provided that the cash paid represents a mere rounding off of the
fractional shares in the exchange and is not separately bargained for consideration. See Prop.
Treas. Reg. § 1.355-3(b)(4)(iii)(B).
•
A direct or indirect acquisition by a distributee corporation of control of Distributing, in one or
more transactions, where the basis of the acquired Distributing stock in the hands of the
distributee corporation is determined in whole by reference to the transferor’s basis. However,
this rule is only applicable with respect to a distribution by Distributing, and does not apply for
purposes of any subsequent distribution by any distributee corporation. See Prop. Treas. Reg. §
1.355-3(b)(4)(iii)(C).
251
Use of Assets Test: Transfer of Non-ATB Assets
D
ATB 1
Trucks
368(c) Stock
C
ATB 2
Facts: For five years, unrelated D and C have engaged in ATB 1 and ATB 2, respectively. In Year 6,
D transfers trucks to be used in C’s ATB 2 in exchange for section 368(c) stock of C in a section 351
transaction in which no gain or loss is recognized.
Result: If D were to distribute C stock, D cannot rely on ATB 2 to satisfy the ATB requirement
unless D’s acquisition of C stock is not within the pre-distribution period (i.e., 5 year period ending
on date of distribution), because D acquired control of C, which conducts the business to be relied on
by D, in exchange for assets not constituting the ATB to be relied on in violation of section
355(b)(2)(D). See Prop. Reg. § 1.355-3(d)(2), ex. 30.
The result would not change even if D acquires section 1504(a)(2) stock in the transaction. The result
would not change if ATB 1 were contributed, and then sold by C prior to the spin-off. See Prop. Reg.
252
§ 1.355-3(d)(2), ex. 37.
Use of Assets Test: Non-DSAG Assets
ATB 1
T
ATB 1
368(c) Stock
P
$
Sh.
$
C
ATB 1 and C Stock
D
ATB 2
C
Facts: For five years, P has owned all of the stock of D, and T and C have engaged in ATB 1 and
ATB 2, respectively. In Year 6, P purchases ATB 1 from T and C stock constituting 368(c) control
from C’s shareholders. In that same year, P contributes ATB 1 and the C stock to D in a section 351
transaction.
Result: If D were to distribute C, D can rely on ATB 1 and C can rely on ATB 2 for purposes of
satisfying the ATB requirement, because neither ATB 1 nor control of C were acquired in exchange
for assets of the DSAG. See Prop. Reg. § 1.355-3(d)(2), ex. 32. Note that the result would change if P
253
recognized section 357(c) gain on the transfer. See Prop. Reg. § 1.355-3(d)(2), ex. 33.
Use of Assets Test: Acquisition of Distributing
Case 1
Sh.
T Stock
Case 2
Sh.
P
$
ATB 1
ATB 2
T
T
D
D
C
ATB 1
ATB 2
C
T
er
erg
M
ATB 1
D
ATB 2
Liquidation
ATB 1
ATB 2
n
ka
c
to
PS
a sh
C
d
P
D
C
C
Facts: For five years, T has owned all of the stock of D, and D has owned the stock of C. During that period, D and
C have engaged in ATB 1 and ATB 2, respectively. In Case 1, P purchases T stock in a taxable transaction in Year
6. In Year 7, T liquidates in a transaction in which no gain or loss was recognized. P’s adjusted basis in the D stock
after the liquidation is determined by reference to T’s adjusted basis in the D stock. In Case 2, P acquires all of the
assets of T in exchange for P stock and cash in an A reorganization in Year 6. In year 8, D distributes C stock to P.
Result: In each case, D can rely on ATB 1 and C can rely on ATB 2 for purposes of satisfying the ATB
requirement. See Prop. Reg. § 1.355-3(b)(4)(iii)(C). However, P cannot rely on ATB 1 or ATB 2 if P were to
254
distribute D or C, unless the Year 6 acquisition is not in the pre-distribution period. See Prop. Reg. § 1.355-3(d)(2),
ex. 40.
Sections 355(b)(2)(C) & (D) – Predecessors & Hot Stock
•
The current regulations only take a “a predecessor in interest” into account for
purposes of applying section 355(b)(2)(D). See Treas. Reg. § 1.355-3(b)(4)(i).
•
The proposed regulations provide that any reference to a corporation includes a
reference to a predecessor of such corporation. A predecessor is defined as a
corporation that transfers its assets to the acquiror in a transaction to which
section 381 applies. See Prop. Treas. Reg. § 1.355-3(b)(4)(iv)(A).
•
Section 355(a)(3)(B) provides that stock of Controlled acquired by distribution
during the pre-distribution period in which gain or loss is recognized (“hot
stock”) is treated as boot.
•
The Preamble to the proposed regulations requests comments concerning the
application of section 355(a)(3)(B) to acquisitions of Controlled stock in gain or
loss transactions that, under these proposed regulations, are not treated as
violating requirements of section 355(b).
255
Section 355: Business Expansion
256
Expansion Doctrine - General
•
Treas. Reg. § 1.355-3(b)(3)(ii):
The fact that a trade or business underwent change during the five-year period
preceding the distribution (for example, by the addition of new or the dropping
of old products, changes in production capacity, and the like) shall be
disregarded, provided that the changes are not of such a character as to
constitute the acquisition of a new or different business. In particular, if a
corporation engaged in the active conduct of one trade or business during that
five-year period purchased, created, or otherwise acquired another trade or
business in the same line of business, then the acquisition of that other
business is ordinarily treated as an expansion of the original business, all of
which is treated as having been conducted during that five-year period, unless
that purchase, creation, or other acquisition effects a change of such a
character as to constitute a new or different business.
257
Expansion Doctrine - General
•
Preamble to section 355 Regulations (T.D. 8238) (Jan. 5, 1989):
In reexamining the active business requirements, Treasury and the Internal Revenue
Service recognized that it is often difficult to determine whether a corporation is
conducting a single business, which may be separated under section 355 if it has been
actively conducted for five years, or multiple businesses, which may be separated under
section 355 only if each has been actively conducted for five years. Correlatively, they
recognized that it is difficult to determine whether a corporate expenditure for a new
activity constitutes the acquisition or creation of a new business or the expansion of an
existing business. Accordingly, it is considered to be appropriate to simplify these
determinations.
As in Estate of Lockwood v. Commissioner, 350 F.2d 712 (8th Cir. 1965), the final
regulations provide that, for purposes of the five-year active conduct requirement, a new
activity in the same line of business as an activity that has been actively conducted by
the distributing corporation for the five-year period preceding the distribution ordinarily
will not be considered a separate business. As a result, the distribution of a new activity
will more easily satisfy the five-year active conduct requirement.
258
Expansion Doctrine – Examples
•
A corporation that owns and operates a department store downtown
may acquire a parcel of land in the suburbs and construct a new
department store. Treas. Reg. § 1.355-3(c), Example 7.
•
A corporation that owns and operates hardware stores in several states
may purchase the assets of a hardware store in a state where it had not
previously conducted business. Treas. Reg. § 1.355-3(c), Example 8;
See also Estate of Lockwood v. Commissioner, 350 F.2d 712 (8th Cir.
1965).
•
A corporation that manufactures a product may acquire assets related
to the installation or distribution of that product. P.L.R. 199937014
(June 15, 1999); P.L.R. 9621030 (Feb. 23, 1996).
•
A corporation may introduce a new product line that complements and
advances its current products by incorporating new technological
developments. P.L.R. 9646019 (Aug. 16, 1996).
259
ATB Requirement -- Business Expansion
•
Bricks and clicks
•
•
Clicks and clicks
•
•
•
•
A corporation that previously only sold to customers through retail stores begins to sell over the
internet
• Do the products have to be identical with those in the stores?
• What if the sales are conducted through an auction process?
A corporation that manufactures computer parts develops/acquires software or know-how that
enhances the performance of its (and similar) products
A corporation that develops software applications develops/acquires applications that are
utilizable in new ways (or by new industries)
A corporation that develops software applications develops/acquires a consulting business with
respect to its or similar products
Results of Product Innovation/Industry Expansion
•
•
•
A corporation that owns and operates cable systems acquires stations or begins to produce
content to show over the network.
A corporation that manufactures televisions begins to manufacture DVD players.
A corporation that provides long distance telephone service begins also to provide local service.
Thereafter, it begins to provide wireless service. That wireless service becomes integrated with
the internet and then, in turn, with hand-held devices. In addition, the company begins to
manufacture telephones that incorporate its recently developed technology for delivery to
customers.
260
Rev. Rul. 2003-18
Year 1
SHs
Year 3
D
SHs
Brand Y
D
Y
$
(2)
C stock
(1)
Brand X
(5-year
Brand X;
Brand Y)
(1)
C stock
(5-year
Brand X)
C
Facts: D has been engaged as an automobile dealer of brand X automobiles for over five years. In Year 1, D acquired
a franchise for the sale of brand Y automobiles and purchased the inventories, equipment, and leasehold of a former
brand Y automobile dealer. D operated the brand Y business through D’s employees. In Year 3, D transferred all of
the assets with respect to the brand X business to C in exchange for the stock of C, and distributed the C stock pro rata
to its shareholders.
Result: The Service ruled that the acquisition of the brand Y business in Year 1 constituted an expansion, because (i)
the product of the brand X business is similar to the product of the brand Y business, (ii) the business activities
associated with the brand X business are the same as the business activities associated with the brand Y business, and
(iii) the operation of the brand Y business involves the use of the experience and know-how that D developed in the
brand X business. See Treas. Reg. § 1.355-3(c), Exs. 7, 8; see also P.L.R. 9241033 (July 13, 1992). This ruling
obsoletes Rev. Rul. 57-190, 1957-1 C.B. 121, which came to a contrary result under the same facts, effective as of
January 5, 1989, the effective date of Treas. Reg. § 1.355-3.
261
Rev. Rul. 2003-38
Year 1
SHs
Year 8
Year 10
SHs
SHs
C stock
D
D
(Retail Shoe
Stores)
D
(Retail Shoe
Stores plus
D.com)
(1)
D.com
(Retail Shoe
Stores plus
D.com)
(2)
C stock
C
Facts: D has operated a retail shoe store business under the name “D” since Year 1. D’s business enjoys favorable name
recognition, customer loyalty, and other elements of goodwill. In Year 8, D created an Internet web site, which it named
D.com to take advantage of its goodwill, and began selling shoes at retail on the web site. In Year 10, D transferred all of the
assets with respect to the web site to C in exchange for the stock of C, and distributed the C stock pro rata to its shareholders.
Result: The Service ruled that the creation of the web site in Year 8 constituted an expansion, because (i) the product of the
retail shoe store and the web site are the same, (ii) the business activities associated with the retail shoe store are the same as
those of the web site, and (iii) the operation of the web site draws to a significant extent on D’s existing experience and
know-how, and the web site’s success will depend in large measure on the goodwill associated with D’s name, even though
the web site’s operation requires some know-how not associated with operating a retail store. See Treas. Reg. § 1.355-3(c),
Exs. 7, 8. What if the web site offered specialized shoes or other products that were not offered in the stores? What if the
web site sold shoes through an auction process?
262
Rev. Rul. 2003-18 v. Rev. Rul. 2003-38
Factors Considered
Rev. Rul. 2003-18
Rev. Rul. 2003-38
1.
Similar Products Sold
Present
Present
2.
Same Business Activities
Present
Present
3.
Use of Experience and
Know-How of Existing
Business
Present
4.
Goodwill Associated with
Name of Existing
Business
Not Considered
Partially Present
(web site’s
operation differs
from retail store)
Present
263
Expansion Doctrine – Proposed Regulations
•
The Service published proposed regulations on May 8, 2007 to provide guidance on certain issues
involving the ATB requirement, particularly the application of section 355(b)(3).
–
As discussed above, section 355(b)(3) generally provides that the ATB requirement is tested by treating all
members of Distributing’s and Controlled’s separate group as a one corporation.
•
The proposed regulations “codify” the facts and circumstances considered in Rev. Ruls. 2003-18
and 2003-38 when applying the expansion doctrine.
•
The Preamble to the proposed regulations indicates that the inclusion of these non-exclusive facts
and circumstances was not intended to be a substantive change, but rather intended to clarify and
restate the current law regarding expansions.
•
The proposed regulations provide that in determining whether an acquired business is in the same
line of business as the original business, all facts and circumstances shall be considered, including
the following –
–
Similarity of products of the businesses,
–
Similarity of activities associated with operation of the businesses, and
–
Whether operation of acquired business (i) involves use of experience and know-how
developed in original business or (ii) draws to a significant extent on experience and knowhow of the owner of the original business, and success of the acquired business will depend
on large measure on goodwill associated with the original business.
264
Expansion Doctrine – Proposed Regulations
•
Because a stock acquisition resulting in the acquired corporation becoming part of a
separate affiliated group (a “SAG”) is treated as an asset acquisition, the Preamble to the
proposed regulations provides that a corporation should be able to expand its existing
business by acquiring the stock of a corporation engaged in a trade or business in the
same line of business, provided that the acquired corporation becomes a subsidiary SAG
member. See Prop. Treas. Reg. § 1.355-3(b)(3)(ii).
•
The Preamble states that the Service and Treasury believe that section 355(b)(3)
provides the exclusive means by which a corporation is attributed the assets (or
activities) owned (or conducted) by another corporation.
•
Accordingly, the Preamble states that a stock acquisition that does not result in the
acquired corporation becoming a subsidiary SAG member should not be an expansion of
the SAG’s original business.
265
Example 1: Direct Acquisition of T Assets by D
(1)
Cash
D
(2)
T’s State Y
Widget Business
T
T’s State Y
Widget Business
C
•
Facts: D owns a 5-year Widget business operating in State X. D acquires T’s 5-year Widget
business operating in State Y for cash. D operates in States X and Y for two years. D
contributes T’s business to C, and immediately thereafter spins-off C.
•
Result: D’s acquisition of T’s business constitutes an expansion. See Treas. Reg. §1.3553(b)(3)(ii)(acquisition of trade or business by corporation engaged in same line of business
ordinarily treated as an expansion of the original business); Treas. Reg. §1.355-3(c), Ex.(7)
(acquisition by Distributing through purchase and construction of new retail location, followed
by transfer of new store to Controlled, satisfies active business requirement); Treas. Reg.
§1.355-3(c), Ex. (8) (purchase by Distributing of new retail store in state where corporation had
not previously conducted any business, followed by transfer of newly acquired assets to
Controlled; Controlled satisfies active business requirements); Prop. Treas. Reg. §1.355-3(c),
Ex. 18; Estate of Lockwood v. Comm’r, 350 F.2d 712 (8th Cir. 1965) (expansion of
Distributing’s business into new geographical area by Controlled is a good 5-year business;
266
relies on Conf. Rep. No. 2543, at 38 (1954)).
Example 2: Acquisition of T Assets
by D/Transitory Ownership
(1)
Cash
D
T
T’s State Y
Widget Business
(2)
T’s State Y
Widget Business
C
•
•
Facts: Same facts as Example 1, except the following:
• D contributes T’s State Y Widget business to C immediately after its acquisition.
• D spins-off C two years after acquiring T’s State Y Widget business.
Issue: Is D’s transitory ownership of T’s business disregarded?
267
Example 3: Acquisition of T Assets/Cause to be Directed
Transfer
(1)
Cash
D
C
T
Right to acquire T’s
State Y Widget Business
(2)
T’s State Y Widget Business
• Facts: Same facts as Example 2, except D directs the T assets to be transferred
directly from T to C.
• Result: The directed transfer presumably is treated as a transfer to D, followed by a
contribution of the assets from D to C. See Rev. Rul. 70-224, 1970-1 C.B. 79.
• See PLR 199937014 (June 15, 1999) (contract for acquisition of assets by parent of
Distributing and immediate transfer of those assets to newly formed subsidiaries of
Distributing constitutes expansion of Distributing’s business).
268
Example 4: Acquisition of T Assets Directly by C
D
(1)
Cash
(2)
Cash
T
C
T Widget Business
• Facts: Same facts as Example 2, except D contributes cash to C; C contracts
directly with T for the cash acquisition of T’s 5-year Widget business
operating in State Y.
• Issue: Should the lack of any transitory actual or constructive ownership by
D of the T assets, as in the previous examples, preclude satisfaction of the
ATB requirement? See Athanasios v. Comm’r, T.C. Memo 1995-72 (in
litigation, IRS appears to have conceded that Controlled’s acquisition of new
restaurant constitutes expansion of Distributing’s active business).
269
Example 5: Expansion of Business through Stock
Acquisition; Spin-Off of Newly Acquired Corporation
Cash
D
P
T Stock
T
• Facts: Same facts as Example 1 regarding D’s and T’s respective Widget Business. D
acquires all of the stock of T from P in a qualified stock purchase; no Section 338
election is made. D spins off T two years after its acquisition.
• Issue: Should the expansion of business principle trump section 355(b)(2)(D) as it does
section 355(b)(2)(C)? Does structure of section 355 and language of section 355(a)(3)(B)
suggest that the latter provision is inapplicable with respect to stock acquisitions that
precede or give rise to Distributing owning an amount of stock satisfying section 368(c)
control? See Prop. Treas. Reg. §1.355-3(b)(c), exs. 20-21 (concluding that stock
acquisition can result in expansion if acquired corporation treated as member of D’s
separate affiliated group); see also PLR 200109027 (Nov. 30, 2000) (suggesting that
expansion requirements not met with respect to a stock acquisition).
270
Example 6: Indirect Expansion of D’s Business
through Acquisition of T Stock
D
(1)
Cash
P
(2)
Liquidation
D
(3)
D’s State X Widget
Business
T Stock
State X
Widget Business
T
T
C
State Y
Widget Business
• Facts: Same facts as Example 1 regarding D’s and T’s respective Widget businesses. D acquires all of
the stock of T from P in a qualified stock purchase; no Section 338 election is made. Two years after its
acquisition, T is liquidated. Immediately thereafter, D contributes its historic State X Widget Business to
C and spins off C.
• Issue: Should the expansion of business principle apply to D’s acquisition of the State Y Widget business
via the liquidation of T? See Prop. Treas. Reg. §1.355-3(b)(c), exs. 20-21 (concluding that stock
acquisition can result in expansion if acquired corporation treated as member of D’s separate affiliated
group); See PLR 200109027 (Nov. 30, 2000); cf. Commissioner v. Gordon, 382 F2d 499 (2d Cir. 1967),
rev’d on other grounds, 391 U.S. 83 (1968) (implying that a single-entity approach applies to active trade
or business analysis); Treas. Reg. §1.355-3(b)(4)(iii) (same, applicable prior to 1987 legislation); Rev.
Rul. 78-442, 1978-2 C.B. 143 (transaction qualifies under Section 355 despite recognition of gain271
upon
Distributing’s transfer of assets to Controlled).
Example 7: Acquisition of T Stock by D
with Section 338(h)(10) Election
(2)
(1)
D
Cash
P
Recharacterization via a
Section 338(h)(10) Election
D
P
T Stock
T
New
T
Cash
Old
T Assets
T
• Facts: Same facts as Example 1 regarding D’s and T’s respective Widget businesses. D
acquires all of the stock of T from P in a qualified stock purchase. D and P make a Section
338(h)(10) election.
• Result/Issue: Acquisition is treated as purchase by New T of all of the Old T assets.
this transaction be treated the same as Example 4?
Should
272
Example 8: Acquisition of T Assets by Holding Company D
(1)
Cash
D
T
T Assets
(2)
T Assets
S
C
• Facts: S owns a 5-year Widget business operating in State X. D is a holding company and satisfies the ATB
requirement through its ownership of the stock of S, a member of the DSAG. D acquires all of the assets of T’s 5year Widget business operating in State Y. D immediately contributes the T assets to the newly formed C. D spins
off C two years following the acquisition of the T assets.
• Issue: Should the fact that D is not directly engaged in an active trade or business change the outcome of Example 2?
See section 355(b)(3).
273
Example 9: Acquisition of T Assets by Holding Company D
D
(1)
Cash
D
T
T Assets
(2)
T Assets
S
C
(3)
S
C
• Facts: Same facts as Example 8, except 10 days following acquisition of T assets, D makes
a retroactive check-the-box election for S effective as of the day before the acquisition.
• Result: See Treas. Reg. §301.7701-3(c)(1) (regarding retroactive effectiveness dates for
check-the-box elections); PLR 200109027 (Nov. 30, 2000) (merger of existing subsidiaries
into disregarded entities satisfies expansion of business test as well as 5% gross assets test).
In light of the SAG rules, must S check the box?
274
Section 355: Partnerships
275
Partnership Attribution – Rev. Rul. 92-17
P
D
GP
20%
C
Limited
P/S
Facts: For more than 5 years, D has owned a 20% general partner in a limited partnership, which has
owned several commercial office buildings that are leased to unrelated third parties. D’s officers
perform active and substantial management functions with respect to LP's activities, including the
decision-making regarding significant business decisions of the partnership. In addition, D's officers
regularly participate in the overall supervision, direction and control of LP's employees in their
performance of LP's operational functions. Employees of the partnership conduct the operational
activities of the business.
Result: If D were to distribute C, D would satisfy the ATB requirement by conducting an ATB
276
through the limited partnership.
Partnership Attribution
Revenue Ruling 2002-49: Situation 1
Years 1-2
D
20%
Y
X
20%
LLC
Years 3-5
C Stock
D
60%
100%
LLC
Year 6
D
40% FMV
Properties
C
40% FMV
Properties
LLC
Facts: D and X jointly perform all active and substantial management functions for LLC
through Year 2. D purchases the LLC interests of X and Y on the first day of Year 3. D
exclusively manages LLC from Year 3 through Year 6. D causes LLC to distribute 40
percent of the value of its rental properties on the first day of Year 6. D then transfers
those properties to C, a newly formed subsidiary, and distributes the stock of C.
Result: The active trade or business requirement is satisfied. In Years 1-2, D satisfies
the requirements of Rev. Rul. 92-17, and the acquisition of X and Y’s interests in Year 3
277
constitutes an expansion.
Partnership Attribution
Revenue Ruling 2002-49: Situation 2
Year 2
D
Securities
X
60%
20% 20%
LLC
Years 3-5
Y
C Stock
D
100%
LLC
Year 6
D
40% FMV
Properties
C
40% FMV
Properties
LLC
Facts: D acquires its interest in LLC on the first day of Year 2 by contributing appreciated
securities to LLC in a transaction described in Section 721. D and X jointly perform all active and
substantial management functions for LLC through Year 2. D exclusively manages LLC from
Year 3 through Year 6. D causes LLC to distribute 40 percent of the value of its rental properties
on the first day of Year 6. D then transfers those properties to C, a newly formed subsidiary, and
distributes the stock of C.
Result: The active trade or business requirement is not satisfied because D will be treated as
having acquired the business of LLC in a transaction in which gain or loss was recognized.
278
Partnership Attribution – Proposed Regulations
• The IRS published proposed regulations on May 8, 2007
which provide guidance as to whether a corporation is
engaged in an ATB through the attribution of trade or
business assets and activities from a partnership.
• The proposed regulations generally are consistent with the
principles of Rev. Rul. 92-17 and Rev. Rul. 2002-49.
• The proposed regulations expand the principle of Rev. Rul.
92-17 to provide that a partner owning a “significant
interest” can be attributed a partnership’s business
irrespective of whether the partner conducts active and
substantial management functions.
• In addition, the proposed regulations do not differentiate
between the nature of a partnership interest and an LLC
interest.
279
Partnership Attribution – Proposed Regulations
• The proposed regulations will apply to
distributions that occur after the date the
regulations are published as final regulations.
• Query whether the Service will entertain ruling
requests on the basis of the proposed regulations
where doing so would be inconsistent with the
Service’s current position.
– Note that the Service has recently issued Rev.
Rul. 2007-42 which concludes that a
“significant interest” in a partnership can
satisfy the ATB requirement.
280
Partnership Attribution – Proposed Regulations
•
•
•
In general, the proposed regulations provide that a corporation is required
itself to perform active and substantial management or operational functions,
although employees of affiliates may perform such functions.
The proposed regulations provide that a partner will be attributed the trade or
business assets and activities of a partnership if either –
– The partner (or its SAG) has a “significant interest” in the partnership, or
– The partner (or its affiliates) perform active and substantial management
functions with respect to the partnership’s business, and the partner (or its
SAG) has a “meaningful interest” in the partnership.
See Prop. Treas. Reg. § 1.355-3(b); see also Treas. Reg. § 1.3681(d)(4)(iii)(B) (COBE requirements)
The Service considers a “significant interest” to be 33 1/3% and a
“meaningful interest” to be 20%, although it is unclear whether lower
percentages would also be treated as such. Rev. Rul. 2007-42 clarifies that a
20% interest would not be a significant interest.
281
Partnership Attribution: Meaningful Interest
Management
X
20% GP
Y
33-1/3% LP
P
Unrelated
Parties
Facts: X and Y are unrelated. P is a partnership that is engaged in manufacturing power equipment.
X has a 20% general partner interest in P and Y has a 33-1/3 % limited partner interest in P. X
performs all of the management functions for P’s business.
Result: X is attributed P’s business activities (and business assets) for purposes of the ATB
requirement because X owns a meaningful interest in P and performs active and substantial
management functions for P’s business. Therefore, X is in the power equipment business. Even
though Y is attributed P’s business activities because Y owns a significant interest in P, because
neither P nor Y perform active and substantial management functions, Y is not in the power
equipment business. X’s management functions are not attributed to Y because X is not in Y’s
282
affiliated group. This result is consistent with Rev. Ruls. 92-17 and 2002-49. See Prop. Reg. § 1.3553(d)(2), ex. 22.
Partnership Attribution: Significant Interest
X
20% GP
Y
33-1/3 % LP
Unrelated
Parties
P
Management
Facts: X and Y are unrelated. P is a partnership that is engaged in manufacturing power equipment.
X has a 20% general partner interest in P and Y has a 33-1/3% limited partner interest in P. P
performs all of the management functions for its business.
Result: X is not attributed P’s business, because it has neither a significant interest in P nor a
meaningful interest coupled with active and substantial management functions. Y has a significant
interest in P and therefore is attributed P’s business activities (including management activities) and
business assets for purposes of the ATB requirement. See Prop. Reg. § 1.355-3(d)(2), ex. 23; cf. Reg.
§ 1.368-1(d)(4)(iii) (COBE). What if X and Y both had a 33-1/3% interest in P? See Prop. Reg. §
1.355-3(d)(2), ex. 24.
Compare result for Y with the result prescribed in Rev. Rul. 92-17. Query whether the IRS will 283
entertain ruling requests on the basis that a partner has a significant interest.
Partnership Attribution: Affiliated Group Rules
Management
X
Y
5%
Unrelated
Parties
20%
P
Facts: X owns all of the stock of Y. P is a partnership that is engaged in manufacturing power
equipment. Y has a 20% partner interest in P. X has a 5% interest in P and performs all of the
management functions for P’s business.
Result: X and Y should be attributed P’s business activities and assets for purposes of the ATB
requirement because together X and Y have a meaningful interest in P coupled with active and
substantial management functions. X is attributed Y’s 20% interest in P because Y is in X’s SAG. Y
is attributed X’s management functions because they are members of the same affiliated group. What
284
would the result be if Y held a 19% interest rather than a 20% interest? See Prop. Reg.
§ 1.355-3(b)(2)(v).
Section 355(g)
285
Section 355(g) – Transactions Involving Disqualified
Investment Companies
•
TIPRA amended section 355 to include section 355(g).
•
Section 355(g) denies tax-free treatment under section 355 if, immediately after the
transaction:
– Either the Distributing or Controlled is a “disqualified investment corporation”
and
– Any person holds a 50% or greater interest of the disqualified investment
corporation who did not hold such an interest prior to the transaction.
•
Section 355(g) defines a “disqualified investment corporation” as any Distributing
or Controlled if the fair market value of the investment assets of the corporation is:
– 3/4 or more of the fair market value of all assets of the corporation (effective
for one year period from the date of enactment), and
– 2/3 or more of the fair market value of all assets of the corporation (effective
after the end of the one year period from the date of enactment, May 17, 2006).
•
The term “investment assets” includes: cash, stocks, securities, interests in a
partnership, debt instruments, options, forwards, notional principal contracts,
derivatives, foreign currency, and other similar assets.
286
Section 355(g) -- Transactions Involving Disqualified
Investment Companies (con’t)
– The following are excluded from the term “investment assets”:
• Assets used in active conduct of a lending, banking, or insurance business
• Securities marked to market
– Rules relating to subsidiaries and partnerships owned by the distributing or controlled
corporation:
• Look-thru rule for 20% controlled entities – For purposes of computing percentages
of investment assets, stocks or securities of a 20% subsidiary are not counted.
Instead, the distributing or controlled corporation is treated as owning a ratable
share of the subsidiary’s assets.
• Look-thru rule for partnerships – Similarly, interests in a partnership are not
counted if one or more of the businesses of the partnership (without regard to the 5year requirement) would satisfy the active trade or business requirement.
– Effective date – The provisions contained in section 355(g) are effective for distributions
after May 17, 2006. However, section 355(g) does not apply to any transaction: (i) made
pursuant to an agreement which was binding on the date of enactment; (ii) described in a
ruling request submitted to the Service on or before such date; or (iii) described on or
before such date in a public announcement or in a filing with the Securities and
Exchange Commission.
287
Section 355(g) — Example
X
Public
40%
2
X
Public
C
D
60%
D
1
C
Facts: X owns a 40% interest in D; the rest of the D stock is publicly traded. For valid business purposes, D
would like to redeem X’s interest. To accomplish this, D creates an new entity, C, contributing to it an active trade
or business with a value of $30 and cash of $70. D then distributes its C stock to X in exchange for X’s D stock.
Analysis: In 2006, the provisions of 355(g) will not apply to this transaction as it satisfies the 3/4 test because the
percentage of investment assets contributed to C is only 70 percent. However, this distribution would fail in 2007
under the 2/3 test. The more stringent percentage requirement did not become effective until one year after the
subsection’s enactment.
288
Economic Substance
289
Coltec Transaction
C/S
Class A Stock
Coltec
$14 million
3
2
7% C/S
Assumption of Liabilities
7% Garrison C/S
Unrelated
Banks
Garlock
$50,000
1
Garrison
$375 million Note
Facts: Coltec, a publicly traded company with numerous subsidiaries, sold the stock of one of its businesses in 1996
and recognized a gain of approximately $240.9 million. Garlock, a subsidiary of Coltec, and its own subsidiary had both
previously manufactured or distributed asbestos products and faced substantial asbestos-related litigation claims.
Coltec caused another one of its subsidiaries, Garrison, to issue common stock and Class A stock to Coltec in exchange
for approximately $14 million. In a separate transaction, Garrison issued common stock to Garlock that represented
approximately a 6.6% interest in Garrison and assumed all liabilities incurred in connection with asbestos related claims
against Garlock, as well as the managerial responsibility for handling such claims. In return, Garlock transferred the
stock of its subsidiary, certain relevant records to the asbestos-related claims, and a promissory note (from one of its
other subsidiaries) in the amount of $375 million. Garlock then sold its recently acquired Garrison stock to unrelated
banks for $500,000. As a condition of sale, Coltec agreed to indemnify the banks against any veil-piercing claims for
asbestos liabilities. On its 1996 tax return, Coltec’s consolidated group claimed a $378.7 million capital loss on the sale
290
of Garrison stock, which equaled the difference between Garlock’s basis in the stock ($379.2 million) and the sale
proceeds ($500,000).
Coltec Decision – Court of Federal Claims
•
The Court of Federal Claims entered a decision after trial in favor of Coltec, upholding the
capital loss claimed by Coltec from the contingent liability transaction at issue in this tax refund
litigation. See Coltec Industries, Inc. v. United States, 2004-2 U.S.T.C. ¶ 50,402 (Ct. Fed. Cl.
2004).
•
The Court of Federal Claims relied on the District Court analysis in Black & Decker (discussed
below) to hold that the operation of the applicable code sections justified a capital loss.
– The contribution of assets in exchange for stock and the assumption of the liabilities
qualified as a nontaxable exchange under section 351.
– Under section 358, the transferor received a basis in the stock equal to the basis of the
assets contributed. Ordinarily, when a transferee in a section 351 exchange assumes
liabilities of the transferor, the transferor’s basis in the transferee’s stock is reduced by the
amount of the liabilities. However, under sections 358(d)(2) and 357(c)(3), if the
satisfaction of the liabilities would have given rise to a deduction to the transferor, the
assumption of such liabilities does not reduce basis. Because satisfaction of the liabilities
assumed by the transferee would have given rise to a deduction to the transferors (had the
liabilities not been transferred), the basis of the stock is not reduced by the liabilities
assumed under section 358(d)(2). After the transfer, payment of the liabilities would give
rise to a deduction by the transferee. See Rev. Rul. 95-74, 1995-2 C.B. 36 (1995). The
government argued that section 357(c)(3) requires that payment of the liabilities would
give rise to a deduction by the transferor. The court held that this interpretation was
incorrect.
– In addition, the court held that section 357(b) did not require basis to be reduced because
there was a bona fide business purpose for the assumption of the liabilities.
291
Coltec Decision – Court of Federal Claims
• The Court of Federal Claims rejected the government’s
argument that the capital loss should nonetheless be disallowed
under the economic substance doctrine.
• The court refused to apply the economic substance doctrine to
the transaction because the transaction satisfied the statutory
requirements of the Code. The court stated: “[I]t is Congress,
not the court, that should determine how the federal tax laws
should be used to promote economic welfare…. Where the
taxpayer has satisfied all statutory requirements established by
Congress, as Coltec did in this case, the use of the ‘economic
substance’ doctrine to trump ‘mere compliance with the Code’
would violate the separation of powers.”
292
Coltec on Appeal – Federal Circuit
•
The Federal Circuit (Judges Bryson, Gajarsa and Dyk) reversed the
opinion of the Court of Federal Claims and held that the taxpayer was
not entitled to a capital loss because the assumption of the contingent
liabilities in exchange for the note lacked economic substance. See
Coltec Industries, Inc. v. United States, 2006-2 U.S.T.C. ¶ 50,389 (Fed.
Cir. 2006).
•
The Federal Circuit upheld the technical analysis of the Court of Federal
Claims in favor of the taxpayer.
•
The court concluded that section 357(c)(3) applies because payment of
the liability would give rise to a deduction. The court stated that the
government’s interpretation that the liabilities must be transferred with
the underlying business was plainly inconsistent with the statute.
•
The court concluded that if a liability was excluded by section 357(c)(3),
then section 357(b)(1) was not relevant. The court reasoned that the
exception in section 358(d)(2) for liabilities excluded under section
357(c)(3) does not contain any reference to section 357(b), nor does
section 357(b) contain any reference to the basis provisions in section
293
358.
Coltec on Appeal – Federal Circuit
• However, the Federal Circuit reversed the Court of Federal
Claims decision with respect to economic substance and held
that the transfer of liabilities in exchange for the note should
be disregarded.
• The Federal Circuit identified five (5) principles of economic
substance.
– The law does not permit the taxpayer to reap tax benefits from a
transaction that lacks economic reality;
– It is the taxpayer that has the burden of proving economic substance;
– The economic substance of a transaction must be viewed objectively
rather than subjectively;
– The transaction to be analyzed is the one that gave rise to the alleged
tax benefit;
– Arrangements with subsidiaries that do not affect the economic interest
of independent third parties deserve particularly close scrutiny.
294
Coltec on Appeal – Federal Circuit
• In applying the economic substance test, the Federal Circuit
focused solely on the transaction giving Coltec the high stock
basis (i.e., the assumption of the liabilities in exchange for the
note) and concluded that Coltec had not demonstrated any
business purpose for that transaction.
• The court rejected Coltec’s claim that it would strengthen its
position against potential veil-piercing claims, since it only
affected relations among Coltec and its own subsidiaries and
had no effect on third parties.
295
Coltec Cert. Petition
•
Coltec filed a cert petition with the Supreme Court.
•
One of the two questions presented for review in the cert petition relates to the
disjunctive vs. conjunctive nature of the economic substance test and the current
circuit split.
– The cert petition stated the question as follows: "Where a taxpayer made a good-faith
business judgment that the transaction served its economic interests, and would have
executed the transaction regardless of tax benefits, did the court of appeals (in
acknowledged conflict with the rule of other circuits) properly deny the favorable tax
treatment afforded by the Internal Revenue Code to the transaction based solely on the
court’s “objective” conclusion that a narrow part of the transaction lacked economic
benefits for the taxpayer?”
•
The other question presented for review in the cert petition relates to the standard of
review in economic substance cases.
– The cert petition stated the question as follows: "In determining that a transaction may be
disregarded for tax purposes, should a federal court of appeals review the trial court’s
findings that the transaction had economic substance de novo (as three courts of appeals
have held), or for clear error (as five courts of appeals have held)?"
•
Dow Chemical Co. filed a cert petition on October 4, 2006 that presented similar
questions.
•
On February 16, 2007, the Supreme Court denied certiorari in Coltec and Dow
Chemical.
296
Heinz Transaction
PUBLIC
PUBLIC
PUBLIC
$130M
Heinz
3.5M
Heinz
shares
Heinz
3.325M
Heinz
shares
Heinz
~ $7.0M
Note
HCC
HCC
HCC
.175M
Heinz shares
Facts: Between August 11, 1994, and November 15, 1994, H.J. Heinz Credit Company (“HCC”), a
subsidiary of the H.J. Heinz Company (“Heinz”), purchased 3.5 million shares of Heinz common stock
in the public market for $130 million. In January of 1995, HCC transferred 3.325 million of the 3.5
million shares to Heinz in exchange for a zero coupon convertible note issued by Heinz. In May of
1995, HCC sold the remaining 175,000 shares to AT&T Investment Management Corp. (“AT&T”), an
unrelated party, for a discounted rate of $39.80 per share, or $6,966,120, in cash. As a result of this sale,
HCC claimed a capital loss and carried this loss back to 1994, 1993, and 1992. The IRS disallowed
Heinz’s claimed capital loss arguing, among other things, that the transaction lacked economic substance
and a business purpose. Heinz paid the tax and filed a $42.6 million refund action with the Court297
of
Federal Claims.
Heinz – Court of Federal Claims
•
H. J. Heinz Company and Subsidiaries vs. United States, United States Court of
Federal Claims, No. 03-2847T (May 24, 2007).
•
All parties agreed that HCC had a basis of $124 million in the 3.325 million shares
that were transferred to Heinz.
•
Heinz asserted that the redemption qualified as a redemption under section 317(b),
that the redemption should be taxed as a dividend, and that HCC’s basis in the
redeemed stock should be added to its basis in the 175,000 shares which it retained.
Accordingly, Heinz claimed that, when HCC sold its remaining 175,000 shares, it
should recognize a large capital loss. Heinz then claimed it was entitled to carry back
HCC’s capital loss to reduce the consolidated group’s taxes in 1994, 1993 and 1992.
•
The IRS asserted that the Heinz acquisition was not a redemption because: (i) Heinz
did not exchange property for the stock within the meaning of section 317(b); (ii) the
transaction lacked economic substance and had no bona fide business purpose other
than to produce tax benefits; and (iii) under the “step transaction doctrine,” HCC’s
purchase and exchange of the stock for the note should be viewed as a direct
purchase of the stock by Heinz.
298
Heinz – Court of Federal Claims
•
The Court of Federal Claims dismissed the IRS’s first argument that no redemption
occurred, but held that the acquisition and redemption of Heinz shares lacked
economic substance and that the step transaction doctrine applied.
•
The court followed the economic substance analysis set forth Coltec in addressing
the IRS’s second argument, quoting the following language from Coltec – “the
transaction to be analyzed is the one that gave rise to the alleged tax benefit.”
•
Accordingly, the court stated that transaction in question is the purchase of Heinz
shares from the public and the subsequent redemption. The court did not analyze
the entire transaction (including the disposition) when applying the economic
substance doctrine.
•
The court in Heinz held that the acquisition and subsequent redemption of Heinz
shares lacked economic substance.
299
Heinz – Court of Federal Claims
•
The Court of Federal Claims was not persuaded by the taxpayer’s assertion that HCC
acquired the Heinz stock for non-tax, business purposes: as an investment and to add
“substance” to HCC’s operations for state tax purposes.
•
In the eyes of the court, the taxpayer’s claim of an investment purpose was undercut by
the factual record, as evidenced by the following factors. First, the convertible notes
were contemplated and, in fact, were in the process of being drafted well before HCC
purchased the Heinz stock. Second, because the acquired stock was not registered,
HCC purchased the stock at full price in the market and sold the Heinz stock at a deep
discount. Third, the purpose of the stock purchase program -- the funding of stock
option programs – could not be achieved so long as HCC held the Heinz stock.
•
The could also found the factual record to be inconsistent with the taxpayer’s second
claim of business purpose, which was to bolster the taxpayer’s tax return position that
HCC should be respected as a Delaware holding company. The court cited three
factors in support of its position. First, the record did not suggest that the taxpayer was
motivated by this non-tax purpose. Second, internal communications indicated that
any tax return exposure could not be limited at the time of the stock acquisition or on a
going forward basis. Third, the record indicated that, at the time of the stock
acquisition, Heinz was considering eliminating HCC’s lending operations, which
raised the very issue that the taxpayer sought to mitigate through the stock acquisition.
300
Transactional Tax Issues
Raised by Coltec
301
Coltec Transactional Tax Issues
•
How Would the Analysis Change if Certain Facts Were Altered?
– What if Garlock did not guarantee up to $200 million to cover Garrison’s capital
needs?
– What if Garlock never sold the stock of Garrison? Does a taxpayer need a
business purpose to transfer liabilities to a subsidiary even if no sale of the
subsidiary is contemplated?
•
What Does it Mean to Disregard a Transaction?
– In Coltec, the Federal Circuit court disregarded both the transfer of the liabilities
and the transfer of the note. The entire transaction was voided.
– What happens when the subsidiary pays off the liabilities?
– Who gets the deduction?
• Are there other tax consequences? Is the payment of the liability by the subsidiary a
deemed payment to the parent?
• Why is the transfer of the note voided? Do you need a business purpose to transfer a
note to a subsidiary? Why are the transfer of the note and the transfer of the liabilities
treated as a single step and not analyzed separately under the courts theory that “the
transaction to be analyzed is the one that gave rise to the alleged tax benefit?
– What happens when the subsidiary receives payments on the note?
• What happens to the buyer of the Garrison stock if the transfer of the liabilities and
transfer of the note are ignored? Is the purchase also ignored? Is the purchase price
adjusted?
302
Coltec Transactional Tax Issues
•
What are the implications of the technical analysis in Coltec for other transactions?
•
In light of the rulings by both the Fourth Circuit in Black & Decker and the Federal
Circuit in Coltec, have any of the government’s positions been revised with respect
to the application of section 357(c)(3) in other rulings?
•
What is the Service’s current position with respect to contingent liability
transactions? Is the position that section 358(h) applies? Or is the position that
Coltec controls and section 358(h) does not apply because the transfer was a sham?
If the later, does section 358(h) ever apply?
•
There is a critical difference between the result under section 358(h) and the result
in Coltec. Under section 358(h), the transaction is respected, but the basis in the
stock of the subsidiary is reduced by the amount of the contingent liabilities. In
contrast, the Federal Circuit in Coltec declared that the transfer of a note and the
transfer of contingent liabilities should be completely ignored. These two different
treatments could lead to different results (e.g., who gets the deduction when the
liabilities are paid, what happens when payments are made on the note).
•
Assuming that section 358(h) applies, will the government follow Rev. Rul. 95-74
and allow the transferee subsidiary to claim a deduction on payment of the
liabilities?
303
Implications of the Step-by-Step Economic Substance
Analysis in Coltec for Other Transactions
• Just as the Supreme Court’s shifting and hard to define
standards in its obscenity jurisprudence left many examining
works to determine whether the works were so offensive as to
be prohibited speech, the Federal Circuit’s new conception of
the economic substance doctrine raises many questions about
current common transactions and whether such transactions
will be deemed prohibited by the courts, even if authorized by
the Internal Revenue Code.
• The following slides depict common transactions that may be
subject to review based on the analysis in Coltec.
• Under current law, all of these transactions should have clear
results and these results should not be undone by the Federal
Circuit’s Coltec analysis.
304
Busting Consolidation -- Example 1
P
100%
100%
S1
S2
50%
50%
LLC
X
Facts: P, a domestic corporation, owns 100% of the stock of S1, S2, and X, and they file a
consolidated return. In order to deconsolidate X, P contributes 50% of the X stock to each of S1
and S2, and S1 and S2 contribute the X stock to a newly formed LLC.
Result: Because X is no longer an includible corporation, it should not be a member of P’s
consolidated group. However, is this result consistent with the business purpose and economic 305
substance analysis in Coltec?
Busting Consolidation -- Example 2
FP
100%
P
50%
S
50%
LLC
X
Facts: FP, a foreign corporation, owns 100% of the stock of P, which owns all of the stock of S,
which owns all of the stock of X. P, S, and X file a consolidated return. In order to
deconsolidate X, S contributes the stock of X to an LLC formed by S and FP.
Result: Because X is no longer an includible corporation, it should not be a member of P’s
consolidated group. However, is this result consistent with the business purpose and economic 306
substance analysis in Coltec?
Avoiding Loss Disallowance Rules
P
100%
100%
S1
S2
50%
50%
X Stock
Z
LLC
Cash
X
X
Facts: P, a domestic corporation, owns 100% of the stock of S1 and S2. The P group wants to
purchase the stock of X, but X has built-in gain assets that could trigger the application of the loss
disallowance rules if the P group later disposes of the stock of X. To avoid the potential application of
the loss disallowance rules, S1 and S2 form LLC (treated as a partnership for federal income tax
purposes), and LLC acquires the stock of X.
Result: Because LLC is not an includible corporation, X should not be a member of P’s consolidated 307
group. However, is this result consistent with the business purpose and economic substance analysis in
Coltec?
Sale to Recognize Loss
P
P has built-in
loss in S stock
•
•
Sale of S stock
Third
Party
S
May a taxpayer sell stock solely to recognize a loss under the Federal Circuit’s analysis in
Coltec?
The Supreme Court in Cottage Savings allowed a taxpayer to exchange mortgage securities
for other mortgage securities and recognize a loss. See Cottage Savings Assn. v.
Commissioner, 499 U.S. 554 (1991). The transaction was done solely for tax purposes and
was disregarded for regulatory purposes. Can Coltec and Cottage Savings be reconciled?
308
Accelerating a Built-In Gain
P
100%
100%
asset
1
S1
S2
cash
50%
50%
LLC
2
Contribute
asset
Facts: P, a domestic corporation, owns 100% of the stock of S1 and S2, and they file a
consolidated return. In Year 1, S1 sells an asset to S2 for cash, resulting in a deferred
intercompany capital gain. In Year 3, the P group has a capital loss that it would like to use, so
S2 contributes the asset to a newly formed LLC owned by S1 and S2.
Result: Because the asset is no longer owned by a member of the P consolidated group, the
deferred capital gain should be triggered. See Treas. Reg. § 1.1502-13(d). However, is this
result consistent with the business purpose and economic substance analysis in Coltec?
309
Section 331 Liquidation
P
100%
S
25% S stock
cash
FS
P
Liquidation
75%
S
25%
FS
Facts: P, a domestic corporation, owns all of the stock of S, which is a domestic subsidiary, and
FS, which is a foreign subsidiary. P has a $100 basis in its S stock. The value of its S stock is
$10. If P liquidates S, loss in the S stock will not be realized. P therefore sells 25% of the S
stock to FS and, after a period of time, S liquidates into P. P’s sale of S stock to FS effectively
causes S’s liquidation not to qualify as tax-free under section 332, and instead to qualify as a
section 331 liquidation.
Result: P can recognize the loss on the remaining 75% of stock in S. See section 331.
However, is this result consistent with the business purpose and economic substance analysis in 310
Coltec?
Section 332 Liquidation
P
25%
FS
P
Liquidation
cash
75%
S
25% S stock
100%
S
FS
Facts: P, a domestic corporation, owns 75% of the stock of S, which is a domestic subsidiary,
and 100% of FS, which is a foreign subsidiary. P has a $10 basis in its S stock. The value of its
S stock is $100. If P liquidates S, the gain in the S stock will be realized. See section 331. P
therefore purchases 25% of the S stock from FS and, after a period of time, S liquidates into P.
Result: P does not recognize the gain on the liquidation under section 332. However, is this
result consistent with the business purpose and economic substance analysis in Coltec?
311
Purchase and Liquidation
A
T stock
P
P
$
Liquidation
T
•
•
T
Section 269(b) states that deductions, credits, or other allowances may be disallowed if (i)
there is a qualified stock purchase, (ii) a section 338 election is not made, (iii) the acquired
corporation is liquidated pursuant to a plan adopted within 2 years, and (iv) there is a
principal purpose to avoid or evade tax.
Does Coltec replace section 269(b)?
312
Liquidation and Sale
P
Sale of S assets
Third
Party
Liquidation
S
•
•
In Commissioner v. Court Holding, the Supreme Court held that a liquidation of a corporation
followed by a sale of the corporation’s assets resulted in tax to the liquidating corporation
because “a sale by one person cannot be transformed into a sale by another by using the latter as a
conduit through which to pass title.” However, five years later, in U.S. v. Cumberland Public
Service Co., the Court held that a liquidation followed by a sale did not result in tax to the
liquidating corporation. The Court stated, “The subsidiary finding that a major motive of the
shareholders was to reduce taxes does not bar this conclusion. Whatever the motive and however
relevant it may be in determining whether the transaction was real or a sham, sales of physical
properties by shareholders following a genuine liquidation distribution cannot be attributed to the
corporation for tax purposes.”
In both Court Holding and Cumberland the sole purpose of the liquidation was to reduce tax.
Under Coltec, could the Federal Circuit disregard the liquidation in each transaction?
313
Busted Section 351 Transaction to Make
Section 338(h)(10) Election
(3) N stock
P
PUBLIC
(2) X & Y Stock
Z
N
X
•
(1) Newco formed
Y
If a corporation transfers stock of subsidiary (i.e., X and Y) to a newly formed subsidiary
(“Newco”) and sells the stock of Newco to the public to “bust” the section 351 transaction
and to be eligible to make the section 338(h)(10) election with respect to the transfer of X and
Y stock to Newco in exchange for less than 80 percent of Newco’s stock, does the analysis in
Coltec allow the sale to be disregarded?
314
‘C’ Reorganization
T S/H’s
P S/H’s
T S/H’s
P S/H’s
T
P Stock
P
T
T Assets
T Assets
•
T S/H’s
P S/H’s
P
T Assets
Liquidates
P
T Assets
What if, as is likely the case, certain steps are undertaken solely to come within the
reorganization provisions in section 368? For example, assume that substantially all of a
target corporation’s assets are acquired by another corporation solely in exchange for voting
stock. If that corporation liquidates following the asset transaction to come within the terms
of a “C” reorganization, is the liquidation step subject to risk under Coltec because it occurred
solely for tax reasons?
315
‘D’ Reorganizations – Cash – Rev. Rul. 70-240
Step One
Step Two
Liquidation
P
Assets
X
Y
X
P
Y
Cash
Facts: P, X, and Y are corporations. P owns all of the stock of X and Y. X transfers all of its assets to
Y in exchange for cash. X then liquidates into P.
Result: This transaction qualifies as a tax-free ‘D’ reorganization under section 368(a)(1)(D). In the
transaction, X distributes substantially all of its assets to D and its shareholder (P) is in control of Y
after the exchange. However, the requirement that stock or securities of the acquiring corporation (Y)
be distributed is not technically satisfied. This requirement is treated as satisfied because a distribution
of Y stock in this example would be a meaningless gesture. See Rev. Rul. 70-240; see also Rev. Rul.
2004-83. Does the analysis in Coltec affect this result?
316
Roll-up Transaction
P
A
Ownership interests in
LLC1, LLC, and LLC3
B
C
LLC1
LLC2
Newco
LLC3
•
Assume that a parent corporation converts several LLCs or partnerships into a corporation in
a roll-up transaction. Is this transaction subject to review under the Federal Circuit’s analysis
in Coltec if the roll-up was done in part to combine income and loss?
317
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structuring of venture capital companies, including the development of hybrid debt and equity instruments. We regularly obtain IRS private letter rulings or
issue opinion letters with respect to transactions. Our work often involves discussions with Congressional, Treasury, and IRS personnel.
Our firm has developed significant experience in the area of debt restructurings and workouts, both within and outside of bankruptcy. In this context, we
analyze tax issues relating to net operating losses, cancellation of indebtedness income, and original issue discount.
We advise affiliated groups of corporations with respect to consolidated return issues, often negotiating and drafting tax−sharing agreements in the context of
acquisition transactions. In addition, through our work with closely held affiliated groups, we encounter with great frequency the at−risk rules, passive loss
rules, and interest limitation provisions, particularly as they apply in a consolidated return setting.
As a corollary to our transactional planning, we render general business tax advice on a continuing basis to a variety of companies. We provide these clients
with advice concerning such matters as tax accounting, depreciation and other forms of capital cost recovery, and the corporate alternative minimum tax.
Pass-Through Entities
The firm provides advice on the formation and operation of business ventures in LLC and partnership form. In this context, we craft LLC and partnership
agreements to fit the specific needs of diverse participants, such as exempt organizations and cross−border investors. The firm also advises on the use of LLC's
and partnerships in the context of corporate restructurings in order to provide new capital to an ongoing venture or to avoid undesirable consolidations. In
addition, we regularly advise clients on the use of entities disregarded for tax purposes to minimize cross−border taxation, isolate liabilities, and effect the
transfer of wealth across generations.
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International Taxation
Much of the firm's tax advice is provided in the cross−border context. Specifically, Steptoe represents foreign and domestic clients in connection with the
acquisition and disposition of businesses located in the United States and abroad. In this regard, the firm provides a full range of legal services, including
structuring transactions, negotiating and drafting contract terms, and advising clients of the tax legislative and regulatory climate that may affect their
transactions.
The firm also provides clients with tax advice concerning the most advantageous ways to structure investments and international business operations,
including deferring current taxation of income, and maximizing the availability of foreign tax credits. We have particular experience advising non−US
clients with respect to the detailed rules relating to their taxation in the US.
We have been instrumental in the development of joint venture arrangements throughout Europe, Latin America, Asia, Russia, and other former Soviet
Republics, and we have helped to structure license agreements and technology transfer arrangements designed to minimize US and foreign tax burdens. We
have extensive experience structuring tax−efficient international investment funds, advising foreign, domestic and multilateral investors as well as the funds
themselves.
Our lawyers advise foreign and domestic clients regarding the audit of their returns by international examination agents of the IRS and by foreign tax
collection agencies. We also participate in Competent Authority matters, generally relating to transfer pricing, involving government−to−government
negotiation of issues relating to the tax returns of specific taxpayers. The firm also has extensive experience litigating tax controversies.
Steptoe is experienced in the transfer pricing area. We advise clients with respect to transfer pricing methodologies (working both with economists and
independently), and documenting those methodologies to help clients avoid penalties.
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Tax Controversy and Litigation
A major component of Steptoe's wide−ranging tax practice is our extensive experience in handling tax controversies, both at administrative levels and in
litigation before the courts.
We represent clients in controversy matters at all levels within the IRS. During the audit phase, we assist our clients in analyzing and evaluating factual and
legal issues and in making presentations to local IRS officials and to the IRS National Office in referrals for technical advice. In Coordinated Examination
and Industry Specialization audits, we deal with IRS attorneys to eliminate issues and to minimize the need for litigation. We work closely with our clients
during the administrative stages of a case to develop an optimum record in the event litigation is necessary. That work includes the preparation of
administrative settlement agreements, drafting refund claims, securing reputable and effective expert witnesses, and responding to or contesting IRS
information and document production demands. We frequently prepare protests of proposed IRS audit adjustments, and we represent our clients in
conferences with IRS Appeals Officers.
The needs of our clients are such that we continuously have cases pending in the United States Tax Court, the United States Court of Federal Claims, and
various federal district and appellate courts on many different substantive and procedural tax issues. In some of these cases, we also served as counsel for our
clients through the administrative process; in others we are engaged initially as litigation counsel. The types of litigation that we have handled cover a wide
range of issues and thus reflect the broad scope of the firm's substantive tax practice. As part of our litigation activities, we represent clients in negotiations
before the IRS and the Tax Division of the Department of Justice with the objective of obtaining favorable settlement of pending litigation matters. At the
conclusion of tax controversies, we also assist our clients in assuring that the necessary tax and interest computations are done correctly, and that interest
netting is applied to the maximum extent.
Among the many types of controversies that we handle on a regular and continuing basis are controversies relating to the proper tax treatment of tax
advantaged investments. We represent numerous clients in all aspects of such disputes, including interpreting registration and listing requirements, handling
both the substantive and procedural issues that arise during the audit stage, drafting protests and conducting IRS Appeals conferences, and, when necessary,
litigating cases. We are also able to use our contacts in the IRS National Office, when necessary, to insure fair treatment for our clients and reasoned
consideration of our clients' positions.
The firm's tax controversy and litigation practice also includes the representation of individuals and corporations who are alleged to have engaged in conduct
exposing them to criminal sanctions. These representations involve a variety of factual circumstances and legal issues, and they include representation that
extends from pre−litigation proceedings (such as grand jury investigations, jeopardy assessment review hearings, and summons enforcement contests), to post−
indictment proceedings (including motions practice and discovery), to trial (working with members of the Firm's White Collar Criminal Defense Practice), to
post−trial proceedings (such as the preparation of sentencing memoranda).
Our attorneys have briefed and argued numerous tax cases before the Supreme Court of the United States. In recent terms, we have handled before that
Court such diverse matters as state insurance premium tax questions, federal statutory limitations on state taxation, corporate tax issues, and ERISA
preemption matters. In addition, the firm is often asked to assist other law firms in drafting petitions for certiorari and in preparing briefs on the merits, as
well as in counseling them with respect to the unique nature of Supreme Court practice.
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Insurance Tax
Steptoe has one of the preeminent insurance tax practices in the country. It covers both company and product tax issues, and involves tax controversy and
tax planning, as well as legislative and administrative lobbying. Our attorneys have extensive experience and skill with substantive insurance tax issues, and
are directly involved in ongoing developments affecting taxation of the industry.
In the tax planning area, we work with clients to devise and implement tax strategy, to obtain private letter rulings, and to develop return positions. We
provide advice on the structure of transactions, including stock and asset acquisitions and dispositions, and with respect to the application of the consolidated
return regulations. Also, we often assist clients with product tax matters, including questions concerning the definition of life insurance.
Our attorneys were extensively involved in the legislative processes resulting in Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and the Deficit
Reduction Act of 1984 and are continuously involved in legislative developments affecting the industry. Additionally, we often represent insurance interests
before the IRS and the Treasury Department regarding coordinated issues, proposed regulations, and other matters of general importance to the industry.
In the controversy area, we represent clients at all administrative levels within the IRS. We assist companies in responding to audit inquiries and proposed
adjustments and in presenting Technical Advice requests to the IRS National Office. In addition, we work with clients to prepare protests, to effectuate
settlements, and to file claims for refund. We often litigate cases for our clients, appearing before the United States Tax Court, the United States Court of
Federal Claims, and other courts. We have successfully represented insurance company clients in several cases before the Supreme Court. Two of those
matters, in which we successfully represented industry groups, raised constitutional issues relating to state premium taxes.
COLI
Steptoe currently represents policyholders that own leveraged corporate owned life insurance ("COLI") and unleveraged bank owned life insurance
("BOLI"). We are uniquely situated to help COLI and BOLI policyholders respond to the IRS's challenges to those policies. As described above, Steptoe
has a wealth of experience defending taxpayers (including COLI policyholders) at the audit, administrative appeal, and litigation levels. Moreover, Steptoe
has the life insurance product tax knowledge that is required to sort through the complex set of insurance issues presented in COLI/BOLI controversies.
We have first−hand experience dealing with Code Section 265(a) issues and the economic substance doctrine. With considerable knowledge regarding rated
policies, we have experience to properly defending inquiries whether sufficient risk shifting has occurred for COLI/BOLI policies to constitute life
insurance. And, with separate account BOLI policies, we are able to rebut challenges to policies based on Code Section 817 diversification and investor
control issues.
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Ethical and Practice Standards
One of our unique areas of practice centers on the standards of conduct for tax professionals. This practice has two principal dimensions.
First, we represent tax professionals who have been charged with misconduct by federal or state officials who exercise regulatory jurisdiction over such
professionals. In this connection, our clients include professional firms, both large and small. Typically, these clients are alleged to have violated the ethical
standards of the American Bar Association, the American Institute of Certified Public Accountants, or similar organizations, as adopted by the licensing
authority of the particular practice jurisdiction. Our representation of professionals and professional organizations also includes advice with respect to
conflicts of interest and the effect of prior government service on private practice in areas related to such service.
The second dimension of this practice involves alleged malpractice by tax professionals. In this connection, we represent either the aggrieved client or the
allegedly negligent tax professional. For this kind of case, we are frequently retained by professional liability insurers to represent insured tax professionals
who have been charged with malpractice.
The law regarding the ethical responsibilities of tax professionals has evolved rapidly over the last few years, and changes in these professional standards have
influenced the development of the law of malpractice in the tax field. In addition, we have recently witnessed the phenomenon of a large number of tax
shelter investments that have failed to achieve their advertised tax or investment objectives. These failed tax shelters have spawned extensive litigation
focused on the professional responsibility and liability of the professionals who were involved in their promotion and sale.
The authoritative text on the subject of ethical standards in tax practice was co−authored by a Steptoe tax attorney, and we have been closely identified with
the development of the law in this area.
Information Reporting and Employment Tax Matters
Steptoe actively represents major institutions in the financial services industry with regard to extensive tax information reporting obligations. Our work
includes ongoing advice regarding federal and state tax information reporting obligations for interest, dividends, and other taxable payments to various
domestic and foreign payees. We also assist clients in complying with information reporting for ERISA plans, tax shelters, and exempt organizations, and
deal with IRS personnel at the national, regional, and local levels in devising practical solutions to frequent technical problems that arise in the context of the
reporting requirements. In addition, we represent clients before the IRS in seeking the abatement of civil penalties that have been imposed for alleged
failures to comply with various information reporting requirements.
We provide legal advice on employment tax issues. We represent employer coalitions before the IRS with regard to the employee/independent contractor
status of large classes of workers, and we represent classes of taxpayer−employees in test cases involving both foreign employment and domestic employment.
Our attorneys are very familiar with issues faced by large corporations, issues that are receiving increased administrative attention in the current enforcement
environment.
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Employee Benefits and Executive Compensation
Our firm's employee benefit and executive compensation practice covers the full range of tax, labor, and legislative issues. We represent retirement, health,
and other plans, plan sponsors, actuaries and other plan consultants, banks, insurers, investment entities, and trade associations that focus on employee benefit
and executive compensation issues. We also provide advice to employers regarding the operation and funding of their executive compensation and stock
option programs, as well as advice on current practices involving executive benefits. In addition, we advise companies on employment agreements and assist
them when controversy arises in connection with severance pay or other benefit claims. These representations give us a very broad range of experience in
issues that relate to employee benefit plans.
We provide advice concerning taxation of benefits, deduction of contributions, and qualification of employee benefit plans. We represent clients before the
IRS and the United States Tax Court when adverse rulings are threatened or issued, and have extensive experience in dealing with the IRS voluntary
compliance programs for plans that have qualification errors. We actively represent clients at all administrative levels before the IRS and the Treasury
Department with respect to new or evolving matters of law to help shape policy. In addition, we have been extensively involved in crafting new products or
approaches in welfare benefit areas in addition to providing regular advice on compliance with HIPAA, COBRA's continued health coverage rules and other
health plan funding vehicles (e.g., VEBAs and defined contribution health accounts). We have also drafted and provided advice with respect to the
implementation and operation of cash balance plans and ESOPs. In addition, we have assisted clients in developing sophisticated and novel nonqualified
deferred compensation programs. We have also reviewed and helped to design programs that maximize the amount of compensation that can be placed in
qualified deferred compensation plans.
Our plan termination and multi−employer withdrawal liability practice takes clients through the termination or withdrawal process and seeks to minimize
liability on account of such events; we recently completed a large plan termination/reversion transaction. We have obtained favorable rulings and settlements
in all areas under ERISA Title IV. In addition, we advise clients on the relationship between the bankruptcy laws and ERISA, taking an active role in
troubled company work−out situations.
In the course of our practice, we represent clients before the Department of Labor on requests for advisory opinions and information letters as well as on
prohibited transaction exemption requests. We have an active fiduciary litigation practice concentrating in preemption issues and damage questions. Our
ERISA practice extends to transactional matters, and we provide relevant advice in mergers and acquisitions, including issues relating to funded plans and
unfunded retiree health costs. Finally, our ERISA attorneys have extensive experience in legislative lobbying and in keeping our clients abreast of legislative
issues and initiatives in the employee benefits and executive compensation field.
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Tax-Exempt Organizations
Steptoe has a team of lawyers who focus on all aspects of the representation of tax−exempt organizations. The firm's clients include federal and state agencies
and instrumentalities, professional and trade associations, educational institutions, healthcare organizations, private family and company foundations, lobbying
and other advocacy groups, political organizations, religious organizations, veterans and other membership groups, and medical research organizations, as well
as a wide variety of other charitable, educational, scientific, religious, and social welfare organizations. In addition, we advise business entities that participate
in commercial ventures with tax−exempt organizations.
Our tax−exempt organizations practice provides a full range of services for non−profit organizations. Steptoe attorneys assist clients in establishing and
maintaining exempt organizations, including providing advice concerning the formation of the organization and its qualification for tax−exempt status under
IRS procedures, and, where applicable, state requirements. Once an organization has been created and qualified, our attorneys provide ongoing counseling
on a broad spectrum of tax issues, including qualification for public charity status, intermediate sanctions, unrelated business income, reporting obligations,
eligibility to conduct legislative or political campaign activities, use of for−profit subsidiaries, participation in partnerships and joint ventures, and maintenance
of charitable giving programs.
Steptoe attorneys work closely with our charitable organization clients in the development and operation of fundraising programs. In this regard, we provide
advice relating to the contributions, recordkeeping, and reporting in the context of capital campaigns, special events, direct mail solicitations, and planned
giving. Steptoe attorneys also advise their clients with respect to federal and state fundraising regulation requirements, including the constitutionality of these
laws. We monitor developments in this area of the law, and assist our clients in registering and reporting under these laws. In addition, we provide advice to
charitable clients and to individual donors concerning the structure and deductibility of charitable contributions. For example, in the case of planned giving,
the firm provides advice and prepares the documents related to major gifts or bargain sales of appreciated property. In addition, the firm advises clients
regarding charitable remainder trusts, pooled income funds, and charitable gift annuities, and where applicable, drafts the operative documents.
Steptoe's tax−exempt organizations practice also includes the handling of complex audits, litigation, and criminal investigations. In addition, we represent
clients on novel and/or complex tax issues before the IRS and on legislative and policy issues before Congress. We also have experience in appellate
litigation involving tax−exempt organizations.
Finally, the Steptoe attorneys provide advice concerning many other areas of the law as they relate to tax−exempt organizations, including, but not limited to,
leases, employment contracts, intellectual property matters, antitrust issues, labor law questions, and matters pertaining to employee benefits and executive
compensation planning. Our attorneys also have significant experience drafting corporate governance documents for non−profit corporations, as well as
drafting joint venture agreements, asset purchase agreements, licenses of intellectual property, and other documents in connection with transactions involving
exempt organizations.
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Excise Taxes
The firm represents domestic and foreign clients in a broad range of excise tax matters, ranging from the excise tax on transportation by air, to excise taxes
applicable to gasoline and other fuels, to the communications excise tax. We also represent clients regarding the excise tax on insurance premiums paid to
foreign insurers of US risks. We provide planning advice as well as advice in connection with audits of excise tax returns. We also litigate excise tax issues.
Multi-State Taxation
Our Washington and Phoenix tax attorneys represent an array of business clients in multi−state and local tax matters. This extensive multi−state tax practice
advises clients of many types and sizes, including high−technology businesses, electric utilities, telecommunications companies, mining and railroad
companies, manufacturers, retailers, banks, printers, mail order businesses, tax−exempt organizations, and resorts. Our attorneys represent these clients on
complex and varied income, sales and use, and property tax matters, including litigation both at the administrative and judicial levels. They also counsel the
firm's clients on the multi−state tax implications of their business transactions. Steptoe is also expanding into the growing e−commerce industry, advising
clients on their complex multi−state income tax responsibilities and their sales and use tax collection obligations.
Examples of our multi−state taxation practice include the following:
•
Advising high−technology businesses on various multi−state and Arizona tax issues, including income, sales and use, and property tax.
•
Handling property tax valuation appeals for high−technology businesses.
•
Counseling businesses on the multi−state tax ramifications of mergers and acquisitions; advising multi−state businesses on state income tax issues,
including the "unitary" combination issue, allocation and apportionment issues, business/non−business income questions, and Public Law 86−272
nexus issues.
•
Counseling clients on the multi−state taxation of flow through entities such as partnerships, S−corporations, and limited liability companies.
•
Advising electric utilities on various state and local tax issues, particularly in light of recent industry deregulation; representing a major electric utility
in a property tax appeal over the value of a nuclear generating plant.
•
Obtaining private tax rulings for clients on state and local tax issues.
•
Drafting state tax legislation for clients and industry groups.
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