In PLR 201930011, released July 26, 2019, the Service ruled that the splitting up of a business between discordant shareholders of a closely held business qualified as a tax-free transaction pursuant to sections 368(a)(1)(D) and 355 (a divisive D reorganization). This ruling illustrates that given the right facts and circumstances and careful structuring, breaking up might not be as hard to do…at least for federal income tax purposes.
This PLR is one of several rulings that the Service has issued since announcing the temporary reversal of its no-ruling policy with respect to section 355 distributions under Rev. Proc. 2017-52, 2017-41 I.R.B. 283. PLR 201930011 implies that business partners going their own way may meet the business purpose requirement under section 355.
In PLR 201930011, the distributing corporation (Distributing) was an S corporation for federal income tax purposes. Distributing’s four shareholders, A, B, C and D held equal interests in Distributing. Distributing was engaged in a single line of business (the Business) that it actively conducted for each of the past five years leading up to the proposed transaction described below. Distributing’s total gross assets were valued at approximately $a. Distributing also owned a general partnership interest in a partnership that was valued at approximately $b.
A and B were at odds with C and D as to how the Business should be conducted so the shareholders negotiated a plan to split the business into two equal parts. The parties requested a private letter ruling for the following proposed split-up:
- Distributing will form two corporations, Controlled 1 and Controlled 2, each of which will make an S election for federal income tax purposes.
- Distributing will then contribute to Controlled 1 50% of the assets and liabilities of the Business, including 50% of the general partnership interest, 50% of Asset 1, 100% of Assets 2, 3, and 4, and $c cash (Contribution 1).
- Distributing will contribute to Controlled 2 the remaining 50% of the asset and liabilities of the Business, including 50% of the general partnership interest, 50% of Asset 1, 100% of Assets 5, 6, 7, 8, and 9, and $d cash (Contribution 2).
- Distributing will subsequently distribute to A and B all of the stock of Controlled 1 in exchange for all of A and B’s shares of Distributing stock (Distribution 1).
- Distributing will simultaneously distribute to C and D all of the stock of Controlled 2 in exchange for all of C and D’s shares of Distributing stock (Distribution 2).
- Distributing will then liquidate as part of the reorganization.
- Controlled 1 and Controlled 2 will sell Asset 1 as soon as the necessary steps required by the applicable state law are completed.
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Nick Gruidl – Partner
Tonya Williams – Supervisor