Thursday, April 17, 2014

Feuding brothers

When brothers feud, they can split up their corporation in two and go their separate ways in a tax free exchange.

In a recent private letter ruling (PLR 201411012), the IRS ruled that no gain or loss would be recognized on division of corporation by feuding siblings.  This is a carefully laid out plan needing to qualify under a plethora of carefully planned criteria to qualify the transaction for non-recognition treatment of the split off.  Under the scenario painted by the taxpayers to the Internal Revenue Service, each corporation will operate one of the two businesses currently being run by the existing company.

By way of background, the Code provides nonrecognition treatment for reorganizations listed in Code Sec. 368(a). Under Sec. 368(a)(1)(D), a so called type "D" reorganization, a transfer of all or part of the assets of one corporation to another corporation qualifies if: (i) immediately after the transfer, the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the transferee corporation; and (ii) stock or securities of the corporation to which the assets are transferred are, under the plan, distributed in a transaction which qualifies under Sec. 354, 355, or  356.
The IRS ruled that the split will qualify for tax-free treatment and specifically ruled that the transaction qualified as a “D” reorganization, neither corporation nor shareholder will recognize any gain, the basis in all assets of both corporations are maintained and the holding periods are tacked on from the prior corporation and the earnings and profits, if any, will be allocated between the two companies under Sec. 312(h) and Reg. §1.312-10(a).
Be aware that there are numerous pitfalls in trying a “D” reorganization.  Among other items, IRS expressed no opinion regarding whether the Split-Off: (i) satisfied the business purpose requirement of Reg. §1.355-2(b)); (ii) was used principally as a device for the distribution of the earnings and profits of either company; or (iii) was part of a plan (or a series of related transactions) pursuant to which one or more persons will acquire directly or indirectly stock representing a 50% or greater interest in either company under Code Sec. 355(e) and Reg. § 1.355-7 .

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