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IRS Rules on Tax Consequences of "Triple Drop and Check" Reorganizations.

(Parker Tax Publishing May 10, 2015)

The IRS has addressed the tax consequences of a series of transactions where a parent corporation transferred all of its interests in a LLC through various subsidiaries, ending with the LLC electing to be treated as a disregarded entity. Rev. Rul. 2015-10.

Background

Under the facts of the revenue ruling, Parent, a corporation, owns all of the interests in LLC, a limited liability company taxed as a corporation. Parent also owns all of the stock of Sub1, which owns all of the stock of Sub2. Sub2 owns all of the stock of Sub3, and Sub3 owns all of the stock of Sub4. Sub1, Sub2, and Sub3 are each holding companies that are corporations.

For valid business purposes, and as part of a plan:

(1) Parent will transfer all of the interests in LLC to Sub1 in exchange for additional shares of voting common stock of Sub1 (Parent's transfer);

(2) Sub1 will then transfer all of the interests in LLC to Sub2 in exchange for additional shares of voting common stock of Sub2 (Sub1's transfer);

(3) Sub2 will next transfer all of the interests in LLC to Sub3 in exchange for additional shares of voting common stock of Sub3 (Sub2's transfer); and

(4) LLC will elect pursuant to Reg. Sec. 301.7701-3(c) to be disregarded as an entity separate from its owner for federal income tax purposes, effective no sooner than one day after Sub2's transfer (LLC's election).

OBSERVATION: This series of transactions, colloquially referred to as a "triple drop and check," effectively transfers Parent's interests in LLC to Sub3 by way of Sub1 and Sub2.

Following the transaction, Sub3 will, through LLC, continue to conduct the business conducted by LLC prior to the transaction.

Analysis

Code Sec. 351(a) provides that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in Code Sec. 368(c)) of the corporation.

Code Sec. 368(a)(1)(D) provides that the term "reorganization" includes a transfer by a corporation of all or a part of its assets to another corporation if 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 corporation to which the assets are transferred.

A transfer of property may be respected as a Code Sec. 351 exchange even if it is followed by subsequent transfers of the property as part of a prearranged, integrated plan (Rev. Rul. 77-449).

The IRS noted that under the facts of the revenue ruling, even though Parent's transfer was part of a series of transactions undertaken as part of a prearranged, integrated plan involving successive transfers of the LLC interests, Parent's transfer satisfies the formal requirements of Code Sec. 351, including the requirement that Parent control Sub1 within the meaning of Code Sec. 368(c). Accordingly, the IRS ruled Parent's transfer is respected as a Code Sec. 351 exchange, and no gain or loss is recognized by Parent. Similarly, the IRS found Code Sec. 351 applies to Sub1's transfer, and no gain or loss is recognized by Sub1.

With regard to Sub2's transfer and LLC's election, the IRS stated that pursuant to Rev. Rul. 67-274, if an acquiring corporation acquires all of the stock of a target corporation in an exchange otherwise qualifying as a Code Sec. 351 exchange, and as part of a prearranged, integrated plan, the target corporation thereafter transfers its assets to the acquiring corporation in liquidation, the transaction is more properly characterized as a reorganization under Code Sec. 368(a)(1)(D).

Accordingly, the IRS determined that Sub2's transfer and LLC's election were more properly characterized as a reorganization under Code Sec. 368(a)(1)(D) than as a Code Sec. 351 exchange followed by a liquidation of the subsidiary under Code Sec. 332.

The IRS thus ruled that a transaction in which (1) a parent corporation transfers all of the interests in its limited liability company that is taxable as a corporation to the first subsidiary in exchange for additional stock, (2) the first subsidiary transfers all of the interests in the limited liability company to the second subsidiary in exchange for additional stock, (3) the second subsidiary transfers all of the interests in the limited liability company to the third subsidiary in exchange for additional stock, and (4) the limited liability company elects to be disregarded as an entity separate from its owner for federal income tax purposes effective after it is owned by the third subsidiary, is properly treated for federal income tax purposes as two transfers of stock in exchanges governed by Code Sec. 351 followed by a reorganization under Code Sec. 368(a)(1)(D).

OBSERVATION: In Rev. Rul. 2015-9, the IRS addressed the tax consequences of a similar series of transactions involving foreign corporations, revoking Rev. Rul. 78-130. There, the IRS ruled a transaction in which (1) a domestic corporation transfers all of the stock of its foreign operating subsidiary to its foreign holding company subsidiary in exchange for additional stock, (2) the foreign operating subsidiary and three foreign subsidiaries of the foreign holding company transfer substantially all of their assets to a newly-formed foreign subsidiary of the foreign holding company in exchange for stock of the new subsidiary, and (3) the subsidiaries that transfer their assets are liquidated, is properly treated for federal income tax purposes as a transfer of the foreign operating subsidiary's stock in an exchange governed by Code Sec. 351 followed by reorganizations under Code Sec. 368(a)(1)(D).

For a discussion of corporate reorganizations, see Parker Tax ¶ 46,500. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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