Federal Tax
FEBRUARY 1, 2003
Atlanta
Charlotte
New York
Advisory
Insights Into Recent Regulatory, Judicial and Legislative Developments
How a Not So Closely-Held Consolidated Group
Accomplishes its Own “Integration”
LTR 200252014 (released 12/27/02)
Research Triangle
Summary
Washington, D.C.
The President is proposing a form of corporate tax integration whereby corporate income is not taxed
twice; his proposal is to eliminate dividend taxation. Corporations can accomplish a similar result
if they can get out of corporate status into passthrough status. There are three huge stumbling blocks
to such efforts: (1) the General Utilities gain that the corporation may have to recognize on its
appreciated assets, (2) the capital gains shareholders may have to recognize on the redemption of their
stock, and (3) the threat that the resulting partnership will be treated as a publicly traded partnership,
and thus not escape taxation as a “C” corporation. However, under the right circumstances, as in this
ruling, the needle can be threaded and a corporation with a significant number of shareholders can
get itself into the single tax world without unbearable gain recognition.
The Facts that Made It Possible
The parent of the consolidated group had a shareholder group made up entirely of employees
and directors. The parent made the market in the stock; there was no public trading. The basic
plan had two major parts. One was for parent to convert or merge all of its corporate subsidiaries
into partnerships or disregarded entities. The other was to redeem presumably the majority of the
shareholders by distributing to them interests in a limited partnership holding the business assets
(now mostly other pass-through entities) and convert the remaining corporate parent into an
S corporation, obviously with a limited number of shareholders; that S corp. will retain between
35-60% of the partnership.
Presumably these steps were not too painful because neither the shareholder level gain nor the
corporate level gain were excessive due to recent market declines, and the capital gains rate enjoyed
by the shareholders is fairly attractive.
Other Factors
Jack Cummings
Editor
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202-756-3300
Fax: 202-756-3333
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The parent will not issue any more stock after the restructuring, but in the future the partnership will
issue partnership interests to employees. Valuation clearly was a key issue. When parent distributes the
partnership interests to departing shareholders it recognizes §311(b) gain. The taxpayer represented
that the value per shareholder would be a percentage of the value of the entire business held by the
partnership, without any discount for minority interest, marketability, etc. That is, the taxpayer gave up
any right to claim, a la Pope & Talbot, that the parts were worth less than the whole.
Planning Possibilities
Employee owned C corporations, even of substantial size, can achieve corporate tax integration
if they are not overvalued, there is tolerance for some tax price, and they are open to innovative ways
to accommodate the interests of hundreds or even thousands of shareholders.
For additional information call Andy Immerman (404) 881-7532 or Kevin Rowe (202) 210-9505.
Federal Tax
Group
Drops After D’s
Rev. Rul. 2002-85
Summary
The ruling transaction involved Mr. A and his two wholly owned corporations, X and Y. X transferred
all of its assets and liabilities to Y for 30% cash and 70% Y stock and then X liquidated. As part of
the integrated transaction, Y retransferred the X assets to Y’s wholly owned subsidiary Z. The ruling
held that the transfer qualified as a §368(a)(1)(D) reorganization, meaning that X did not recognize
General Utilities gain on its assets and Mr. A recognized his X stock gain only to the extent of the cash
boot he received.
Significance
This is the first time that the IRS has publicly ruled that where all of the other requirements
of a “Type D” reorganization are met, the asset transferee’s retransfer of the assets to its controlled
subsidiary will not disqualify the Type D reorganization. Such “drops” by the acquiring corporation
long have been explicitly allowed after other forms of tax free reorganization, and so taxpayers might
stumble into a taxable transaction by such a drop absent this ruling.
Sam K. Kaywood, Jr.
Co-Chair
404-881-7481
Edward Tanenbaum
Co-Chair
212-210-9425
Pinney L. Allen
404-881-7485
Gideon T. J. Alpert
212-210-9403
Pamela S. Ammermann
202-756-3341
Saba Ashraf
404-881-7648
Henry J. Birnkrant
202-756-3319
Robert T. Cole
202-756-3306
Type D reorganizations occur not only in the scenario described with an individual shareholder, but
can occur any time one corporation transfers substantially all of its assets to another corporation
and distributes stock of the transferee to its shareholder. For example, the two corporations can
be subsidiaries of a holding corporation, in which case a Type D reorganization can be found even
without stock being exchanged. That is, a sale between two subsidiaries might be recast as a Type D
reorganization; sometimes this is intended, sometimes it is not.
Jasper L. Cummings, Jr.
202-756-3386
The Type D Reorganization
Donald M. Etheridge, Jr.
404-881-7734
This reorganization type, for which the Code allows tax free treatment, as for mergers, is relatively
unknown to taxpayers because it is not used typically in acquisitions, although it can be: the key
is that the corporation receiving substantially all of another corporation’s assets must be more than
50% controlled by the transferor’s shareholders. For example, Bigco may transfer all of its assets
and liabilities to Littleco, in exchange for Littleco stock and cash, and then Bigco liquidates. If Bigco
shareholders wind up with more than 50% of Littleco, and get too much boot to have a Type C
reorganization, they will have to rely on the Type D reorganization to avoid recognizing gain on the
Bigco assets, as well as full gain on the shareholders’ stock.
Philip C. Cook
404-881-7491
James E. Croker, Jr.
202-756-3309
Tim L. Fallaw
404-881-4479
Terence J. Greene
404-881-7493
Michelle M. Henkel
404-881-7633
L. Andrew Immerman
404-881-7532
Andrea M. Knight
404-881-4522
Planning Implications
This ruling highlights the importance of being aware of (1) the availability of the non-divisive
Type D reorganization (it is also used in spin-offs) in acquisitive settings, (2) the pitfalls that can
block that availability, including this pitfall that has been removed, at least for drops to 80% controlled
subsidiaries, (3) the possibility that an intended “taxable” corporate exchange can be made into
a carryover basis transaction by the Type D reorganization, and (4) when and what sort of follow-on
drop down of assets or stock acquired in a reorganization are allowed without negative impact on
the transaction’s tax deferral nature.
For additional information call Jack Cummings (919) 862-2302 or Saba Ashraf (404) 881-7648.
Andrea Lane
202-756-3354
Brian E. Lebowitz
202-756-3394
Timothy J. Peaden
404-881-7475
Kevin M. Rowe
212-210-9505
Matthew C. Sperry
404-881-7553
Joe T. Taylor
404-881-7691
All regular monthly and “Special Alert” issues of the Federal Tax Advisory can
be viewed on our Website at www.alston.com (click Services, then
Publications, then Legal Advisories & Articles) or contact us at [email protected].
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Gerald Von Thomas II
404-881-4716
Charles W. Wheeler
202-756-3308