Check the timing of the check-the-box election.In the late 1990s, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. and Treasury published entity classification regulations under Sec. 7701 (check-the-box regulations) that were designed to simplify the lives of both taxpayers and the government. The purported pur·port·ed
Assumed to be such; supposed: the purported author of the story.
pur·ported·ly adv. simplicity of those regulations, however, may give rise to traps for the unwary in certain
situations. This item describes one such potential trap, involving the effective date of an election, and discusses how to address it.
To appreciate the issue fully, some background information is necessary. Specifically, one must have some knowledge of the check-the-box regulations, the liquidation-reincorporation doctrine and exceptions to its application, and the consequences of the regulatory reg·u·late
tr.v. reg·u·lat·ed, reg·u·lat·ing, reg·u·lates
1. To control or direct according to rule, principle, or law.
2. repeal The Annulment or abrogation of a previously existing statute by the enactment of a later law that revokes the former law.
The revocation of the law can either be done through an express repeal of the Bausch & Lomb doctrine.
Overview of the Check-the-Box Regulations
The check-the-box regulations set forth rules for classifying business entities for federal tax purposes. Under those rules, an eligible entity with just one owner may elect to be classified as a corporation or as an entity disregarded dis·re·gard
tr.v. dis·re·gard·ed, dis·re·gard·ing, dis·re·gards
1. To pay no attention or heed to; ignore.
2. To treat without proper respect or attentiveness.
n. as separate from its owner (disregarded entity). Under Regs. Sec. 301.7701-3(g), if an eligible entity classified as a corporation elects to change its classification to be treated as a disregarded entity (disregarded entity election), the corporation is deemed to liquidate To pay and settle the amount of a debt; to convert assets to cash; to aggregate the assets of an insolvent enterprise and calculate its liabilities in order to settle with the debtors and the creditors and apportion the remaining assets, if any, among the stockholders or owners of the by distributing all of its assets and liabilities to its single owner (the deemed liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts.
A type of proceeding pursuant to federal Bankruptcy ). The tax treatment of the deemed liquidation is determined under all relevant provisions of the Code and general principles of tax law, including the step-transaction doctrine.
Regs. Sec. 301.7701-3(g)(3) (the effective date provision) provides that the deemed liquidation occurs immediately before the close of the day before the effective date of the disregarded entity election. Thus, if an entity classified as a corporation files a disregarded entity election effective on January January: see month. 1, the deemed liquidation is treated as occurring immediately before the close of December December: see month. 31.
It is the effective date provision that raises the potential issue discussed in this item. To illustrate, consider the following examples.
Example 1: X, an entity classified as a corporation, owns all the stock of both Y and Z, each of which is also classified as a corporation for federal tax purposes. On January 1, 2008, x contributes all Y's stock to Z (the stock contribution). Immediately thereafter and pursuant to the same plan, Y files a disregarded entity election (Y's election) effective on January 2, 2008. Under the effective date provision, the deemed liquidation of Y occurs at the end of January 1, 2008 (and thus at a time when Y is owned by Z). Thus, for federal tax purposes, the transactions to be examined (and potentially recast re·cast
tr.v. re·cast, re·cast·ing, re·casts
1. To mold again: recast a bell.
2. ) are X's contribution of all Y's stock to Z, followed by a liquidation of Y in which Y distributes all its assets (subject to its liabilities) to Z.
Example 2: Assume the same facts as in Example 1, except that Y's election is effective on January 1, 2008--the date of the stock contribution. Now, under the effective date provision, the deemed liquidation of Y occurs at the end of December 31, 2007--a time when Y is owned by X. Thus, for federal tax purposes, the transactions to be examined (and potentially recast) are a liquidation of Y into X, followed by X's contribution of the former Y assets (subject to the former Y liabilities) to Z.
The Liquidation-Reincorporation Doctrine
It has long been the IRS's position that a corporation's purported liquidation that is preceded or followed by a transfer to another corporation of all or part of the liquidating corporation's assets may be recharacterized in accordance Accordance is Bible Study Software for Macintosh developed by OakTree Software, Inc.
As well as a standalone program, it is the base software packaged by Zondervan in their Bible Study suites for Macintosh. with its substance (see, e.g., Regs. Sec. 1.331-1 (c)). This position, commonly referred to as the liquidation-reincorporation doctrine, generally results in the treatment of a liquidation of a wholly owned subsidiary Wholly Owned Subsidiary
A subsidiary whose parent company owns 100% of its common stock.
In other words, the parent company owns the company outright and there are no minority owners. followed by the parent's reincorporation of all or substantial part of the assets received in the liquidation in another, existing wholly owned subsidiary as a reorganization under Sec. 368(a)(1)(D) (a D reorganization) for federal tax purposes.
Historically, that treatment would prevail regardless of whether (1) the parent contributed the target corporation's stock to another subsidiary and the target liquidated DAMAGES, LIQUIDATED, contracts. When the parties to a contract stipulate for the payment of a certain sum, as a satisfaction fixed and agreed upon by them, for the not doing of certain things particularly mentioned in the agreement, the sum so fixed upon is called liquidated damages. (q.v. (as in Example 1) or (2) the target corporation liquidated into the parent and then the parent contributed the target's assets to the other subsidiary (as in Example 2). Thus, given that the stock contribution and Y's election in both examples occur as part of the same plan, a knowledgeable federal tax practitioner might assume that the federal tax treatment of the transactions in Examples 1 and 2 should be the same. As discussed below, however, that may not necessarily be the case.
Exceptions: The IRS may assert that the liquidation-reincorporation doctrine does not apply to situations in which the liquidation occurs in a transaction that also qualifies as a reorganization under Sec. 368(a)(1). For example, in Rev. Rul. 69-617, the IRS examined the federal tax treatment of an acquisition by a parent corporation (P) of all the assets of its partially owned subsidiary (S1) in a statutory merger, followed by P's immediate transfer of all the assets received in the liquidation to a newly formed corporate subsidiary (S2) of P. Clearly, under the liquidation-reincorporation doctrine, the acquisition by P and subsequent transfer of S1's assets to $2 could have qualified as a reorganization in which S2 directly acquired all S1's assets. In the ruling, however, the IRS concludes that the merger of S1 into P qualifies as a reorganization under Sec. 368(a)(1)(A) (an A reorganization). The subsequent transfer of S1's assets to S2 was a transfer of assets The conveyance of something of value from one person, place, or situation to another.
The law recognizes that persons are generally entitled to transfer their assets to whomever they wish and for whatever reason. The most common means of transfer are wills, trusts, and gifts. acquired in the reorganization to a subsidiary controlled by P, as permitted under Sec. 368(a)(2)(C).
By way of background, Sec. 368 (a)(2)(C) provides that a transaction qualifying as a reorganization will not be disqualified dis·qual·i·fy
tr.v. dis·qual·i·fied, dis·qual·i·fy·ing, dis·qual·i·fies
a. To render unqualified or unfit.
b. To declare unqualified or ineligible.
2. solely because some or all of the assets acquired in the reorganization are transferred to a corporation that the acquiring company controls. One rationale rationale (rash´nal´),
n the fundamental reasons used as the basis for a decision or action. for the IRS's position in Rev. Rul. 69-617 may be that the mere existence of Sec. 368 (a) (2) (C) "stops" the step-transaction doctrine from recharacterizing an upstream From the consumer to the provider. See downstream.
(networking) upstream - Fewer network hops away from a backbone or hub. For example, a small ISP that connects to the Internet through a larger ISP that has their own connection to the backbone is downstream from the larger transaction that qualifies as a reorganization followed by a contribution of all the acquired assets in a Sec. 368(a)(2)(C) contribution.
Another possible rationale may be that the facts of this ruling state that the minority shareholders of S1 received P stock in the merger. Note that if the transaction is treated as an A reorganization, the receipt of the P stock is tax free to that minority. If, however, the overall transaction were tested as a D reorganization, the minority shareholders would have been taxed on the receipt of the P stock became P stock is not qualifying consideration in a D reorganization in which S2 acquires S1's assets. Perhaps the potential whipsaw Whipsaw
A condition where an investor's security transaction is quickly followed by an opposite reaction. Sometimes referred to as "being whipped".
An example would be buying a stock and, shortly after, the stock falls substantially in price. effect illustrated by the IRS's loss in King Enterprises, 418 F2d 511 (1969), earlier that same year influenced the ruling's outcome.
Repeal of the Bausch & Lomb Doctrine
The upstream transaction described in Rev. Rul. 69-617 qualified as a reorganization under Sec. 368(a)(1)(A) (an A reorganization) because it occurred under a state merger statute. In contrast, the deemed liquidation in Example 2, above, occurred as a result of a disregarded entity election and does not qualify as an A reorganization. But could it qualify as some other type of reorganization? The most likely candidate would be a Sec. 368(a)(1)(C) reorganization (a C reorganization), but historically that treatment would have been prevented by the Bausch & Lomb doctrine (see Bausch & Lomb Optical Co., 267 F2d 75 (2d Cir. 1959)).
For transactions occurring after December 31, 1999, however, Regs. Sec. 1.368-2(d)(4) repeals the Bausch & Lomb doctrine. Thus, an upstream liquidation of a wholly owned subsidiary into its parent (or deemed liquidation of a subsidiary as a result of a disregarded entity election) occurring after December 31, 1999, may qualify as a C reorganization. As discussed further below, if the deemed liquidation of Y into X in Example 2 qualifies as a C reorganization, the IRS may attempt to turn off the application of the liquidation-reincorporation doctrine and thus set up a potential disparity dis·par·i·ty
n. pl. dis·par·i·ties
1. The condition or fact of being unequal, as in age, rank, or degree; difference: "narrow the economic disparities among regions and industries" in the federal tax treatment of Examples 1 and 2.
Possible Federal Tax Treatment
Applying general principles of federal tax law, including the step-transaction doctrine, to the facts in Example 1, it is relatively clear that the integrated transaction should be treated as a D reorganization of Y into Z (see, e.g., Rev. Rul. 67-274). One would think that those same general principles of federal tax law should apply to integrate the transactions in Example 2, resulting in the same treatment as in Example 1. Nevertheless, the possibility that an upstream liquidation might qualify as a C reorganization under current law (if such treatment turns off the step-transaction doctrine) could have a profound effect on the treatment of the Example 2 transactions.
At this point, the reader may wonder why the X-Y-Z group in our examples would care whether the transactions in Example 2 are treated as a D reorganization or a C reorganization followed by a Sec. 368(a)(2)(C) contribution of assets. In either situation, the transactions are seemingly seem·ing
Outward appearance; semblance.
seeming·ly adv. tax flee flee
v. fled , flee·ing, flees
1. To run away, as from trouble or danger: fled from the house into the night.
2. to all the participants. Moreover, regardless of which characterization A rather long and fancy word for analyzing a system or process and measuring its "characteristics." For example, a Web characterization would yield the number of current sites on the Web, types of sites, annual growth, etc. applies, Z's basis in Y's assets will equal Y's basis in those assets immediately prior to the transactions.
There are, however, important differences in the consequences of the transactions, depending on which characterization applies. For example, because a Sec. 368(a)(2)(C) contribution is not a Sec. 381 transaction, the characterization of the transaction may affect the location of Y's federal tax attributes when the transaction dust has settled. Further, in the consolidated group context, there may be unexpected (and likely unintended) consequences to the group if there is a deferred gain with respect to X's stock in Y (see Regs. Sec. 1.150213(f)(5)(ii)(B)).
The differences could be even more profound in an international context. For instance, in Example 2, assume that X is a domestic corporation, while both Y and Z are foreign corporations. If the transactions in Example 2 are integrated and treated as a direct acquisition by Z of all the Yassets from Y, the transactions would be treated as a foreign-to-foreign D reorganization of Y into Z. On the facts described, that transaction should not give rise to income or gain recognition for any of the parties involved (see Regs. Sec. 1.367(b)-4(b)).
In contrast, if the transactions in Example 2 are treated as an upstream C reorganization in which X acquires all of Y's assets and then contributes them to Z in a permissible per·mis·si·ble
Permitted; allowable: permissible tax deductions; permissible behavior in school.
per·mis Sec. 368(a)(2)(C) contribution, the federal tax consequences are quite different. Specifically, the upstream C reorganization of Y (a foreign corporation) into X (a domestic corporation) would be a repatriation Repatriation
The process of converting a foreign currency into the currency of one's own country.
If you are American, converting British Pounds back to U.S. dollars is an example of repatriation. of foreign corporate assets in a nonrecognition transaction. As a result, under Regs. Sec. 1.367(b)-3(b)(3), X would be required to include in income as a deemed dividend the "all earnings and profits amount" (as defined in Pegs. Sec. 1.367(b)-2(d)) with respect to its stock in Y. Depending on certain factors, including but not limited to the length of X's ownership of Yand the profitability of Y during that period, that could result in a substantial income inclusion for X, even if there is little or no gain inherent in X's stock in Y.
In addition, the Sec. 368(a)(2)(C) contribution of Y's assets by X (a domestic entity) to Z (a foreign corporation) would be an outbound out·bound
Outward bound; headed away: outbound trains.
Adj. 1. outbound - that is going out or leaving; "the departing train"; "an outward journey"; "outward-bound ships" contribution of those assets subject to Sec. 367(a). Under that section, such a transfer will be completely taxable to X unless and to the extent that exceptions to the general recognition rule apply (e.g., the assets transferred are used in an active trade or business outside the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. or the assets transferred are stock and securities in a foreign corporation and a gain recognition agreement is filed). Depending on the amount of gain inherent in Y's assets (which amount would not be reduced by the all-earnings-and-profits inclusion occurring as a result of the upstream C reorganization), that Sec. 367(a) "toll charge" could result in a substantial amount of federal tax for X.
Which Treatment Should Apply?
In the author's view, the transactions in Example 2 (like those in Example 1) are better viewed as a D reorganization of Y into Z. First, there is no substantive Substantive may refer to:
Second, the liquidation-reincorporation doctrine developed out of a long line of arguments set forth by the IRS and adopted by the courts to recharacterize liquidations followed by reincorporations as D reorganizations--even when the transaction at issue did not satisfy the technical requirements for such treatment (see, e.g., Davant, 366 F2d 874 (5th Cir. 1966)). The apparent trend favoring favoring
an animal is said to be favoring a leg when it avoids putting all of its weight on the limb. A part of being lame in a limb. D reorganization treatment for asset transfers between related corporations is reflected in Sec. 368(a)(2)(A) (providing that a transaction that is both a C reorganization and a D reorganization is treated as a D reorganization, except for purposes of determining whether Sec. 368(a)(2)(C) applies).
Moreover, this preference for D reorganization treatment recently culminated in the IRS's issuing temporary regulations under which stock is deemed issued in certain transactions involving corporations held by the same shareholders, such that those transactions may qualify as D reorganizations even though no stock in the acquiring company is actually issued in the transactions (see Temp. Regs. Sec. 1.368-2T).
Further, in the international context, treatment of the transaction as an upstream C reorganization followed by a contribution appears incorrect from a policy perspective. Although the check-the-box regulations provide that the disregarded entity election gives rise to a deemed liquidation for federal tax purposes, in fact, Y's assets never leave the foreign jurisdiction. Because Y remains an actual legal entity under foreign law, a foreign entity actually continues to own those assets at all times. In such a situation, it would seem odd for the IRS to argue that the better treatment of the transactions is a deemed inbound in·bound 1
Bound inward; incoming: inbound commuter traffic.
Adj. 1. inbound transaction followed by a deemed outbound transaction, when a result more reflective Refers to light hitting an opaque surface such as a printed page or mirror and bouncing back. See reflective media and reflective LCD. of the actual circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or is available.
Finally, Sec. 368(a)(2)(C) was added to the Code to prevent the step-transaction doctrine from applying to convert a transaction otherwise qualifying as a reorganization into a taxable transaction Taxable transaction
Any transaction that is not tax-free to the parties involved, such as a taxable acquisition. solely as a result of a post-transaction shuffling of assets within a controlled group of corporations. This was done in response to the "remote continuity of interest" concerns presented by the Supreme Court's decisions in Groman, 302 US 82 (1937), and Bashford, 302 US 454 (1938). In contrast to that goal, applying Sec. 368(a)(2)(C) to prevent Example 2 from qualifying as a foreign-to-foreign D reorganization in the international context described above can, in certain situations, convert an otherwise tax-flee transaction into a taxable transaction--solely as a result of a poor or uninformed choice of an election's effective date. For these reasons, the deemed liquidation and the stock contribution occurring under the same plan should be treated as a D reorganization, regardless of the effective date of the election.
The Easy Fix
Notwithstanding the arguments above, it is possible that the IRS could assert that the transactions in Example 2 should be treated as an upstream C reorganization of Y into X followed by a Sec. 368(a)(2)(C) transfer by X of the former Y assets to Z. And, as discussed above, such an assertion (programming) assertion - 1. An expression which, if false, indicates an error. Assertions are used for debugging by catching can't happen errors.
2. In logic programming, a new fact or rule added to the database by the program at run time. could have a significant tax cost. If the parties want to avoid that characterization, however, Example 1 illustrates how that may be accomplished. Quite simply, Y should elect to be treated as a disregarded entity effective on the day after Z acquires all of Y's stock. In the international context described above, this ensures that Y's liquidation is treated as occurring when Z, a foreign corporation, is Y's sole owner. In such a situation it is relatively clear that the stock acquisition and the liquidation should be treated for federal tax purposes as a foreign-to-foreign D reorganization of Y directly into Z. Thus, the potential inbound and outbound transactions are avoided entirely.
FROM DEANNA Meaning of the name, Deanna.
Deanna, (pronounced DEE-anna or DEE-na) is a female first name of Latin and Old English origin.
In Latin origins, it means 'Divine', but in Old English, it means 'Girl From The Valley'. WALTON HARRIS Harris, Scotland: see Lewis and Harris. , J.D., LL.M LL.M Legum Magister (Master of Laws) ., WASHINGTON Washington, town, England
Washington, town (1991 pop. 48,856), Sunderland metropolitan district, NE England. Washington was designated one of the new towns in 1964 to alleviate overpopulation in the Tyneside-Wearside area. , DC