Continuity-of-interest requirement not affected by partnership's distribution of stock received in reorganization.

It has been a long-standing IRS position that the continuity-of-interest requirement is met only if the shareholders of the target corporation maintain a meaningful and definite ownership in the acquiring corporation. In Rev. Rul. 66-23, the Service suggested that five years of unrestricted ownership normally was sufficient to warrant a conclusion that continuity of interest existed on the part of the target shareholders through their ownership in the acquiring corporation. When the target shareholder is a partnership, it has been unclear whether the partners of the partnership could be viewed as the relevant target shareholders. If so, this would permit the partnership to distribute to the partners the acquiring corporation stock received in the reorganization in a nonliquidating distribution without violating the continuity-of-interest requirement.

In the Sec. 351 area, the IRS has issued Rev. Rul. 84-111, allowing a partnership-transferor to distribute to its partners the stock received from the transferee corporation without violating the control requirement of Sec. 351 (a). However, until the issuance of Rev. Rul. 95-69, there was no assurance that the Service would apply the rationale of Rev. Rul. 84-111 in a reorganization context. Similarly, while in Rev. Rul. 84-30 the IRS ruled that continuity was satisfied when a corporate shareholder of the target distributed the acquiring corporation stock to its sole corporate shareholder, there was no similar authority in the partnership context

In Rev. Rul. 95-69, a limited partnership owned all of the outstanding stock of X corporation. An unrelated individual held all of the outstanding stock of Y corporation. X merged into Y, with the partnership exchanging all of the X stock for Y stock. Immediately thereafter, the partnership made a nonliquidating distribution of Y stock to its partners in order to qualify Y as a small business corporation. Y then made an S election.

The IRS held that satisfaction of the continuity-of-interest requirement of Regs. Sec. 1.368-1 (b) was not affected by a partnership's distribution of stock received in a reorganization to its partners in accordance with their partnership interests. The Service concluded that the partners, the indirect owners of X enterprise, continued to own that enterprise through the Y stock held by the partnership. Accordingly, the partnership's distribution of that stock did not change that ownership and thus did not violate the continuity-of-interest requirement.

From Mark L. Yecies, J.D., and C.Y. Wang, CPA, Washington, D.C.