Transfer of Stock in Newly Formed Corporation to Newly Formed Partnership Does Not Taint Tax-Free Exchange

02.13.2015

The Internal Revenue Service (IRS) has just released a private letter ruling on February 11, 2015, that confirms that the subsequent transfer of stock to a partnership does not cause the original contribution to fail to qualify as a non-taxable transfer to a controlled corporation under Section 351(a) of the Internal Revenue Code of 1986, as amended (the Code).  This private letter ruling is consistent with Rev. Rul. 2003-51, 2003-21 IRB 938, where the IRS ruled that an exchange that qualified under Section 351(a) was not disqualified by the subsequent transfer of the stock to another corporation in a non-taxable disposition, where the transferors retained a continuing interest in the property transferred to the corporation.  The private letter ruling makes clear that certain properly structured subsequent transfers of stock can be accomplished without tainting the original 351(a) transaction.

Background

Under the Code, no gain or loss is recognize when property is transferred to a corporation solely in exchange for stock of that corporation and immediately after the transfer the transferor(s) are in control of the corporation.  Section 351(a) of the Code.  Control means ownership of stock possessing (i) at least 80 percent of the total combined voting power of all classes of stock entitled to vote,  and (ii) at least 80 percent of the total number of share of all other classes of stock of the corporation.  Section 368(c).  The control requirement is not satisfied if, under a binding agreement entered into by the transferor(s), the transferor(s) lose control of the corporation to a third party that did not also transfer property to the corporation in the original transfer that was intended to qualify under Section 351(a).  See Klein on the Square (2nd. Cir. 1951) and Hazeltine Corp. (3rd Circ. 1937).

Facts

Partnership A formed Corporation A, which is regulated as a life and health insurer and treated as an insurance company for federal income tax purposes.  Partnership A contributed cash and Corporation A and New Investors contributed appreciated assets to Corporation C solely in exchange for stock of Corporation C.  Partnership A, Corporation A and the New Investors were collectively in “control” of Corporation C within the meaning of Section 368(c) upon the transfer of the cash and assets in exchange for the stock of Corporation C.

Pursuant to a pre-existing and binding plan, Partnership A, Corporation A and the New Investors contributed their stock in Corporation C to newly-formed Partnership B in exchange for Partnership B Units.  The contribution of the Corporation C stock to Partnership B qualified as a non-taxable contribution to a partnership under Section 721(a) of the Code.

IRS Ruling

The IRS ruled in Private Letter Ruling 201506008 (02/06/2015) that  the transfer of assets by Partnership A, Corporation A and the New Investors (collectively, the Corporation C Shareholders) in exchange for Corporation C stock (the Corporation Contribution) constitutes a transfer of property to a controlled corporation that meets the requirements of Section 351(a) of the Code and that,  therefore, no gain or loss is recognized by the Corporation C Shareholders or Corporation C.  Further, the IRS stated that the subsequent transfer of the Corporation C stock received by the Corporation C Shareholders to Partnership B does not cause the Corporation C Contribution to fail to qualify as a nontaxable transfer to a controlled corporation under Section351(a).

This private letter ruling by the IRS adds to the quiver of tools tax advisors can use when structuring transactions, such as joint ventures, that  taxpayers may consider in connection with a transaction that implicates Section 351(a) of the Code.