United States

Watch your preliminary steps when exiting a business line


To exit a business line, preliminary steps may be necessary within a corporate group. Assets (and liabilities) of the business that will be transferred may need to be brought together under the ownership of one company in the group before that company is transferred to the acquirer (or to the shareholders). These preliminary steps should be approached with caution, as a recent IRS ruling (PLR 201633014) illustrates.

Spin off and merger of spun-off company

The corporate group receiving this ruling planned to distribute a business line (the Target Business) to its shareholders in a tax-free spin-off, after which the Target Business would merge into a subsidiary of an unrelated company.   

Preliminary steps: intra-group asset transfers

To ready the Target Business for the spin-off and merger, preliminary steps were needed to transfer the Target Business assets to the spun-off company. These steps raised tax issues that prompted the company to request a ruling from the IRS.  

The complex series of preliminary steps involved converting some corporate subsidiaries (Liquidated Corporations) to limited liability companies (LLCs), treated as a liquidation of each of these subsidiaries. Some of the assets formerly held by the Liquidated Corporations were then transferred to new subsidiaries (Recipient Corporations). Next, some of the Recipient Corporations, along with some other Target Business assets, were transferred to the company that would later be spun off and merged. 

Tax issue raised

The concern was that the transfer of assets to one or more Recipient Corporations would fall subject to the “liquidation-reincorporation” doctrine, under which a liquidation could instead be treated as the reorganization of a Liquidated Corporation as a Recipient Corporation. If this were to occur, the corporate group would not retain tax attributes of the liquidated corporation. These might include tax attributes needed for tax-free treatment of the subsequent spin-off (such as business history) or attributes desired for other tax purposes (such as net operating losses). 

The IRS provided a favorable ruling, holding that the liquidation-reincorporation doctrine would not apply. That ruling relied on the representation that there was no plan or intention to transfer to a Recipient Corporation more than 30 percent of the fair market value of any Liquidated Corporation’s gross assets.

This ruling is a good illustration of the significant tax issues often raised by preliminary structuring steps when exiting a business line. The ruling addressed a tax-free exit plan, but similar issues may arise when preparing for a business exit via taxable sale. In either scenario, the tax consequences of preliminary steps should be well-considered.

Stefan Gottschalk

Senior Director

Stefan guides businesses and their owners through M&A, corporate tax and financial instruments tax issues. Contact him at stefan.gottschalk@rsmus.com.

Areas of focus: Corporate TaxationMergers & AcquisitionsWashington National Tax