Acquisition of control of a C corporation by an S corporation.

• Author: Kempke, Robert E.

Since the repeal of the General Utilities doctrine, it is not uncommon for the selling shareholders of a C corporation to demand that a sale be structured as a stock transaction. This is typically the case when the outside basis of the stock is substantially in excess of the inside basis of the underlying assets. A significant double tax results if the selling corporation sells assets and subsequently distributes the proceeds in liquidation.

If the acquiror of the target stock is an S corporation, particular problems are raised with respect to the effect on the acquiror's S election and the taxability to the S shareholders on the distribution of the target's assets to the S corporation in complete liquidation.

Under Sec. 1361(b)(2)(A), an S corporation cannot be a member of an affiliated group of corporations, as defined in Sec. 1504(a), without regard to the exceptions in Sec. 1504(b). Obviously, the target must be liquidated immediately after the acquisition. Therefore, the first issue is whether the momentary ownership of the target stock violates the affiliated group test and will result in the termination of the acquiror's S election.

Sec. 1371(a)(1) provides that, except as otherwise provided and except to the extent inconsistent with subchapter S, subchapter C applies to an S corporation and its shareholders. Sec. 1371(a)(2) provides that, for subchapter C purposes, an S corporation in its capacity as a shareholder of another corporation is treated as an individual. Accordingly, if target stock is deemed to be held by an individual, the required liquidation of the target results in gain or loss recognition to the target under Sec. 336, to the extent the fair market value of the corporation's assets exceeds its tax basis. If the target stock is deemed to be held by a corporation, no gain or loss is recognized to the target under Secs. 332 and 337(a).

Recently, the IRS issued Letter Ruling (TAM) 9245004, which not only ruled favorably on both issues but also ruled that the purchase of the target stock was a "qualified stock purchase" under Sec...