Alternative disposition technique using sec. 338(h) (10).

• Author: Baldarsaro, P. Michael

Under certain circumstances, Sec. 355 permits a corporation to distribute the stock of a controlled subsidiary to one or more of its shareholders without tax to either the distributing corporation or the shareholder(s). A technical requirement under Sec. 355 is that the shareholders of the parties must not have a plan or intention to dispose of the stock of either corporation after the distribution. Additionally, the Sec. 355 regulations impose the concept of historic shareholder continuity on Sec. 355 distributions. As a result, it has been difficult to use Sec. 355 to retain a second-tier subsidiary or any other assets of a first-tier subsidiary when the first-tier subsidiary is being sold in a taxable transaction.

Under Sec. 338(h)(10), a corporate seller of a consolidated subsidiary and the corporate purchaser of that subsidiary may jointly elect to treat the stock sale as an asset sale for federal income tax purposes. If such an election is made, the subsidiary is treated as if it sold all its assets for the grossed-up purchase price or fair market value, followed by a tax-free liquidation of the subsidiary into its selling parent under Sec. 332. The selling consolidated group recognizes the gain on the deemed sale of assets in its consolidated return for the year of the transaction. In turn, the subsidiary's assets take a stepped-up basis when the subsidiary becomes affiliated with its new corporate purchaser.

Letter rulings

IRS Letter Rulings 8938036 and 9044063 provide a road map for a planning technique under which the results of a "busted" spinoff under Sec. 355 can be achieved using Sec. 338(h)(10) without generating a tax on a presale intracorporate restructuring. Under the appropriate circumstances, careful planning can result in substantial tax savings to corporate taxpayers that wish to dispose of a first-tier subsidiary in a taxable transaction, but desire to retain one or more second-tier subsidiaries or other assets of the first-tier subsidiary.

Both of these letter rulings involve situations in which a Sec. 338(h)(10) election was going to be made by the respective parties. In each situation, a first-tier subsidiary adopted a complete plan of liquidation under Sec. 332 before the sale of the stock of the first-tier subsidiary or any presale distributions. Immediately before (or concurrently with) the stock sale, the first-tier subsidiary distributed to the selling corporation, among other assets, the stock of a...