How to document a tax-free D reorganization with a split-off.

• Author: Drucker, Steve

In the past, a taxpayer could request an 1RS private letter ruling on whether a transaction qualifies for nonrecognition treatment under Sec. 355 or whether a transaction constitutes a reorganization under Sec. 368.To conserve 1RS resources, Rev. Proc. 2013-32 restricted the scope of letter rulings that address issues arising from Sec. 355 transactions and Sec. 368 reorganizations. Effective Aug. 23, 2013, the 1RS no longer rules on an entire transaction under Sec. 355 or a reorganization under Sec. 368.

Rev. Proc. 2016-3 contains the revised guidance for 2016 on 1RS no-rule areas. Section 3.01(50) of Rev. Proc. 2016-3 provides that the 1RS will still not issue a letter ruling about whether a transaction qualifies under Sec. 355 for nonrecognition treatment or whether it constitutes a corporate reorganization within the meaning of Sec. 368. In addition, Section 3.01(53) of Rev. Proc. 2016-3 continued the IRS's even longer-standing prohibition on rulings on the individual issues of whether a distribution has a corporate business purpose and that the transaction is not a device for purposes of Sec. 355. In August, in Rev. Proc. 2016-45, the 1RS modified Rev. Proc. 2016-3, Section 3.01(53), to remove the corporate business purpose and device issues from the no-rule list. However, the 1RS did not modify Section 3.01(50) of Rev. Proc. 2016-3 and will still not rule on whether the entire transaction qualifies for nonrecognition treatment under Sec. 355.

With Rev. Proc. 2016-3 in effect, taxpayers are unable to obtain a ruling on whether a Type D tax-free split-off reorganizations under Sec. 368(a)(1)(D) will receive nonrecognition treatment. Instead, if a transaction is challenged by the 1RS, a taxpayer must document in detail how it meets all the requirements of a split-off reorganization, including the control requirement, establishing that the transaction is not a device to distribute earnings and profits, and the active trade or business requirement, among others. To aid practitioners in documenting the requirements, following is an example of a Type D reorganization memorandum that includes a statement of facts, the reason for the memorandum, a statement of law, an analysis, a conclusion, and procedural matters exhibits. The memorandum is the backbone of the documentation, supplemented by supporting exhibits, for how a transaction qualifies for nonrecognition treatment.

Split-Off Type D Reorganization Memorandum

This memorandum is being completed on behalf of Corporation A. The memorandum details that its reorganization to split off part of the business meets all the requirements of a Type D tax-free reorganization under Sec. 368(a)(1)(D).

1. STATEMENT OF FACTS

   1. Taxpayer Information

      The Corporation's legal name is [legal name of corporation].

      The Corporation's address is [corporation's address] and its phone number is [phone number].

      The Corporation's taxpayer identification number is [corporation's TIN].

      The Corporation's tax year begins Jan. 1 and ends on Dec. 31.

      The Corporation is owned 50% by [owner 1] and 50% by [owner 2].

      The Corporation's method of accounting for maintaining the accounting books and filing its federal income tax return is cash.

   2. Description of Taxpayer's Business Operations

      Corporation A is a closely held corporation that was incorporated in the State of Iowa on Jan. 1, 1994. The business activity code number for Corporation A is 112210. The business activity of Corporation A is farming, and the product or service is hogs.

   3. Facts Relating to Transaction

      [Owner 1] and [owner 2] each own 50% of Corporation A. [Owner 1] and [owner 2] are brothers who have developed a difference in opinion on how the hog operation should be conducted. [Owner 2] is going to split off from Corporation A and start a new company, Corporation B Inc. ("Corporation B"). Both [owner 1] and [owner 2] believe the business would be more profitable and run more efficiently if the business were split off with each brother managing and operating his own company. This is the business purpose of the transaction. Corporation B will be in the same hog confinement business as Corporation A. The split of assets and liabilities between Corporation A and Corporation B is as follows as of closing on Dec. 31, 2015:

      Corporation A--

   1. Hog Confinement Building at [address 1]: Fair market value (FMV) of $500,000

   2. Tractor: FMV of $10,000

   3. Cash: FMV of $40,000

   4. Loan from [owner 2]: Loan Balance of $100,000

      Total Value Received: $650,000

      Corporation B--

   1. Hog Confinement Building at [address 2]: FMV of $650,000

      Total Value Received: $650,000

      The net value of assets and liabilities that Corporation B received is larger than the net value of assets and liabilities Corporation A received in the split off. A loan from Corporation B to Corporation A has been executed in the amount of $100,000 for the difference in values that Corporation B received compared to Corporation A.

      The split-off took place on Dec. 31, 2015, and is effective starting Jan. 1, 2016.

2. REASON FOR MEMORANDUM

   The memorandum is being completed for the following reason:

   1. Corporation A's business reorganization meets all the requirements of a Type D tax-free split-off reorganization under Sec. 368(a)(1)(D), and related tax authorities, including Treasury regulations, 1RS rulings, and court cases.

3. STATEMENT OF LAW

   This memorandum is based on the law and analysis set forth below. To the best of the taxpayer's knowledge, there is no pending legislation that may affect the issues and transactions discussed in this memorandum. Corporation A is not under a current or pending 1RS examination.

   Tax-Free Reorganization Under Sec. 368(a)(1)(D)

   1. Sec. 368(a)(1)(D) provides as follows:

      The term reorganization means--

      A transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including...