Sec. 357(c) and single-member LLCs or QSSSs.

• Author: Luchs, Lorin D.
• Position: Internal Revenue Code s. 357(c - Brief Article

Sec. 357(c) provides an exception to gain nonrecognition in certain types of otherwise tax-free property transfers, such as Sec. 351 property transfers and D reorganizations (including acquisitive Ds in conjunction with Sec. 354). If Sec. 357(c) applies, it requires the transferor of property to recognize gain, to the extent the liabilities assumed plus the liabilities to which the property transferred is subject exceed the basis of the property transferred.

Sec. 357(c) also operates as a trap for the unwary. A merger of a corporation into a brother-sister corporation or a downstream merger of a parent corporation into a subsidiary may be a D reorganization (in addition to being an A reorganization); accordingly, Sec. 357(c) may apply.

The Sec. 357(c) "trap" may now have been expanded by the introduction into the tax law of the elective treatment of single-member limited liability companies (LLCs) under the "check-the-box" regulations and qualified subchapter S subsidiaries (QSSSs). If a single-member LLC chooses to be disregarded as an entity separate from its owner or an S corporation makes a QSSS election for an eligible subsidiary, the LLC or QSSS is treated as having distributed all of its assets and liabilities to its owner in liquidation; see Prop. Regs. Sec. 301.7701-3(g)(1)(iii) and the House Committee Report to the Small Business job Protection Act of 1996. If an existing C or S corporation acquires in a tax-free acquisition the entire membership interest of an LLC, which then elects to be disregarded as an entity separate from its owner, or if an existing S corporation acquires all of the outstanding stock of a C or S corporation in a tax-free acquisition and makes a QSSS election for the acquired corporation, under the step-transaction doctrine the acquisition of the entity followed by the...