Triple Drop and Check

Sounds like an ice hockey term, but this is a tax blog so don’t get your hopes up.

Parent corporation owns all the stock of subsidiary 1, which owns all the stock of subsidiary 2, which owns all the stock of subsidiary 3. Parent corporation also owns 100% of an LLC that had elected to be taxed as a corporation.

Parent corporation will transfer all of its interests in the LLC to subsidiary 1, which will transfer it to subsidiary 2, which will transfer it to subsidiary 3 (with stock issued to the transferor by the transferee at each step). After it is in subsidiary 3 a check-the-box election will be filed to treat the LLC as a disregarded entity. Hence the name – triple drop and check [the box].

How should this be taxed – as 3 successive Section 351 transfers, followed by a Section 332 deemed liquidation of the corporate LLC in subsidiary 3 upon the check-the-box election? No, says the IRS, in Rev.Rul. 2015-10. Instead, this is two Section 351 transfers. Then, the transfer from subsidiary 2 to subsidiary 3 is not a third Section 351 transfer, but is a ‘D’ reorganization. Does it matter? In many circumstances, the same tax results may apply. But Section 351 and the reorganization provisions can yield different results as to income and basis, so proper characterization may be important.

The IRS relied on Rev. Rul. 67-274. In that ruling, the IRS ruled that an acquisition by a corporation of stock of another corporation with its own stock followed by a liquidation of the acquired corporation should be treated as a ‘C’ reorganization. Because the stock of the new subsidiary was not acquired from a third party, a ‘D’ reorganization instead of a ‘C’ reorganization fits the bill in Rev.Rul. 2015-10, but the same general reorganization characterization from Rev. Rul. 67-274 applies here by analogy.

It is not material that there were three drops here. If there had only been one transfer of the LLC to subsidiary 1 followed by a check-the-box of the LLC to become a disregarded entity, the same ‘D’ reorganization treatment should again apply (this time at the subsidiary 1 level).

Rev.Rul. 2015-10