LIABILITIES IN EXCESS OF BASIS NOT A PROBLEM IN SOME SECTION 351 TRANSACTIONS

Under Code Section 351, taxpayers generally do not recognize gain or loss when they transfer assets to a corporation in exchange for control of the corporation. An important exception to this rule is Code Section 357(c)(1), which provides that if the transferee corporation assumes liabilities of the transferor in excess of the adjusted basis of the transferred assets, the transferor recognizes gain to that extent.

At times, a Code Section 351 transaction can also qualify as an acquisitive 'D' reorganization under Code Section 368(a)(1)(D). That provision generally allows for the acquisition of assets of one corporation by another commonly controlled corporation in exchange for stock of the acquiring corporation. Thus, when there is a transfer between commonly controlled corporations the transfer can constitute both a Section 351 transfer and a 'D' reorganization.

Previously, 'D' reorganizations were subject to the same gain recognition rule under Section 357(c) for liabilities in excess of basis as Section 351 transfers. However, under the American Jobs Creation Act of 2004, 'D' reorganizations are now NOT subject to Section 357(c). So what happens if the acquiring corporation assumes liabilities of the transferring corporation as part of the transaction that are in excess of the adjusted basis of the transferred assets when the transaction qualifies both under Section 351 and a 'D' reorganization? This issue was recently addressed in Revenue Ruling 2007-8.

Under the Revenue Ruling, the IRS concludes that Section 357(c) will not apply, per 'D' reorganizations not being subject to it (even though Section 351 transfers are subject to it). It also noted that an overlap can exist between a 'G' reorganization and a Section 351 transfer, and that Section 357(c) will not be applied in that situation either.

Why did Congress change the law in 2004 to exclude 'D' reorganizations from the reach of Section 357(c)? The Ruling advises that this was done because in such transactions the transferor ceases to exist and cannot be enriched by the assumption of its liabilities. It further shows that the amendment was made to conform the treatment of 'D' acquisitive reorganizations to the treatment of other acquisitive reorganizations.

Rev. Rul. 2007-8, 2007-7 IRB

SOME SURPRISING RULES FOR INHERITED IRA’S

A few months ago, we discussed how the Pension Protection Act of 2006 provides for the use of “inherited IRA” accounts for the receipt of nonspousal qualified plan assets at the death of a participant. See MORE DETAILS ON NONSPOUSAL ROLLOVER OF INHERITED QUALIFIED PLANS (click on the link and read the August 29, 2006 entry). As noted, a primary purpose of the new option was to allow nonspousal qualified plan recipients to have certain available deferred payout options even if the plan itself did not specifically allow for them – such payout options are available if the proceeds are placed into a qualified “inherited IRA.”

The IRS has now issued guidance on inherited IRA accounts, and there are some unexpected provisions. These include:

·A qualified plan IS NOT required to allow for distribution to an inherited IRA. This appears to contradict the expressed purpose of the changes in the law, which was to make the deferred payout arrangements available to all nonspousal beneficiaries regardless of the provisions of the qualified plan from which the proceeds would be paid. We can expect some vocal opposition to the IRS’ interpretation of the new law in this regard.

·If the qualified plan provides for a 5 year payout of benefits to nonspousal beneficiaries if the participant dies before the “required beginning date,” the inherited IRA is also stuck with that 5 year payout rate instead of being able to use the life expectancy of the beneficiary.

·The IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”

·If a qualified plan does offer the inherited IRA rollover option, but not to all participants, it must offer them in a nondiscriminatory manner.

·If the decedent was required to take a required minimum distribution (RMD) before he died but did not, that RMD portion cannot be rolled over to the inherited IRA.

Notice 2007-7, 2007-5 IRB ; IR 2007-7

14.4% ESTATE TAX DISCOUNT UNDER DRIBBLE-OUT METHOD

Shares of stock, like other assets, are subject to estate tax based on fair market valuation at the date of death (or six months after using alternate valuation rules). If the stock is publicly traded, the value is easily determined based on the trading values on the date of death or the alternate valuation date.

At times, a decedent may own shares in a publicly traded corporation, but his or her shares are not registered for public sale. Further, the shares may be owned by affiliates of the public company, triggering Rule 144 restrictions on resale. In these situations, a discount off of the trading values for the shares is appropriate. Such cases may degenerate into a "battle of the experts" between the IRS and the estate to determine what appropriate valuation methodology and discount applies.

Such a battle occurred in the recent case of Estate of Georgina T. Gimbel, et al. v. Comm., TC Memo 2006-270 (12/19/2006). In the case, the decedent's shares were both unregistered and subject to Rule 144 resale restrictions. The Tax Court made some interesting observations and conclusions in arriving at a final value:

1. The Court found that the "dribble-out" method of valuation applied to a number of the shares. This method is based on Rule 144 restrictions, which limit the number of shares of restricted stock that can be sold in any 3 month period. The maximum number of shares that can be sold is the greater of 1 percent of the outstanding class of stock to be sold or the average weekly trading volume for the previous 4 weeks. In the case, this formula when applied meant that it would take at least 39 months to sell all of the decedent's shares. The dribble-out method applies time value of money discounting principles and risk of loss due to value fluctuations, to discount value for the required delay if it was desired to sell the shares. The Court found that a 14.4-percent discount from the valuation date trading value was appropriate.

2. In factoring in that the shares were not registered for public sale, the Court considered the likelihood (or actually, the unlikelihood) that the company would register the shares for sale.

3. Another factor in accounting for the nonregistered nature of the shares was the likelihood that the subject shares could be sold "unregistered" in a private placement.

4. Another valuation factor was the likelihood that the issuer of the shares would repurchase the shares from the successor owners.