Converting Stock Sales to Assets Sales (and Back Again) S - - PowerPoint PPT Presentation
Converting Stock Sales to Assets Sales (and Back Again) S Corporation Committee ABA Section of Taxation May 12, 2017 Washington, D.C. Mary Beth Dolan, John S. Harper Bryan Cave, LLP Morrison & Foerster, LLP St. Louis, MO McLean, VA
*There are no safe paths in this part of the world. Remember you are over the Edge of the Wild now, and in for all sorts of fun wherever you go.” J.R.R. Tolkien
Target B Buyer 1 A C Section 338(h)(10) 80%+ purchased by single buyer Target B A C Buyer 2 Buyer 3 Section 336(e) 80%+ disposed by shareholders to any buyers §338 requires a single corporate purchaser of Target stock (or consolidated group acquirer) of at least 80% of Target. §336(e) permits any number and type of purchasers to be parties to stock dispositions that cumulate to at least an 80% disposition of Target stock. Overlap rule: §338(h)(10) takes priority if the transaction qualifies under both sections. Target stock Target stock
Old Target Buyer(s) New Target 1 Deemed assets sale Deemed consideration, including Buyer notes Treated for federal income tax purposes as if the sale of Old Target assets to New Target had actually occurred. Old Target treated as having received from New Target the consideration actually issued by Buyer(s) to the stockholders. Flow-through asset sale gain for state income tax purposes is generally sourced based on Old Target nexus factors. B A C 10 80 10
Old Target B A C 10 80 10 Deemed distribution in liquidation to shareholders, including any Buyer notes 2 All consideration paid by Buyer, including installment notes, are treated as if distributed by Old Target to shareholders, including installment notes issued by Buyer(s). Old Target has no gain on actual or deemed distributions of “qualifying installment obligations” via §453B(h). Shareholders treat consideration received from Buyer as if received for stock of Old Target in redemption of Old Target stock, per §453(h). Shareholders’ stock gain is gain from the sale of intangible assets, generally treated as income sourced to each shareholder’s state of residence.
Target B A C Actual asset sale Target B A C DRE deemed asset sale DRE Target assets DRE interests Consideration Consideration 1 1 2 Consideration distributed in liquidation 2 Consideration distributed in liquidation Actual or DRE asset sale is more flexible than §336(e) and §338(h)(10) qualification. Buyer
the shareholder receives (in exchange for the shareholder's stock) an installment obligation acquired [by the corporation] in respect of a sale or exchange by the corporation during the 12- month period beginning on the date a plan of complete liquidation is adopted and the liquidation is completed during such 12-month period, then, for purposes of this section, the receipt of payments under such obligation (but not the receipt of such obligation) by the shareholder shall be treated as the receipt of payment for the stock.
shareholder who receives the obligation, the obligation is treated as a payment in the year of the sale.
basis recovery first in a §331 liquidating distribution.
(1) an installment obligation is distributed by an S corporation in a complete liquidation, and (2) receipt of the obligation is not treated as payment for the stock by reason of section 453(h)(1), then, except for purposes of any tax imposed by subchapter S, no gain or loss with respect to the distribution
Under regulations prescribed by the Secretary, the character of the gain or loss to the shareholder shall be determined in accordance with the principles of section 1366(b).
stockholders (Codified in 1954 Code §§337 and 311)
maximizing the gross profit percentage.
This percentage is the amount of gain that is recognized on receipt of each installment payment.
level gain (i) accelerates shareholder income on the pass-through and (ii) increases shareholder stock basis above zero.
shareholder basis. Such deductions (e.g. compensation deductions, including option settlement payments) may not pass through to the shareholder anyway after basis is reduced to zero.
corresponding pass-through of that gain and stock basis increase.
trigger gain (for actual and DYI asset sales).
but does not increase the amount received by the shareholder in liquidation. Treas. Reg. §1.453-11(a)(4).
debt by a shareholder creates a deduction at the corporate level as if paid by the corporation.
10 80% FMV $8,000 Basis $1,200 10 Target B Buyer A C $10,000 purchase price 50% cash at closing and 50% note payable in 2018 100% Target stock Assets FMV $10,000 Basis $1,500 10% each FMV $1,000 Basis $150 80
$10,000 Deemed sale proceeds (cash and notes delivered to A, B and C) ($1,500) Less asset basis $8,500 Gross profit 85% Corporate gross profit percentage [$8,500 / $10,000] $5,000 Corporate deemed cash payment received $4,250 Corporate gain on deemed cash payment [85% x $5,000]
$1,200 Starting stock basis $3.400 Pass-through income [80% x $4,250] $4,600 Stock basis at liquidation $8,000 Contract price [$4,000 cash + $4,000 note] $3,400 Gross profit [$8,000 - $4,600] 43% Gross profit percentage [$3,400 / $8,000] $4,000 Closing cash payment received $1,700 Stock gain on cash payment [43% x $4,000] $1,700 Stock gain on cash payment $3.400 Pass-through income $5,100 A’s total 2017 income $8,000 A’s total amount realized $4,000 A’s closing payment received in 2017 50% A’s ratio of 2017 cash received to gain realized 75% A’s ratio of 2017 gross income to gain realized
Buyer Entire consideration in Buyer notes: $10,000 purchase price 50% payable in 2017 50% payable in 2018 100% Target stock Target has no installment sale gain reportable in the year of sale due to receipt of notes only. Target has no gain on deemed distribution of the notes in liquidation due to §453B(h). Shareholders have no pass-through income from the sale. 10 80% FMV $8,000 Basis $1,200 10 Target B A C 10% each FMV $1,000 Basis $150 80
Assets FMV $10,000 Basis $1,500
$1,200 Stock basis $8,000 Contract price [$8,000 note] $6,800 Gross profit [$8,000 - $1,200] 85% Gross profit percentage [$6,800 / $8,000] $4,000 Cash payment received in 2017 $3,400 Stock gain on cash payment [85% x $4,000] $3,400 Stock gain on cash payment $ 0 Pass-through income $3,400 A’s total 2017 income $8,000 A’s amount realized $6,800 A’s gain realized 50% A’s ratio of 2017 cash received to gain realized 50% A’s ratio of 2017 gross income to gain realized
B and C form Buyer to purchase A’s shares for an $8,000 note. On the same day, B and C contribute their Target stock to Buyer for Buyer stock. Buyer’s purchase from A is a QSP and the parties agree to make a §338(h)(10) election. 10 80% FMV $8,000 Basis $1,200 10 Target B Buyer A C $8,000 purchase price Entire consideration paid in one note: 50% payable in 2017 and 50% payable in 2018 10% each FMV $1,000 Basis $150 B C 50 50 80 80% Target stock for $8,000 Buyer note to A 20% Target stock for Buyer stock issued to B and C Target 100 1 2
$10,000 Deemed sale proceeds (note and grossed-up ADSP [($8,000 / 80%) - $8,000] ($1,500) Less asset basis $8,500 Gross profit 85% Corporate gross profit percentage [$8,500 / $10,000] $2,000 Corporate deemed cash payment received [grossed-up ADSP] $1,700 Corporate gain on deemed cash payment [85% x $2,000]
$1,200 Starting stock basis $1,360 Pass-through income [80% x $1,700] $2,560 Stock basis at liquidation $8,000 Contract price [$8,000 note] $5,440 Gross profit [$8,000 - $2,560] 68% Gross profit percentage [$5,440 / $8,000] $4,000 Cash payment received in 2017 $2,720 Stock gain on cash payment [68% x $4,000] $2,720 Stock gain on cash payment $1.360 Pass-through income $4,080 A’s 2017 income $8,000 A’s amount realized $4,080 A’s 2017 income 50% A’s ratio of 2017 cash received to gain realized 60% A’s ratio of 2017 gross income to gain realized
$150 Starting stock basis $170 Pass-through income [10% x $1,700] $320 Stock basis at liquidation $1,000 Payment received [deemed receipt of cash] $680 Gain on deemed cash payment $680 Stock gain on deemed cash payment $170 Pass-through income $850 B’s 2017 income $1,000 B’s amount realized $850 B’s 2017 income 85% B’s ratio of 2017 gain recognized to gain realized 85% B’s ratio of 2017 cash received to gain realized All of B’s gain in stock is recognized on closing due to combination of deemed receipt of the grossed-up portion of the ADSP at corporate level and deemed receipt of those cash proceeds as if then distributed to B in liquidation of Target. C’s gain computations are the same as B’s.
entirely avoid the defect in §453(h) because the deemed payment to the non-selling shareholders is required to be treated as cash received by Target, and some part of the resulting corporate level gain is allocated to the shareholder who receives solely installment obligations from the buyer.
A
B and C each sell their 10% stock interest to A for fair market value on an installment basis for notes of A. A sells 100% of the Target stock to Buyer, receiving a note from Buyer for 100% of the value of Target stock. Buyer’s purchase from A is a QSP and the parties agree to make a §338(h)(10) election. A B C Target 80 10 10
Target Buyer B C 50 50 100 100% Target stock Buyer’s note 1 2 20%Target stock A’s notes
from A to B and C be netted against the notes from B and C to A?
conduit sale by B and C to Buyer?
treated as boot in a §351 transaction and also violate the related party prohibition of §338 purchase definition (because “50% or more” ownership by B and C of Buyer causes §318 attribution between Buyer and B or C).
not avoided, because their stock in the hands of Buyer is nonrecently purchased stock.
the hands of Buyer?
asset sale between Target and New Target, it is acknowledged that §1239 does not apply to the sale between Target and New Target.
marketable stock rules where rules of §453(k) “otherwise would be avoided through the use of related parties, pass-thru entities, or intermediaries”.
Holdco B A C
Target (DRE) Buyer 80 10 10 80% interest in DRE Buyer note 1 2 A receives Buyer note in complete redemption
B C 50 50 Holdco B C Target (Pship) 50 3 50 Distribution of 20% interest in Pship to B and C in redemption A, B and C form Holdco and make an S election for Holdco. A, B and C then each contribute their shares of Target to Holdco. Holdco makes a Q-Sub election for Oldco and converts Holdco to a single-member LLC (DRE). Holdco sells 80% of its interest in DRE to Buyer (owned 50/50 by B and C) in exchange for a note payable to Holdco by Buyer. Because DRE is a disregarded entity with respect to Holdco, the sale of a DRE membership interest to Buyer is a deemed sale of 80% of the DRE assets to Buyer, followed by an asset contribution to Target as a partnership. Pursuant to a plan of liquidation, A receives the Buyer note in complete redemption of his stock under §453(h). Within the 12-month liquidation period, the remaining 20% of Target as a partnership must be distributed from Holdco to B and C (assume a closing of the books to allocate all §336 gain to B and C only if distribution is made in the same taxable year of Holdco). 80% 20%
exchanged by the shareholders at the shareholder level?
actually received by each shareholder.
combined 20% (not “more than 50%”) of Holdco before the sale of assets by Holdco to Buyer.
because neither B nor C would own “more than 50%” of Holdco at the time of the distribution. Gain of Holdco on the distribution would pass through to B and C and basis in the 20% underlying property would be increased to FMV.
than 50% of the stock of each of Holdco and Buyer are owned by the “same persons” per §267(b)(11). This results in immediate ordinary income and prevents use of installment sale treatment by Holdco.
Buyer and Holdco?
Target A B C 80 10 10 Redemption
exchange for Target notes 1 Target A 80 (100%) Buyer $8,000 Buyer note Target stock B C 50 50 2 Target redeems all of the stock of B and C in exchange for notes in the amount of $1,000 each. See Treas. Reg. §1.338-3(b)(5). A becomes the sole owner of Target, and sells 100% of the stock of Target to Buyer for $8,000 in Buyer debt. ADSP is amount paid for A’s Target stock plus internal debt of Target = $10,000. In the installment sale, assumed debt of Target is offset against basis in Target assets, yielding an $800 deemed payment to Target in the year of sale. A recognizes pass-through gain of $800 using a closing of books allocation. Remainder of A’s gain is recognized when payments are made on Buyer’s note.
Target 100
Target notes payable to B and C
10 80% FMV $8,000 Basis $1,200 10 Target B Buyer A C $8,000 purchase price in a Buyer note 50% payable in 2017, and 50% payable in 2018 Asset basis = $1,500 10% each FMV $1,000 Basis $150 B and C form Buyer to purchase A’s shares for an $8,000 note. On the same day as the purchase from A, B and C contribute their Target stock to Buyer for Buyer stock. Buyer’s purchase from A is a QSP and the parties agree to make a §338(h)(10) election. Target’s sole asset is depreciable equipment with a basis of $1,500. Target has taken $1,500 in depreciation deductions (all constitutes §1245 recapture). B C 50 50 80 80% Target stock for $8,000 Buyer note to A 20% Target stock for Buyer stock to B and C
$10,000 Deemed sale proceeds (note and grossed-up ADSP [($8,000 / 80%) - $8,000]) $1,500 Less asset basis (reduced but not below zero by assumed debt) $1,500 Less recapture income $7,000 Gross profit (installment sale gross profit is reduced by accelerated recapture income) 70% Corporate gross profit percentage [$7,000 / $10,000] $2,000 Corporate deemed cash payment received [grossed-up ADSP] $1,400 Corporate gain on deemed cash payment [70% x $2,000] $2,900 Total pass-through income [$1,400 + $1,500 from recapture]
$1,200 Starting stock basis $2,320 Pass-through income [80% x $2,900] $3,520 Stock basis at liquidation $8,000 Contract price [$8,000 note] $4,480 Gross profit [$8,000 - $3,520] 56% Gross profit percentage [$4,480 / $8,000] $4,000 Payment received $2,240 Gain on cash payment [56% x $4,000] $2,320 Gain on cash payment $2,240 Pass-through income $4,560 A’s 2017 income $8,000 A’s amount realized $4,080 A’s 2017 income 50% A’s ratio of 2017 cash received to gain realized 67% A’s ratio of 2017 gross income to gain realized (approximate)
*Never laugh at live dragons . . . You aren't nearly through this adventure yet . . . J.R.R. Tolkien
Pass-through entity status follows federal provisions such as S status.
Corporate taxable income starts with federal income, subject to specified adjustments.
Corporate level income apportioned and allocated (under same rules applicable to C corporations).
sales factor only, and market source allocation etc.).
income.
Pass-through of apportioned income for each state is taken into account by shareholders.
shareholder is not resident.
satisfies the nonresidents’ tax liability and filing obligation.
so that authority to collect tax from non-residents without presence in the jurisdiction is backed- stopped by corporate level liability. Gain from the sale of intangible personal property (such as stock) is typically allocated to the state of residence of the owner of the property. Under these general principles, unless otherwise specified by state tax law:
allocated and taxed only in the shareholder’s state of residence.
among the states in which the corporation conducts business.
made on the asset sale.
consideration for the sale of stock (but not from the note issuer but from the liquidating corporation, in a redemption of stock).
Definition of a pass-through entity [Va. Code Ann. §58.1-390.1]. Tax liability of owners of pass-through entities [Va. Code Ann. §58.1-390.2]. S corporation withholding on income allocated to non-resident owners [Va. Code Ann. §58.1-486.2].
58.1-421].
allocable to nonresident owners [Va. Code Ann. §58.1-395].
No specific Virginia authority on taxation of gain from sale of intangible personal property.
personal property to the extent that such income is from property employed by the taxpayer in a business, trade, profession, or occupation carried on in Virginia [Va. Code Ann. §58.1-302].
Commonwealth of Virginia, Department of Taxation, Dockets CL06-5696 CL06-6291 [Va. Cir. Ct., 06/22/2007].
All corporations (including S corporation) subject to tax on “taxable income” in the form of a corporate franchise tax. [D.C. Code §47-1807.02] "Taxable income” is defined as “the amount of net income derived from sources within the District within the meaning of §§47-1810.01 to 47-1810.03.” [D.C. Code §47-1807.01(2)] “Net income" means the gross income of a taxpayer less the deductions allowed by this chapter.” [D.C. Code §47-1803.01] “Gross income" has the “same meaning as defined in §61 of the Internal Revenue Code of 1986.” [D.C. Code §47-1803.01] Installment sale conformity mandated by DC law: “If a person reports any portion of his income from installment sales for federal income tax purposes under §453 of the Internal Revenue Code of 1986 . . . he may report such income under this chapter in the same manner and upon the same basis as the same was reported by him for federal income tax purposes, if such method of reporting is accepted and approved by the Commissioner of Internal Revenue.” [D.C. Code §47-1804.04] Touchstone Consulting Group Inc. v DC Office of Tax and Revenue (Office of Administrative Hearings, 2010- OTR-00007, 4/27/2011)
delivered and payable directly to nonresident shareholders in a §338(h)(10) transaction
did not recognize gain on the deemed distribution of the notes under §453B(h)
ended on the closing date.
Pre-GU repeal, there was §337 conformity, so that gain on liquidation sales was not included in corporate taxable income. Letter of Deputy Commissioner for Legal Affairs, New York City Department of Revenue (August 6, 1984). 2009 – FIRPTA-like tax imposed on stock gains arising from closely-held corporations. If assets are least 50% NY real estate, the tax applies to Individuals gain on sale of interest in flow-through entities and non-publicly traded C corporations with 100 or fewer shareholders is treated as NY source based on ratio of value of NY real estate to total assets. [NYTL §631(b)(1)(A)(1); TSB-M-09(5)I (May 5, 2009)] Matter of Baum, NY Tax Appeals Tribunal, Dkt. No. 820837 (2/12/2009), affirming, New York Division of Tax Appeals (12/20/2007). (S corp pass-through gain apportioned to NY; resulting stock loss on liquidation not apportioned to NY, even though pass-through gain was apportioned to NY; on disallowance of the stock loss, taxpayers challenged the inclusion of deemed sale gain in their return by apportionment. Held no deemed corporate level gain existed for NY purposes that was available to apportion to the stockholders; thus allowance of loss not relevant.) Matter of Myron Mintz, NY Division of Tax Appeals, Dkt. No. 821807 (06/04/2009). (Shareholder’s installment gain in January 2009 per §453(h) after December 2008 sale of S corporation assets for note that distributed under §453B(h) was not NY source income; last sentence of §453B(h) referring to “character” of income does not affect “source” of income as stock gain.)
terminates taxable status in NY, and will pass-through to the shareholders sourced to NY based on corporate level apportionment factors for year of sale.
to extent determined on corporate level apportionment factors for year of sale (reversing Baum).
received is treated as NY source income based on corporate level apportionment factors for year of sale (reversing Mintz).
gain, is allocated to shareholders state of residence, is not apportioned (consistent with Tax Dept. assertion in Baum that the stock loss was not allowable to offset the pass-through gain): “For purposes of a section 338(h)(10) election, when a nonresident shareholder exchanges his or her S corporation stock as part of the deemed liquidation, any gain or loss recognized shall be treated as the disposition of an intangible asset and will not increase or offset any gain recognized on the deemed assets sale as a result of the section 338( h)( 10) election.”
intangible personal property sourced to the state of residence of the partner: “an IRC § 1060 election allows the seller to consider the transaction to be the sale of an intangible interest, which is non-taxable, while the buyer considers the transaction to be the purchase of an asset, which is taxable.”
S corporations are subject to California franchise and income taxes [Ann.Cal.Rev.&T. Code § 23802]. Sections 453, 453A and 453B of the Internal Revenue Code apply except as otherwise provided [Ann.Cal.Rev.&T. Code § 24667]. Installment gain of corporation is accelerated on cessation of business in in California [Ann.Cal.Rev.&T. Code § 24672]. In the Matter of the Appeal of: West Valley Land Management Co. and Marvin Malmuth and Edwin Malmuth, California State Board of Equalization, No. 91A-0302 (8/2/1995). (Cal.Rev. & T. Code § 24667 permitting application of § 453B(h) does not preclude application of Cal.Rev.&T. Code §24672 to accelerate gain at corporate level on uncollected installment obligations.) Appeal of Thompson K. Vodrey, California State Board of Equalization, Case No. 258566 (9/1/2005) (Distribution of installment obligations by S corporation more than 12 months after adoption of plan of liquidation resulted in inclusion in income of all installment sale gain at the corporate level upon distribution and immediate taxation to stockholders on pass-through basis.)
In the Matter of the Appeal of: Jincan Guo and Wei Huang; and Guo Technologies Co., California State Board of Equalization, Case Nos. 511289 and 511297 (1/11/2012).
reported by shareholder as collected under §453B(h). Resident shareholder reported no pass- through income from the corporation’s receipt of the cash at closing.
installment receivables for 2006 tax under Cal.Rev.&T. Code §24672 for purposes of the 1.5% corporate level tax, and (2) whether the shareholder must include pass-through gain on cash paid at closing?
California corporate level tax on gain recognized by the corporation and is not an acceleration of installment note to increase pass-through gain to the shareholder, as well as dilution of installment reporting due to cash received by corporation at closing. California Franchise Tax Board Internal Procedures Manual Ch. 16.9(d) (2007):
decided at the shareholder level, following Personal Income Tax law. Therefore, non-California resident individual shareholders report the gain/loss on deemed liquidating distributions to the state they live in, not to California.”
recognition was used to report income, the character of the gain/loss reportable by the non-resident shareholders on installment payments should be determined pursuant to IRC §453B(h)(1) and (2) and IRC §1366(b).”
year period prior to sale of such entity shall apportion income (including gain or loss realized from sale, exchange or other disposition of an interest in the entity) using certain property, payroll and sales factors for the current and preceding two taxable years for business income, and situs for non-business income. [Ohio R.C. 5747.212]
income of the business such that it may be taxed in Ohio, even if the taxpayer subject to such tax is a nonresident, nondomiciliary of Ohio.
Ohio’s connection is an indirect one.”
process reasons: Ohio’s connection was to the intangible property that was being transferred, not the taxpayer, so Ohio did not have jurisdiction over the income from such sale.
profits is treated as a dividend of retained earnings or a distribution of the shareholders’ distributive share of S corporation income.
distributive shares. The dividend is considered nonbusiness income that may be entirely allocated outside of Ohio.
the state. However, a concurrence argued that Corrigan should be overruled and decided based
and involvement with the business were irrelevant.
1981]
interest in a business was sold and caused the basis in the assets to increase for federal income tax purposes, the business was required to add the basis increase to gross business profits (creating a “phantom tax.”) [RSA 77-A:4, XIV before S.B. 342]
added back to income and gain or loss is reported on sale of property by excluding unrecovered
transaction that increased the basis in the assets for federal income tax purposes. If this election is made:
the basis of all assets transferred or sold during the tax period in which the sale or exchange of an interest in the entity took place; and
increase in basis, and gain or loss upon sale or disposition of assets takes into account the basis increase. [RSA 77-A:4 XIV(b)] New law is colloquially known as the “Planet Fitness Tax” because the change arose when Planet Fitness threatened to move its corporate headquarters from NH if an exception to prior law was not granted around its IPO.
In re Lambert, 1998 WL352173 (ED La 1998), affd 179 F3d 281 (5th Cir 1999) -- Sale of land located in Mississippi by S corporation owned by nonresident, in exchange for installment notes distributed under section §453B(h) and §453(h); gain reportable by shareholder on collection of the note not apportioned to Mississippi. Prince v. State Dept. of Revenue, 55 So.3d 273 (Ala. 2010) – Pass-through gain on sale of S corporation stock with a §338(h)(10) election was treated income from a sale of assets, so that gain allocable to a nonresident shareholder was apportionable based on activities of the corporation. Illinois Dept. of Rev. General Information Letter IT 07-0017-GIL (4/13/2007) -- In §338(h)(10) sale, no gain is recognized by S corporation deemed distribution of installment obligations under §453B(h) for Illinois replacement tax purposes. Illinois Dept. of Rev. General Information Letter IT 09-0033-GIL (09/28/2009) -- Nonresident stockholder’s gain from sale of stock of an S corporation doing business in Illinois not apportioned to Illinois because the stockholder was not doing business in Illinois. “It is remarkable to me that the due process clause limitations on the imposition of income tax on general partners, limited partners, and managing or non-managing limited liability company members are so poorly defined, given that more than 50 percent of all earnings in this country flow through one or more passthrough entities.” Nexus Over Nonresident Partners or Members, Clark R. Calhoun, State Tax Notes Today, Tax Notes Doc 2016-51288 (1/3/2017).
“His head was swimming, and he was far from certain even of the direction they had been going in . . . He guessed as well as he could, and crawled along for a good way, till suddenly his hand met what felt like a tiny ring of cold metal lying on the floor of the tunnel. It was a turning point in his career, but he did not know it. He put the ring in his pocket almost without thinking; certainly it did not seem of any particular use at the moment.” J.R.R. Tolkien