On May 5, the IRS issued a revenue ruling ( Rev. Rul. 2015-10) along with Rev. Rul. 2015-09, which held that three successive contributions made by a limited liability company (LLC) to each of three subsidiaries in a vertical chain — followed by a check-the-box election to treat the LLC, which was classified as an association, as a disregarded entity — is more properly characterized under step transaction principles as two Section 351 transactions followed by a reorganization under Section 368(a)(1)(D).

In Rev. Rul. 2015-10, a domestic corporation (P) owned all the outstanding interests in a limited liability company that was treated as an association and taxed as an LLC and all the outstanding stock of a domestic corporation (S1). S1 owned all the stock of a domestic corporation (S2), and S2 owned all the stock of a domestic corporation (S3). S3, in turn, owned all the stock of a domestic corporation (S4). P, S1, S2 and S3 were holding companies. For valid business purposes and as part of a plan, P, S1, S2, and S3 entered into the following transactions:

  • P transferred all of the interests in LLC to S1 in exchange for additional shares of voting common stock of S1 (the first drop).
  • S1 transferred all of the interests in LLC to S2 in exchange for additional shares of voting common stock of S2 (the second drop).
  • S2 transferred all of the interests in LLC to S3 in exchange for additional shares of voting common stock of S3 (the third drop).
  • LLC made an election under Treas. Reg. Sec. 301.7701-3(c) to be disregarded as an entity separate from its owner, effective no sooner than one day after the third drop (the check).

A transfer of property may be treated as a Section 351 transaction even if it is followed by subsequent transfers of the property as part of a prearranged, integrated plan. (For example, see Rev. Rul. 77-449 and Rev. Rul. 83-34.) Under step transaction principles, however, a transfer of property that otherwise meets the definition of a Section 351 transaction won't qualify under Section 351 if a different treatment is warranted to reflect the substance of the transaction as a whole. (For example, see Rev. Rul. 54-96 and Rev. Rul. 70-140.)

The IRS ruled that the first drop and the second drop satisfied the formal requirements of Section 351 and that an analysis of the transaction as a whole doesn't dictate that the steps should be treated other than in accordance with their form, to reflect the substance of the transaction. The IRS ruled that the third drop and the check, on the other hand, are more properly characterized under step transaction principles as a reorganization under Section 368(a)(1)(D), rather than a Section 351 transaction followed by a Section 332 liquidation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.