Tax Law

Consequences of S Corporation Reorganization

In a 2010 published letter ruling,[1] two shareholders owned all of the stock of a C corporation. The plan was for the original corporation to form a new subsidiary. An agreement was reached to transfer some of the original corporation's assets to the new subsidiary in a tax-free exchange along with some cash[2] to make the transaction fair to both shareholders. Then one of the shareholders of the original corporation would give up the stock held in that corporation for all of the stock in the newly formed corporation. The newly formed corporation would elect to be an S corporation immediately following the distribution.[3] The original corporation would elect to be taxed as an S corporation as of January 1, 2011.[4]

One of the features of the reorganization was that a major asset passing to the newly-formed corporation was to be rented to the surviving shareholder of the original corporation. Interestingly, the letter ruling does not discuss the rental agreement although the reorganization rules specify that immediately after the distribution of assets to the newly-formed corporation, both the parent corporation (the "original" corporation) and the subsidiary must be engaged in the active conduct of a trade or business, or immediately before the distribution the distributing corporation had no assets other than stock or securities in the controlled corporation and each of the corporations is engaged immediately after the distribution in the active conduct of a trade or business.[5] Although there is no discussion in the ruling about the nature of the lease or the type of rental (cash rent or share rent) there is firm authority that cash rented assets do not meet trade or business test, at least in a farm or ranch context.[6] Land that is share-rented does meet the "trade or business" test.[7] It is surprising that this issue was not addressed in the 2010 letter ruling.

The ruling does note that the newly-formed corporation (the "subsidiary") would be subject to the built-in gain provisions applicable to S corporations[8] with respect to assets transferred to the newly-formed corporation.[9] Moreover, upon becoming an S corporation, the original corporation, now shrunken by the transfer of assets to the newly-formed corporation, will also be subject to the built-in gain provisions[10] with respect to its retained assets.[11] This feature of the ruling has great significance and could discourage some from using the reorganization strategy to solve problems in farm and ranch corporations.[12]


This is a preview excerpt from the upcoming July 2011 release of the Matthew Bender publication Farm Income Tax Manual, chapter 7, "Farm Corporations". Author: Neil E. Harl-Charles F. Curtiss Distinguished Professor in Agriculture; Emeritus Professor of Economics; Member, Iowa Bar; Former Director, Center for International Agricultural Finance.


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[1] Ltr. Rul. 201102046, September 28, 2010.

[2] See I.R.C. § 351.

[3] I.R.C. § 1362(a).

[4] Id.

[5] I.R.,C. § 355(b)(1)(A), (B).

[6] Rev. Rul. 86-126, 1986-2 C.B. 58 (active business requirement not met where corporation cash rented farmland to tenant).

[7] Rev. Rul. 73-234, 1973-2 C.B. 180 (livestock share lease with active involvement in management satisfied the "trade or business' requirement).

[8] I.R.C. § 1374.

[9] Ltr. Rul. 201102046, September 28, 2010.

[10] I.R.C. § 1374.

[11] Ltr. Rul. 201102046, September 28, 2010.

[12] See Harl, "Consequences of a Divisive, Type D, Reorganization for S Corporations," 22 Agric. L. Dig. 25 (2011).