Category: Corporations Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Taxpayer (TP) is a C corporation the stock of which is 100% owned by individual F. Among its other debts, TP has about $100,000 owed in approximately equal proportions to F and F's sister-in-law. On a fair market value basis and taking into account only stated liabilities, TP is solvent. There are certain contingent liabilities which, if taken into account, would render TP insolvent. TP has a net operating loss carryforward of about $950,000. F's son, S, wishes to take over ownership of the company. S proposes to have the father contribute the shareholder debt to capital and the sister-in-law (SL) to forgive the debt she is owed. Thereafter, S will buy F's stock for $1. Issues 2. How are contingent liabilities treated for purposes of the insolvency rules of Section 108? Discussion: Issue One BUT...Temp. Reg. Section 382-2T(h)(6)(iii) provides that Temp. Reg. Section 382-2T(h)(6)(ii)--the rule that treats all family members as one shareholder--does not apply to a family member who would not be a 5% shareholder but for the all-family members-treated-as-a-single-shareholder rule. This rule appears to say that a family member who would not be a 5% shareholder except through some type of attribution does not count for purposes of the rule that treats all family members as a single shareholder. If I understand the rule correctly, it guts TP's plans. Under Temp. Reg. Section 382-2T(h)(6)(iii), since S does not own any stock in his own right, he would not be part of F's family group for determining whether an ownership change has occurred. BUT...there is private ruling, PLR 9030012, holding that a sale of 100% of the stock to the son-in-law of the sole shareholder does not trigger an ownership change under Section 382. The reasoning of this ruling could be used to argue that the sale of stock by F to S should not trigger a Section 382 limitation. Frankly, I am not convinced that the conclusion of the ruling is correct. In any event, private rulings cannot be cited as precedent under Section 6110(j)(3). It seems to me the parties to this transaction would need a ruling of their own in order to insure the outcome of this transaction: I am not comfortable that the logic underlying Ruling 9030012 would withstand scrutiny. It seems to me there may be a better, or at least more certain way, to structure this transaction. Under IRC Section 382(l)(3)(B), if stock is transferred by gift, the transferee is treated as having owned the stock during the period it was owned by the transferor. In essence, it would seem possible for F to give his stock to S without triggering a limitation under Section 382. Obviously, the estate and gift tax consequences of such a transfer must be taken into account. Collateral Issue Discussion: Issue Two There is no definitive test for whether a contingent liability should be counted for insolvency purposes. It seems to be a question of weighing the facts and circumstances of each liability based on the likelihood the taxpayer will be called upon to perform under the contingency. See Conestoga Transportation Company v. Cmr., 17 TC 506 (1951) in which both going concern value and various stated reserves for contingencies were counted in the determination of solvency. Frankly, this case does not tell us much (if anything) and is the only case on point I can locate. Personally, I would be very hesitant to count any kind of contingent liability in the insolvency calculation unless it is A) probable that the taxpayer will be called upon to perform under that liability in the reasonably near future; B) the amount of the liability is reasonably estimable; and C) the probability of having to perform at that given level is clearly demonstrable. |
