Category: Corporations; Estate & Gift Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background A and B each have only one class of stock outstanding. Each share of Corporation A stock is identical as to value and voting power to all other Corporation A shares. The same is true for Corporation B's stock. H & W plan to give 50% of their existing Corporation A stock to S1 and 50% of their corporation B stock to S2 such that Corporation A will be owned 50% by H & W and 50% by S1 and Corporation B will be owned 50% by H & W and 50% by S2. Prior to the gifts, Corporations A and B are members of a controlled group of corporations as defined by IRC Section 1563. Issues 2. If so, what is the timing? Answers 2. Corporations A and B will no longer be treated as members of a controlled group in the first year in which S1 and S2 own stock for more than half the year. This assumes no other ownership changes than those described above. Discussion After the gifts described above, H & W directly own only 50% of each corporation. Without attribution to H & W of the stock owned by S1 and S2, Corporations A and B would not be considered a controlled group. Section 1563(d)(2) provides that stock ownership includes actual ownership as well as constructive ownership as defined by Section 1563(e). Section 1563(e)(6)(B) addresses attribution between parents and children having attained the age of 21 years. If either parent owns more than 50% of the stock of the corporation, then the child's stock is attributed to the parent. This rule works in reverse as well. The level of ownership that triggers attribution is more than 50%. Since the level of ownership here is exactly 50%, the stock of S1 and S2 are not attributed to H & W. Accordingly, Corporations A and B are not members of a controlled group of corporations at some point after the gift. See below for a discussion of the date on which controlled group status is broken. While it cannot be cited as precedent, PLR 8401016 addresses a circumstance similar to that above in which parents and adult children own exactly 50% of the stock of two corporations. The ruling holds the corporations are not members of the same controlled group. There is absolutely no margin for error here. I cannot find a case in which a 50%-50% ownership situation has been challenged, but I urge extreme caution nonetheless. There must be no arrangement --whether formal or informal--and there must be no circumstance in the totality of the facts surrounding these two corporations that would have the effect of making H & W's stock more valuable or have more voting power than the stock held by S1 or S2. I am reminded of the concern that existed some years ago in the S corporation area that various seemingly unrelated events could be construed as creating different classes of stock and thereby inadvertently terminating S corporation status. For example, paying one employee shareholder unreasonable compensation was mentioned in that context. I recognize that the S corporation situation is not completely analogous to the issue presented here, but I bring up the issue to underscore that point that it would be possible for the IRS to raise the issue that H & W's stock is somehow being favored (and is thus more valuable or has more voting power) than the same number of shares held by S1 or S2. Since with a 50%-50% arrangement there is zero tolerance for any difference between the stock held by H & W versus the stock held by S1 or S2, extreme care must be exercised in order to avoid any favoritism whatsoever. Regarding timing, Section 1563(b)(2) and (b)(3) control. Although testing of controlled group status is made on December 31 of any given year and affects the corporation's tax year that includes such December 31, that general determination can be overridden based on the length of time the requisite ownership has been met (or not met) during a given year. In essence, in order to include corporations in the same controlled group, the ownership tests must have been met one-half or more of the days of the year in question. Conversely, in order to avoid controlled group status, the corporation must fail to meet the requisite ownership tests for more than one-half the days in the tax year in question. In this case, the taxpayer is concerned about calendar year 1998. It seems to me that if the parties make the gifts described above prior to the half-way point in 1998, then Corporations A and B will not be part of a controlled group for the tax year 1998. |
