SPIN-OFF TO ALLOW KEY EMPLOYEE TO ACQUIRE EQUITY INTEREST QUALIFIES AS REORGANIZATION.

UIL Number(s) 0355.01-00, 0368.04-00

                                             Date: December 18, 1992

This letter responds to your request dated August 6, 1992 for rulings on the federal income tax consequences of a proposed transaction. You have submitted additional information in letters dated October 12, November 4, November 5, and December 14, 1992. The information submitted for consideration is summarized below.

Distributing, a State X corporation, is an accrual basis S corporation engaged in Business F and Business G. Distributing has outstanding two classes of common stock, with the sole distinction between the two classes being that one class is voting common stock and the other nonvoting common stock. The following individuals, none of whom are members of the same family within the meaning of section 318(a)(1) of the Internal Revenue Code and all of whom are United States citizens, own the number and percentage of shares of Distributing as set forth below:

             Voting                    Nonvoting

We have received financial information indicating that Distributing's Business F and Business G have each had gross receipts and operating expenses representative of the active conduct of a trade or business for each of the past five years.

E is a key employee of Distributing's Business G and is unrelated (within the meaning of section 318(a)(1)) to any of Distributing's shareholders. E wishes to acquire a direct equity interest in Business G. E does not want to acquire stock in Distributing which includes Business F, a business in which E has no interest and for which E has never performed any services. Also, E does not want to acquire an equity interest in Business E as a subsidiary of distributing, because in that case a single shareholder, Distributing, would own a controlling interest in Business G. Moreover, if Business G were dropped into a subsidiary of Distributing, distributing's S election would be automatically terminated. Therefore, the taxpayers have proposed the following transaction:

(i) Distributing will form controlled and will transfer to Controlled all of the operating assets of Business G in exchange for all of Controlled's issued and outstanding stock and controlled's assumption of the Business G liabilities. All of the Business G employees will become employees of Controlled and Controlled will thereafter operate Business G.

(ii) Distributing will distribute to its shareholders, pro rata, all of the issued and outstanding stock of controlled.

(iii) Controlled will sell to E a number of shares of controlled which will equal 20 percent of each of the voting and nonvoting Controlled stock outstanding. E will pay $h in cash, obtained from E's personal funds or from third party financing. After the transaction, E will possess an equal vote with the other four shareholders of Controlled.

The taxpayers have made the following representations in connection with the proposed transaction:

(a) Distributing and Controlled and their respective shareholders will each pay their own expenses, if any, incurred in connection with the transaction.

(b) No part of the consideration distributed by Distributing is being received by a shareholder as a creditor, employee, or in any capacity other than that of a shareholder of the corporation.

(c) Following the proposed transaction, Distributing and Controlled will each continue the active conduct of their respective business, independently and with their own separate employees.

(d) The total adjusted basis and the fair market value of the assets transferred to controlled by Distributing will each equal or exceed the sum of the liabilities assumed by Controlled plus any liabilities to which the transferred assets are subject.

(e) The liabilities assumed in the transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred.

(f) No intercorporate debt will exist between Distributing and Controlled at the time of, or subsequent to1 the distribution of the Controlled stock, except for the existing operating line of credit now in effect in which Business B has borrowed money through Distributing. The indebtedness owned by Controlled to Distributing subsequent to the distribution of the Controlled stock will not constitute stock or securities within the meaning of section 355 of the Code.

(g) The investment tax credit previously computed with respect to the section 38 property transferred, if any, will be adjusted in the year of transfer to reflect an early disposition of the property pursuant to section 47(a)(1) and (5) of the Code.

(h) No two parties to the transaction are investment companies as defined in section 368(a)(2)(F)(iii) and (iv) of the Code.

(i) The five years of financial information submitted on behalf of distributing is representative of its present operations, and there have been no substantial operational changes since the date of the last financial statement submitted.

(j) There is no plan or intention to liquidate either Distributing or Controlled, to merge either corporation with any other corporation, or to sell or otherwise dispose of the assets of either corporation subsequent to the proposed transaction, except in the ordinary course of business.

(k) There is no plan or intention by the shareholders of Distributing to sell, exchange, transfer by gift, or otherwise dispose of any of the stock in either Distributing or Controlled subsequent to the transaction.

(l) Payments made in connection with any continuing transactions between Distributing and Controlled will be for fair market value based on terms and conditions arrived at by the parties bargaining at arm's length.

(m) Controlled will elect to be an S corporation under section 1361 of the Code for federal income tax purposes.

Based on the information submitted and on the representations set forth above, we hold as follows:

(1) The transfer by Distributing to controlled of the assets described above solely in exchange for all of the stock of controlled and the assumption of certain liabilities, as described above, followed by the pro rata distribution of the control led stock to the distributing shareholders will be a reorganization within the leaning of section 368(a)(1)(D) of the code. distributing and controlled will each be "a party to a reorganization" within the meaning of section 368(b).

(2) Distributing will recognize no gain or loss upon the transfer of assets, subject to liabilities, to Controlled in exchange for controlled stock, as described above (section 361(a) and 357(a)).

(3) Controlled will recognize no gain or loss on the receipt of assets in exchange for Controlled stock, as described above (section 1032(a)).

(4) Controlled's basis of the assets received from Distributing as described above will equal the basis of such assets in the hands of Distributing immediately prior to their transfer (section 362(b)).

(5) Controlled's holding period of the Distributing assets will include the period during which Distributing held such assets (section 1223(2)).

(6) Distributing will recognize no gain or loss upon its distribution of controlled stock pursuant to the plan of reorganization, as described above (section 361(c)(1)).

(7) Distributing shareholders will recognize no gain or loss on their receipt of the controlled stock as described above (section 355(a)(1)).

(8) A Distributing shareholder's basis of the shares of controlled and Distributing stock after the distribution will, in each instance, equal the aggregate basis of the Distributing stock held immediately before the distribution, allocated in proportion to the fair market value of each in accordance with section 1.358-2(a)(2) of the income Tax Regulations (section 358(b)(1)).

(9) A Distributing shareholder's holding period of the controlled stock received will, in each instance, include the holding period of the Distributing stock with respect to which the distribution will be made, provided that the Distributing stock is held as a capital asset on the date of the exchange (section 1223(1)).

(10) As provided in section 312(h) of the code, proper allocation of earnings and profits between Distributing and controlled will be made under section 1.312-10(a) of the regulations.

(11) The momentary control of controlled by Distributing corporation will not cause the Distributing to lose its S corporation status.

These rulings are contingent upon the bona fide acquisition by E of a number of shares equal to 20 percent of the voting shares and 20 percent of the nonvoting shares of outstanding Controlled stock for $h in cash, obtained from E's personal funds or from third party financing. If L does not make this acquisition, this ruling letter will have no force and effect. We express no opinion about the tax treatment of the transaction under other provisions of the Code and regulations or about the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction that are not specifically covered by the above rulings. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

Each affected taxpayer must attach a copy of this letter to the taxpayer's federal income tax returns for the taxable year in which the transaction covered by this ruling letter is consummated.

In accordance with the power of attorney on file in this office, we have sent a copy of this letter to the taxpayer.

                                   Sincerely yours,