COMPANY MUST RECOGNIZE GAIN, HAS DEEMED CONTRIBUTION FROM LLC TRANSACTION.

Third Party Communication: None

This letter responds to your November 19, 2008 request for certain rulings regarding the federal income and gift tax consequences of a proposed transaction. The information submitted in that request and later correspondence is summarized below.

Prior to Date 1, CORP owned 100% of the membership interests in LLC, which was formed in Year 3 and disregarded as an entity separate from CORP for federal tax purposes. LLC's operations consist solely of investing in a diversified portfolio of passive investment assets, including hedge funds, mutual funds, and private equity funds. LLC has no outstanding liabilities.

Shareholder A and CORP reached an agreement pursuant to which Shareholder A was admitted as a new member of LLC on Date 1. Specifically, Shareholder A contributed $n1 in cash to LLC in exchange for a newly issued, non-voting, preferred interest in LLC. The terms and pricing of the preferred interest were based on an independent appraiser's determination of market rate terms for similar equity investments.

In general, in accordance with Article VIII of the LLC Agreement, and subject to certain adjustments for operating and capital losses, Operating and Capital profits are allocated to the preferred interest up to an amount equal to the "Priority Allocation Amount." The term "Priority Allocation Amount" is defined in Article I as follows:

For what have been represented to be valid business purposes the following steps have been proposed (the "Proposed Transaction"): (i) CORP will distribute q%, and possibly up to r%, of its membership interests in LLC pro-rata to its stockholders (the "Distributed LLC Interests") and (ii) the operating agreement of LLC will be amended to provide CORP with a share of LLC's profits disproportionate to capital in exchange for CORP providing future management services to LLC with respect to LLC's ongoing activities.

Section 25.2701-1(a)(2) provides that if § 2701 applies to a transfer, the amount of the transferor's gift, if any, is determined using a subtraction method of valuation. See § 25.2701-3(a). Under this method, the amount of the gift is determined by subtracting the value of any family-held applicable retained interests and other non-transferred equity interests from the aggregate value of family-held interests in the corporation or partnership. Section 25.2701-2(a)(1) and (2) provide generally, that in determining the value of any applicable retained interest held by the transferor or an applicable family member, any put, call, or conversion right, any right to compel liquidation, or any similar right is valued at zero, and any distribution right in a controlled entity (e.g., a right to receive dividends) is valued at zero unless the right is a "qualified payment right" (as defined in § 25.2701-2(b)(6)). Any other right (including a qualified payment right) is valued as if any right valued at zero did not exist but otherwise without regard to § 2701.

Section 25.2701-1(b)(2) provides that a transfer includes a contribution to the capital of a new or existing entity.

Section 25.2701-1(b)(3) provides that a distribution right is the right to receive distributions with respect to an equity interest. A distribution right does not include any right to receive distributions with respect to an interest that is of the same class or a class that is subordinate to the transferred interest, any extraordinary payment right, mandatory payment rights, rights to guaranteed payments of a fixed amount under § 707(c), or non-lapsing conversion rights.

Section 25.2701-2(b)(5) provides that, for purposes of § 2701, a controlled entity is a corporation or partnership controlled, immediately before the transfer, by the transferor, applicable family members, or lineal descendants of the parents of the transferor or the transferor's spouse. In the case of a partnership, control means the holding of at least 50 percent of either the capital interest or the profits interest in the partnership.

Section 25.2701-2(b)(6) provides, in part, that a qualified payment right is a right to qualified payments. A qualified payment is a distribution that is a dividend payable on a periodic basis (at least annually) under any cumulative preferred stock, to the extent such dividend is determined at a fixed rate, or any other cumulative distribution payable on a periodic basis (at least annually) with respect to an equity interest, to the extent determined at a fixed rate or as a fixed amount. A qualified payment right includes any distribution right for which an election has been made pursuant to § 25.2701-2(c)(2).

Section 25.2701-2(c)(2) provides that a transferor holding a distribution right in a controlled entity that is not qualified payment right may elect to treat the distribution right as a qualified payment right, to be paid in the amounts and at the times specified in the election. An election may be a partial election, in which case the election must be exercised with respect to a consistent portion of each payment right in the class as to which the election has been made. See section 25.2701-2(d)(Example 5). The election is effective only with respect to the payments specified in the election. Further, the payments specified in the election must be permissible under the instrument giving rise to the right, and the payment must be consistent with the legal right of the entity to make the payment.

If the transferor makes the election, then in determining the value of the transferor's gift, the distribution rights with respect to the applicable retained interest are not valued at zero. However, because the distribution right is treated as qualified payment right, the right is subject to the recapture rules applicable to all qualified payment rights.

Section 25.2701-4(a) provides that, in general, if a taxable event occurs with respect to any applicable retained interest conferring a distribution right that was previously valued as a qualified payment right, the taxable estate or taxable gifts of the individual holding the interest are increased by the amount determined under § 25.2701-4(c).

Section 25.2701-4(b)(1) defines a taxable event, generally, as the transfer of a qualified payment interest, either during life or at death. Further, any termination of an individual's rights with respect to a qualified payment interest is a taxable event.

Section 25.2701-4(c)(1) provides that the increase to an individual's taxable estate or taxable gifts is the excess, if any, of the sum of the amount of qualified payments payable during the period (plus the earnings on those payments, determined hypothetically based on a specified discount rate, as if each payment were paid on its due date), over the amount of the qualified payments actually paid during the same period plus the hypothetical earnings on those payments, determined as if each payment were reinvested as of the date actually paid at a yield equal to the appropriate discount rate.

In the present case Shareholder A transferred $n1 in cash to LLC, a controlled entity, in exchange for a nonvoting "Preferred Interest." The transfer constitutes a contribution to the capital of LLC that is subject to the rules of § 2701 pursuant to § 25.2701-1(b)(3). The Preferred Interest that Shareholder A received in exchange for the transfer is an applicable retained interest, since it is an equity interest in a controlled entity with respect to which there is a distribution right. Thus, the transaction is subject to § 2701.

In order for the dividend attendant upon the Preferred Interest to constitute a qualified payment right, the dividend must be determined at a fixed rate or as a fixed amount. In this case, the dividend does not meet this standard. Rather, the dividend will be $n5 per year (p% X $n2) through Year 4. Thereafter, the dividend will be redetermined for each subsequent three-year period based on an unspecified rate to be determined in the future. Thus, the dividend is payable neither at a fixed rate nor in a fixed amount. This is not a qualified payment right within the meaning of § 25.2701-2(b)(6).

This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this letter must be attached to the federal income tax return of each taxpayer involved in the taxable year in which the transaction is consummated.

Pursuant to a power of attorney on file in this office, we have sent the original of this letter to the taxpayer's representative and a copy of this letter to the taxpayer.