Rev. Rul. 79-82

ISSUES

(1) Is a partnership or each partner the "qualified electing shareholder" who must make the election to have the benefits of section 333 of the Internal Revenue Code of 1954 apply to the gain realized upon the complete liquidation of a domestic corporation owned by the partnership?

(2) What are the Federal income tax consequences to the partners as a result of such election?

FACTS

A, an individual, and Y and Z, both corporations, are the only members of an entity treated as a partnership for Federal income tax purposes. For many years the partnership has owned all of the stock of X, a domestic corporation, which has adopted a plan of complete liquidation. The outstanding stock of X consists of one class of common stock. The plan calls for the distribution of all of X's property in complete cancellation or redemption of all of the stock owned by the partnership within a period of one calendar month. The proposed liquidation of X meets the requirements of section 333(a) of the Code. If the partners owned their interests in X directly, based on their ownership interests in the partnership property, A would own 10 percent of the X stock, Y would own 30 percent, and Z would own 60 percent.

LAW AND ANALYSIS

Issue (1)

The applicable sections of the Code and Income Tax Regulations are sections 333 and 1.333-2(d), relating to election as to recognition of gain in certain liquidations, section 703(b), relating to elections of a partnership, and section 702, relating to a partner's distributive share of partnership income.

Section 333(e) of the Code provides that upon the liquidation of a corporation the recognized gain therefrom of a noncorporate "qualified electing shareholder" is limited to the greater of the shareholder's ratable share of earnings and profits accumulated after February 28, 1913, or money and stock or securities (acquired after December 31, 1953) received by the shareholder. Where gain is recognized, each qualified electing noncorporate shareholder's ratable share of accumulated earnings and profits is treated as a dividend and the excess, if any, is treated as long term or short term capital gain, as the case may be. Section 333(f) provides that each qualified electing corporate shareholder's gain is recognized (as capital gain) to the extent of the greater of such shareholder's ratable share of accumulated earnings and profits, or money and stock or securities (acquired after December 31, 1953) received by the shareholder.

Section 333(b) of the Code provides that the provisions of section 333 are not applicable to a corporation that at any time between January 1, 1954, and the date of adoption of the plan of liquidation owns more than 50 percent of the voting stock of the liquidating corporation.

A "qualified electing shareholder," as defined by section 333(c) of the Code, is one (other than an excluded corporation as defined in section 333(b)) who owns any class of stock of a corporation at the time of the adoption of the plan of liquidation and who has timely filed a written election to have the benefits of section 333 apply. Section 1.333-2(d) of the regulations provides that an election to be governed under section 333 can be made only by or on behalf of the person by whom gains, if any, will be realized, and the shareholder who may make such an election must be the actual owner of the stock and not a mere record holder, such as a nominee.

Section 703(b) of the Code specifically states, with certain exceptions not relevant here, that any election which affects the computation of taxable income derived from a partnership is to be made by the partnership.

Because in the present case the X stock is partnership property, the partnership is the actual owner for purposes of section 1.333-2(d) of the regulations and not a mere record holder of the stock. As owner, the partnership, upon disposition of such stock, realizes gain for purposes of computing the taxable income derived from the partnership. (Each partner must then take into account separately the partner's distributive share of such income pursuant to section 702 of the Code as discussed in Issue (2) below.)

In addition, the section 333 elections will affect the computation of taxable income derived from the partnership pursuant to section 703(b) of the Code.

Therefore, the partnership is the qualified electing shareholder who must make the election to have the benefits of section 333 apply to the gain realized upon the liquidation of X.

Issue (2)

The remaining issue relates to the Federal income tax consequences to the partners of the partnership's section 333 election.

The relevant sections of the Code and regulations are 702 and 1.702-1(a)(8)(ii), relating to income of a partner, and 703, relating to partnership income computations.

Section 703(a) of the Code and the regulations thereunder provide that the taxable income of a partnership is computed in the same manner as in the case of an individual except that the items described in section 702(a) are separately stated. Section 702(a)(1), (2), (5), and (8) refer to capital gains and losses, dividends, and "other items of income, gain, loss, deduction or credit to the extent provided by regulations." Section 1.702-1(a)(8)(ii) of the regulations provides that each partner must take into account separately the partner's distributive share of any partnership item which if separately taken into account by any partner would result in an income tax liability for that partner different from that which would result if that partner did not take the item into account separately.

Section 702(b) of the Code requires that the character of any item of income or gain included in a partner's distributive share under paragraphs (1) through (7) of section 702(a) be determined as if such item were realized directly from the source from which realized by the partnership.

In view of the differing treatment of gain from certain corporate liquidations accorded corporate and noncorporate shareholders under section 333(e) and (f), each partner's fractional share of the partnership shareholder's gain under section 333 must be taken into account separately in compliance with the requirements of section 702(a)(1), (2), (5), and (7), and section 702(b).

If the election to have the benefits of section 333 of the Code apply is properly and timely made by the partnership, each partner's distributive share of the gain, determined in accordance with the partner's respective interests in the partnership property, is taken into account by the partner as provided in section 702 and recognized to the partner to the extent prescribed in section 333. Thus, for purposes of applying the provisions of section 333, each of the partners is treated, based on the partner's ownership interest in the partnership property, as owning such interest in X directly and as realizing gain on the liquidation directly. A partner who is an individual will take the partner's share of the gain into account in accordance with the recognition rules stated in section 333(e). A partner that is a corporation will take its share of the gain into account in accordance with the recognition rules specified in section 333(f) provided, however, that such corporate partner would not be an "excluded corporation" as defined in section 333(b) if it owned its interest in the liquidating corporation directly. To the extent that the gain is attributable to an interest in partnership property owned by a corporation that would be an "excluded corporation" within the meaning of section 333(b) if it owned its interest in the liquidating corporation directly, such corporate partner will be treated as an "excluded corporation" as to its share of such gain, and such gain will be recognized pursuant to section 331(a).

Therefore, A's distributive share of the gain realized on the liquidation will be recognized by A under section 333(e) of the Code to the extent of 10 percent of X's earnings and profits (this amount being treated as a dividend), and if 10 percent of the cash or post-1953 securities distributed by X exceed the amount of such dividend, such excess will be treated by A as capital gain but in an amount which together with the amount treated as a dividend does not exceed A's distributive share of the gain realized on the liquidation.

Y's distributive share of the gain realized on the liquidation will be recognized by Y under section 333(f) of the Code as capital gain to the extent of the greater of (a) 30 percent of the earnings and profits of X, or (b) 30 percent of the cash and post-1953 securities distributed by X.

Z's distributive share of the gain realized on the liquidation, however, will not be subject to the provisions of section 333 of the Code because Z is considered to own 60 percent of X's stock directly for purposes of applying section 333, and section 333(b) provides that the provisions of section 333 do not apply to a corporation which at the time of the adoption of the plan of liquidation owns more than 50 percent of the voting stock of the liquidating corporation. Therefore, Z's distributive share of the realized gain on the liquidation will be recognized pursuant to section 331(a).

HOLDINGS

(1) A partnership is the qualified electing shareholder that must make the election to have the benefits of section 333 of the Code apply to the gain realized upon the complete liquidation of a domestic corporation.

(2) For purposes of applying the provisions of section 333 of the Code, each of the partners is treated, based on the partner's ownership interest in the partnership property, as owning such interest in X directly and as realizing gain on the liquidation directly. Thus, each partner's distributive share of the gain, determined in accordance with the partner's respective interest in the partnership property, is taken into account by the partner as provided in section 702 and recognized to the partner to the extent prescribed in section 333(e) and (f), or 331(a) if the corporate partner is treated as an excluded corporation.