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AICPA Requests Clarification of Proposed Purchase Price Allocation Regs

MAR. 15, 2000

AICPA Requests Clarification of Proposed Purchase Price Allocation Regs

DATED MAR. 15, 2000
DOCUMENT ATTRIBUTES
  • Authors
    Lifson, David A.
  • Institutional Authors
    American Institute of Certified Public Accountants
  • Cross-Reference
    For a summary of REG-107069, see Tax Notes, Aug. 9, 1999, p. 831; for

    the full text, see Doc 1999-26561 (42 original pages), 1999 TNT 158-

    8 Database 'Tax Notes Today 1999', View '(Number', or H&D, Aug. 5, 1999, p. 2339. For the full text of T.D. 8858, see

    Doc 2000-975 (134 original pages) or 2000 TNT 4-5 Database 'Tax Notes Today 2000', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    stock purchases as asset purchases
    basis
    asset acquisition allocations
    S corporations
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-8089 (7 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 53-12

 

=============== SUMMARY ===============

 

The American Institute of Certified Public Accountants has asked the IRS to clarify provisions in the temporary and proposed regulations on purchase price allocations that deal with S corporation acquisitions. Specific requests include (1) modifying the instructions to the current form for making a section 338(h)(10) election to reflect the regs' requirement that nonselling shareholders must consent to the election and (2) clarifying that a section 338(H)(1) election can be made when an S corporation sells a C corporation subsidiary. Other desired clarifications include specifying that a qualified stock purchase for which a section 338(h)(10) election is made will be treated as a stock sale, not as an asset sale followed by a liquidating distribution, for purposes of the one-class-of-stock requirement under section 1361(b)(1)(D).

 

=============== FULL TEXT ===============

 

March 15, 2000

 

 

Honorable Charles O. Rossotti

 

Commissioner of Internal Revenue

 

Internal Revenue Service

 

Courier's Desk

 

1111 Constitution Avenue, N.W.

 

Washington, DC 20044

 

 

Re: Comments on Temporary Regulations under Section 338 Regarding

 

Purchase Price Allocations in Deemed and Actual Asset

 

Acquisitions

 

 

Dear Commissioner Rossotti:

[1] Enclosed are an original and eight (8) copies of the American Institute of Certified Public Accountants' comments on the above-referenced regulations. The comments were developed by members of the S Corporation Taxation Technical Resource Panel and approved by the Tax Executive Committee. We hope they will be of help in developing the final regulations.

[2] We would be pleased to discuss the regulations with you or a member of your staff. You may contact one of the following: me at (212) 572-5555; Carol Kulish Harvey, member of the S Corporation Taxation Technical Resource Panel at (202) 481-7770; or Marc A. Hyman, AICPA Technical Manager at (202) 434-9231.

Sincerely,

 

 

David A. Lifson, Chair

 

Tax Executive Committee

 

 

cc: Victor L. Penico (CORP-3)

 

Paul F. Kugler (P&SI-ACC)

 

 

* * * * *

 

 

AMERICAN INSTITUTE OF

 

CERTIFIED PUBLIC ACCOUNTANTS

 

 

Comments on Temporary Regulations Relating to

 

Purchase Price Allocations in Deemed and Actual Asset Acquisitions

 

Issued on January 5, 2000

 

 

S CORPORATION TAXATION TECHNICAL RESOURCE PANEL

 

 

and Approved by the

 

 

TAX EXECUTIVE COMMITTEE

 

 

Submitted to the Internal Revenue Service

 

March 15, 2000

 

 

[3] These comments are submitted in response to temporary regulations relating to the allocation of purchase price in deemed and actual asset acquisitions that were published in the Federal Register on January 5, 2000 ("Temporary Regulations"). Proposed regulations relating to the same issues were published in the Federal Register on August 10, 1999 ("Proposed Regulations"). According to the Preamble to the Temporary Regulations, the Temporary Regulations "are substantively the same" as the Proposed Regulations. These comments were prepared by the S Corporation Taxation Technical Resource Panel of the AICPA and only address issues in the Temporary Regulations that specifically relate to S corporations.

EXECUTIVE SUMMARY

[4] As a threshold matter, the AICPA commends the Internal Revenue Service ("IRS") and the Department of the Treasury ("Treasury") for clarifying that the installment method can be used to report gain on the acquisition of an S corporation in a Section 338(h)(10) transaction 1 (if such method otherwise would be available). 2 We also commend the IRS and Treasury for providing that, when the stock of an S corporation that has Qualified Subchapter S Subsidiaries ("QSubs") is acquired and a Section 338(h)(10) election is made, the subsidiaries will remain QSubs for purposes of reporting the effects of the target S corporation's deemed sale of assets and deemed liquidation. These are well-reasoned provisions that should be retained in the final regulations. However, as explained below, we respectfully recommend that the following clarifications of the rules applicable to S corporations that are acquired in Section 338(h)(10) transactions be reflected in the final regulations or in other guidance:

o The instructions to the current form for making a Section

 

338(h)(10) election should be modified expeditiously to

 

reflect the requirement of the Temporary Regulations that non-

 

selling shareholders must consent to the election. In the

 

interim, Section 338(h)(10) elections should be respected as

 

valid even if they do not contain consents of non-selling

 

shareholders, given that the instructions to the current

 

election form require only selling shareholders to consent.

 

 

o The final regulations should make clear that a qualified stock

 

purchase with respect to which a Section 338(h)(10) election

 

is made will be treated as a stock sale, not as an asset sale

 

followed by a liquidating distribution, for purposes of the

 

one-class-of- stock requirement of Section 1361(b)(1)(D).

 

 

o The final regulations should make clear that a Section

 

338(h)(10) election can be made when an S corporation sells a

 

C corporation subsidiary.

 

 

[5] These recommendations are discussed in greater detail below.

INSTALLMENT SALE ISSUES

[6] In a letter dated March 3, 1999, the AICPA asked the IRS and Treasury to clarify that installment reporting is available when an S corporation is acquired in a qualified stock purchase and a Section 338(h)(10) election is made. Thus, we commend the IRS and Treasury for including a provision in the Temporary Regulations making clear that installment reporting may be available in this circumstance. We recognize, however, that the recently-enacted Ticket to Work and Work Incentives Improvement Act of 1999 repealed the installment method for taxpayers using the accrual method of accounting. Thus, we encourage the IRS and Treasury to provide guidance expeditiously as to the impact of this law change on deemed and actual assets sales by accrual method S corporations.

QSUB ISSUES

[7] The Temporary Regulations provide that, when a Section 338(h)(10) election is made with respect to the purchase of stock of an S corporation that has QSubs, the QSubs are treated as remaining QSubs through the close of the acquisition date. The Preamble to the Proposed Regulations explains that the QSubs are considered to remain QSubs "for purposes of target's and its S corporation shareholders' reporting the effects of target's deemed sale of assets and deemed liquidation." We believe that this is the proper conclusion and recommend that this provision be retained in the final regulations. Treating the QSub's assets as being transferred as part of the deemed asset sale is consistent with both the fiction of the QSub rules that the parent S corporation owns the assets (subject to liabilities) of the subsidiary for tax purposes, and with the fiction of the Section 338(h)(10) rules that the stock sale is disregarded and the transaction instead is treated as an asset sale.

TREATMENT OF NON-SELLING SHAREHOLDERS

[8] Prior to the issuance of the Temporary Regulations, it was not completely clear whether all of the shareholders of an S corporation had to consent to a Section 338(h)(10) election or whether a dissenting shareholder could block such an election. The former regulations implied that all the shareholders had to consent to the election. Former Treas. Reg. Section 1.338(h)(10)-1(d)(2) provided that a Section 338(h)(10) election is made jointly by the purchasing corporation and "the S corporation shareholders" on Form 8023 in accordance with the instructions to the form. Former Treas. Reg. Section 1.338(h)(10)-1(c)(2) defined the S corporation shareholders as the target corporation's shareholders immediately before the acquisition date. Although Former Treas. Reg. Section 1.338(h)(10)-1(e)(3) provided special rules for minority shareholders, this section explicitly did not apply to S corporation shareholders and there were no other provisions that removed any S corporation shareholders from the consent requirement.

[9] Nevertheless, the form that is filed to make a Section 338(h)(10) election (Form 8023) requires only shareholders selling their S corporation stock to sign the form, indicating their consent to the election. This result was consistent with the former regulations insofar as Former Treas. Reg. Section 1.338(h)(10)- 1(d)(2), quoted above, required that the election be made by S corporation shareholders "on Form 8023 in accordance with the instructions on the form." Nonetheless, the issue of whether 80 percent consent was sufficient was confusing, in light of the regulatory language regarding "S corporation shareholders."

[10] The Temporary Regulations change the consent requirement from that currently in the instructions to Form 8023 to provide that all shareholders must consent to the Section 338(h)(10) election. Reg. Section 1.338(h)(10)-1T(c)(2) explicitly provides that "S corporation shareholders who do not sell their stock must also consent to the election." The Preamble to the Proposed Regulations indicates that this is a "clarification" and that Form 8023 will be modified to reflect the unanimous consent requirement.

[11] We are concerned that the Preamble to the Proposed Regulations describes the unanimous consent requirement as a "clarification," rather than as a modification, of existing law, given that the former regulations had pointed to the election form as setting out the rules for the election and the instructions to the Form 8023 requires only the selling shareholders to consent. Taxpayers who relied on the former regulations and the instructions to the form clearly should not be penalized for failing to secure the consent of non-selling shareholders. Further, we submit that taxpayers who in good faith follow the instructions to the current form even after the issuance of the Temporary Regulations should not be penalized for so doing. Therefore, we recommend that the instructions to Form 8023 be modified expeditiously and that, in the interim, otherwise valid elections not be treated as invalid due to lack of consents of non-selling shareholders.

SECOND CLASS OF STOCK ISSUES

[12] When an acquiring corporation wants to make a Section 338(h)(10) election in connection with an S corporation target, the continued qualification of the target as an S corporation is of utmost importance. Further, the amount of the payment per share of stock (and the timing of payment) often will vary among the shareholders. Although the fact that shareholders may receive different consideration for their stock in no way affects the economic rights associated with their shares of stock, a technical issue arguably arises as to whether the different amount of payment per share creates a second class of stock, thereby terminating the corporation's S election, as a result of the fictional transactions deemed to occur when a Section 338(h)(10) election is made.

[13] Pursuant to Section 1361(b)(1)(D), an S corporation cannot have more than one class of stock. Treas. Reg. Section 1.1361-1(l)(1) generally provides that a corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation "confer identical rights to distribution and liquidation proceeds." The second class of stock issue arises because: (1) the "fiction" of a Section 338(h)(10) transaction is that the target sells its assets to a "new target" and then liquidates; (2) the shareholders would be treated as receiving different amounts per share in this deemed liquidation; and, (3) as indicated above, the one-class-of-stock rules require that all shares of S corporation stock have identical liquidation rights.

[14] Further, pursuant to Section 1362(d)(2), if a corporation ceases to meet the S corporation eligibility requirements, its S election is terminated effective on and after the date of such cessation. Therefore, if the target corporation were treated as having a second class of stock as a result of the differing amounts paid for its stock and the Section 338(h)(10) election, it might be treated as a C corporation on the date of the transaction. This could be a disastrous result because a Section 338(h)(10) election can be made only if target stock is acquired from S corporation shareholders, a selling affiliate, or a selling consolidated group -- none of which seemingly would be the case if the target were treated as a C corporation on the date of the transaction.

[15] The IRS has reached the reasonable conclusion in two recent private letter rulings that a target S corporation should not be treated as having a second class of stock merely because shareholders receive different consideration for their shares and a Section 338(h)(10) is made. Priv. Ltr. Ruls. 9821006 and 199918050. In Priv. Ltr. Rul. 199918050, the IRS addressed a situation in which an S corporation was acquired in a reverse subsidiary cash merger, which is treated as a purchase of the S corporation's stock. The acquiring corporation wanted to make a Section 338(h)(10) election. Pursuant to the merger agreement, if a Section 338(h)(10) election were made, each shareholder of the S corporation would be compensated for any increased liability for federal and state income taxes or reduction in selling price resulting from the election. The amount of the payment per share of stock was to vary among the shareholders, due to their different tax situations.

[16] The Service ruled that, solely for purposes of the one- class-of-stock rules, it would treat the transaction as a sale of stock and not as a liquidating distribution, notwithstanding the Section 338(h)(10) election. Thus, the IRS found that the S corporation would not be treated as having a second class of stock by reason of the unequal payments to the shareholders and the Section 338(h)(10) election. The ruling stated that this conclusion was based on the representation that the shareholders of the S corporation had sold their stock for fair market value pursuant to an agreement negotiated at arm's length.

[17] Although the Temporary Regulations do not explicitly address second class of stock concerns, the inclusion of the scope statement in an effort to provide a general model could create an inference that the deemed liquidation must be treated as an actual liquidation for purposes of determining whether there is a second class of stock and that the reasoning reflected in Priv. Ltr. Rul. 199918050 may no longer be applied. The Preamble to the Proposed Regulations indicates that all affected parties are to determine the tax consequences as if they had actually engaged in the fictitious transactions deemed under Section 338. Further, in describing the tax consequences of the deemed liquidation resulting from a Section 338(h)(10) election, Reg. Section 1.338(h)(10)-1T(d)(4) provides that "[t]he transfer from old T is characterized for Federal income tax purposes in the same manner as if the parties had actually engaged in the transactions deemed to occur because of this section and taking into account other transactions that actually occurred or are deemed to occur."

[18] We strongly recommend that the final regulations explicitly recognize that the fact that certain transactions may be deemed to occur for Federal tax purposes in no way changes the legal rights to distribution proceeds between a corporation and its shareholders and cannot create a second class of stock. The focus of the second class of stock rules should be on whether each share of stock has the same liquidation and distribution rights as a matter of law, not on what shareholders may negotiate at arm's length with third parties in consideration for the sale of their stock. Thus, we recommend that the final regulations make clear that a qualified stock purchase with respect to which a Section 338(h)(10) election is made will be treated as a stock sale, not as an asset sale followed by a liquidating distribution, for purposes of the one-class-of- stock requirement of Section 1361(b)(1)(D).

SALE OF C CORPORATION SUBSIDIARY

[19] We respectfully recommend that the final regulations make clear that a Section 338(h)(10) election can be made when at least 80 percent of the stock of a C corporation subsidiary is sold by an S corporation (as well as when at least 80 percent of the stock of a QSub is sold in a transaction that is otherwise treated as a re- formation of the subsidiary followed by a stock sale). The Temporary Regulations suggest this result since such a subsidiary should fall within the definition of an affiliated target for which a Section 338(h)(10) election can be made. Similar conclusions have been reached in private letter rulings for other non-consolidated, affiliated corporations. See, e.g., Priv. Ltr. Ruls. 9646016, 9723026 and 9543036. Further, there is no policy reason for precluding the availability of a Section 338(h)(10) election in such a situation.

CONCLUSION

[20] As indicated above, we commend the Treasury and IRS for some of the decisions relating to acquisitions of S corporations that are reflected in the Temporary Regulations. We recommend, however, that clarifications be made to certain of the provisions. We thank you for taking our comments into account. Should you have any questions, please contact one of the following individuals: me at (212) 572-5555; Carol Kulish Harvey, member of the S Corporation Taxation Technical Resource Panel at (202) 481-7770, or Marc A. Hyman, AICPA Technical Manager at (202) 434-9231.

Very Truly Yours,

 

 

David A. Lifson, Chair

 

Tax Executive Committee

 

FOOTNOTES

 

 

1 Except to the extent provided otherwise, all section references are to the Internal Revenue Code of 1986, as amended, or to the Treasury regulations promulgated thereunder.

2 As indicated below, we recognize that the recently-enacted Ticket to Work and Work Incentives Improvement Act of 1999 repealed the installment method for taxpayers using the accrual method of accounting.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Lifson, David A.
  • Institutional Authors
    American Institute of Certified Public Accountants
  • Cross-Reference
    For a summary of REG-107069, see Tax Notes, Aug. 9, 1999, p. 831; for

    the full text, see Doc 1999-26561 (42 original pages), 1999 TNT 158-

    8 Database 'Tax Notes Today 1999', View '(Number', or H&D, Aug. 5, 1999, p. 2339. For the full text of T.D. 8858, see

    Doc 2000-975 (134 original pages) or 2000 TNT 4-5 Database 'Tax Notes Today 2000', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    stock purchases as asset purchases
    basis
    asset acquisition allocations
    S corporations
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-8089 (7 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 53-12
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