CONSOLIDATION OF S CORPORATIONS IS TAX-FREE.

Index Number: 1361.05-00

[1] This responds to your letter dated June 11, 1999, submitted on behalf of Z, requesting rulings as to Z's acquisition of the stock of two S corporations and contemplated Qualified Subchapter S Subsidiary (QSUB) elections for the acquired companies.

FACTS

[2] X was incorporated under the laws of State on D1 and is a solvent S corporation. X elected S corporation status effective D4. Y was incorporated under the laws of State on D2 and is a solvent S corporation. Y elected S corporation status effective D5. Z was incorporated under the laws of State on D3 and is a solvent S corporation. Z was formed to acquire the stock of X and Y pursuant to a plan of liquidation. A, B, and C own all of the shares of X, Y, and Z.

[3] A, B, and C propose to transfer all of their shares in X and Y to Z. Effective the same day as the above transfer of shares, it is anticipated that Z will make QSUB elections, for X and Y.

[4] Z has made the following representations:

     (a) To the best of Z's knowledge and belief, the transfer of X

[5] Section 381(a) provides that in the case of the acquisition of assets of a corporation by another corporation in a distribution to such other corporation to which section 332 applies, or in a transfer to which section 361 applies, but only if the transfer is in connection with a reorganization described in subparagraphs (A), (C), (D), (F), or (G) of section 368(a)(1), the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in section 381(c) of the distributor or transferor corporation, subject to the conditions and limitations specified in section 381(b) and (c).

[6] Section 381(c) delineates the items referred to in section 381(a). These items include the subchapter C earnings and profits of the distributor or transferor corporation as described in section 381(a). Sections 381(c)(2), 1.381(c)(2)-1.

[7] Section 1.381(a)-(1)(a) of the Income Tax Regulations provides that a corporation which acquires the assets of another corporation in certain liquidations and reorganizations shall succeed to, and take into account, as of the close of the date of distribution or transfer, the items described in section 381(c) of the distributor or transferor corporation. These items are taken into account by the acquiring corporation subject to the conditions and limitations specified in sections 381, 382(b), and 383 and the regulations thereunder.

[8] Section 1361(b)(3)(A) provides that a corporation which is a qualified subchapter S subsidiary (QSUB) shall not be treated as a separate corporation and all of its assets, liabilities, and items of income, deduction, and credit shall be treated as the assets, liabilities, and such items (as the case may be) of the S corporation.

[9] Section 1361(b)(3)(B) defines a QSUB as a domestic corporation which is not an ineligible corporation, if 100 percent of the stock of the corporation is owned by the S corporation, and the S corporation elects to treat the corporation as a QSUB. The statutory provision does not, however, provide guidance on the manner in which the QSUB election is made or the effective date of the election. The legislative history to the act provides "if an election is made to treat an existing corporation (whether or not its stock was acquired from another person or previously held by the corporation) as a qualified subchapter S subsidiary, the subsidiary will be deemed to have liquidated under sections 332 and 337 immediately before the election is effective." H.R. Rep. No. 586,104th Cong. 2d Sess. 89 (1996), 1996-3 C.B. 331, 427.

[10] On January 13, 1997, the Service published Notice 97-4, 1997-1 C.B. 351, providing a temporary procedure for making a QSUB election. Under Notice 97-4, a tax payer makes a QSUB election with respect to a subsidiary by filing Form 966, subject to certain modifications, with the appropriate service center. The election may be effective on the date Form 966 is filed or up to 75 days prior to the filing of the form, provided that date is not before the parent's first taxable year beginning after December 31, 1996, and that the subsidiary otherwise qualifies as a QSUB for the entire period for which the retroactive election is in effect.

[11] Section 1223(2) provides that the holding period for property however acquired includes the period for which such property was held by any other person, if such property has for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person.

[12] Section 1374 provides that for any taxable year beginning in the recognition period an S corporation has a net recognized built-in gain, there is a tax imposed on the income of such corporation for such taxable year.

[13] Section 1.1374-8(b) provides that a separate determination of tax is made with respect to the assets the S corporation acquires in one section 1374(d)(8) transaction from the assets the S corporation acquires in another section 1374(d)(8) transaction and from the assets the corporation held when it became an S corporation.

CONCLUSION

[14] Based solely on the facts submitted and the representations made, we rule as follows:

     1) Neither Z, X, nor the shareholders of X will recognize gain

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

                                   Sincerely,