Section 336(e) Elections: Tax Basis Step-Up Through Deemed...

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Section 336(e) Elections: Tax Basis Step-Up

Through Deemed Asset Sale TreatmentStructuring Qualifying Stock Dispositions for Partnership and Private Equity Acquirers

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WEDNESDAY, NOVEMBER 14, 2018

Presenting a live 90-minute webinar with interactive Q&A

Scott J. Bakal, Partner, Neal Gerber & Eisenberg, Chicago

Robert C. Stevenson, Attorney, Skadden Arps Slate Meagher & Flom, Washington, D.C.

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Neal, Gerber & Eisenberg LLP / Skadden, Arps, Slate, Meagher & Flom LLP and AffiliatesSection 336(e) Elections

Section 336(e) Elections

Scott J. Bakal & Robert C. Stevenson

Tax Basis Step-Up Through Deemed Asset Sale Treatment

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Presented By

•Scott J. Bakal

•Neal, Gerber & Eisenberg LLP

•www.nge.com

•Two North LaSalle Street, Suite 1700

•Chicago, IL 60602

•312.269.8022

•312.578.1545 (fax)

•[email protected]

•Robert C. Stevenson

•Skadden, Arps, Slate, Meagher & Flom LLP

•www.skadden.com

•1440 New York Avenue, N.W.

•Washington, D.C. 20005-2111

•202.371.7056

•202.661.9056 (fax)

•[email protected]

7


http://www.nge.com/

http://www.skadden.com/


Overview of Section 336(e) Elections

• A parent corporation that sells or distributes stock of a corporate subsidiary, or shareholders that sell

stock of an S corporation, may be subject to double taxation on a single economic gain

− Corporate parent taxed on sale of subsidiary stock, and subsidiary’s assets retain built-in gain

− Corporate parent taxed on built-in gain upon distribution of subsidiary stock if distribution does not qualify for tax-free

treatment, and there is no increase in basis of target’s assets

− Shareholders of S corporation taxed on sale of S corporation stock, but basis of target’s assets not increased to

reflect gain, so (i) potential double taxation if corporate level tax imposed as a result of terminated S status and (ii)

timing and/or character mismatches for the purchasing shareholder

• Section 336(e) authorizes the issuance of Treasury regulations under which an election may be made

to treat the sale, exchange, or distribution of at least 80 percent of the voting power and value of the

stock of a corporation (target) as a sale of all its underlying assets

− Purpose is to provide relief from potential double taxation of the same economic gain upon transfer of

appreciated corporate stock without corresponding basis step-up in assets of the corporation, by allowing

purchaser to step-up basis in acquired assets

• Enacted as part of General Utilities repeal in 1986

− Before repeal, corporations generally recognized no gain or loss on distribution of appreciated property to

its shareholders

• 27 years later, Treasury issued final regulations in 2013

− Proposed regulations issued in 2008. 73 Fed. Reg. 49965

− Final regulations issued on May 10, 2013 (TD 9619), effective for dispositions with a “disposition date” on or

after May 15, 2013

− Treasury plans to issue additional proposed regulations refining the section 336(e) rules

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Eligibility Requirements for Election

• A section 336(e) election is available if a domestic corporation (or S corporation

shareholder(s)) dispose of stock of a target corporation in a qualified stock

disposition (“QSD”)

• A QSD is any transaction(s) in which:

− Stock meeting the requirements of section 1504(a)(2) of a domestic corporation is sold,

exchanged, and/or distributed;

− by another domestic corporation (or S corporation shareholders);

− during a 12-month disposition period;

− stock basis to Purchaser not determined by stock basis to Seller;

− stock is not disposed of in a section 351, 354, 355 (except for section 355(d)(2) or

(e)(2) transactions in which gain recognized), or 356 transaction, or a transaction in

which the transferor does not recognize gain or loss realized;

− Sale is not a “qualified stock purchase” under section 338(d)(3); and

− stock is not disposed of to a related person

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Disposition – Sections 355(d) and (e)

• A disposition can also include a section 355 distribution to a person who is not a

related person in a transaction in which the full amount of stock gain would be

recognized pursuant to section 355(d)(2) or (e)(2).

• Stock may be considered disposed of if, under general principles of tax law,

Seller is considered to sell, exchange, or distribute the stock notwithstanding

that no amount is paid for (or allocated to) the stock (i.e., section 311

distribution).

• Stock disposed of and reacquired by Seller or a member of Seller’s consolidated

group during the 12-month disposition period is not considered disposed of

(similar rule for reacquisition by S corporation shareholder).

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Disposition – No Related Persons Rule

• “Disposition” does not include a transfer to a related person (exclusion not

required under section 336(e)).

• Consistent with section 338 regulations, person is “related” if stock in a

corporation owned by one of the persons would be attributed to the other person

under section 318(a), other than 318(a)(4) (option attribution).

• Sections 318(a)(2)(A) and 318 (a)(3)(A) do not apply to attribute stock

ownership from a partnership to a partner or vice versa if such partner owns,

directly or indirectly, interests representing less than 5% of the value of the

partnership. Reg. § 1.336-1(b)(12).

• Section 338(h)(3)(C) and Reg. § 1.338-3(b)(3) principles apply in determining

whether a person is related. Reg. § 1.336-1(b)(5)(iii).

− Thus, relatedness generally tested “immediately after” the disposition or last of a

series of dispositions.

11



Election Mechanics

• Election Mechanics(Treas. Reg. § 1.336-2(h))

− Seller(s) and Target must enter into a written, binding, agreement to make the election

− in the case of an S corporation target, all shareholders of the S corporation target must

enter into the agreement

• Timing (Treas. Reg. § 1.336-2(h))

− Election statement must be attached to the relevant federal income tax return(s)

− Seller(s) and target are members of consolidated group

» election statement filed on consolidated return and common parent must provide election

statement to target on or before due date (including extensions) of consolidated group’s

return

− Seller(s) and target are members of affiliated group not filing consolidated return:

» election statement filed with seller’s and target’s timely-filed returns.

− Target is an S corporation:

» election statement filed on the S corporation’s return (with extensions)

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Consequences of a 336(e) Election – Stock Sale

• Old Target is deemed to sell its assets to an unrelated person for the aggregate deemed asset disposition price (“ADADP”) at close of disposition date. Reg. § 1.336-2(b)(1)(i)(A).

• New Target is deemed to purchase its assets from an unrelated person for the adjusted grossed-up basis (“AGUB”). Reg. § 1.336-2(b)(1)(ii).

• For ADADP and AGUB purposes, Old Target liabilities deemed to be assumed by New Target are first determined as of the beginning of the day after the disposition date. Reg. §1.336-3(d)(2).

• Old Target is deemed to liquidate (typically under section 332) after the sale but before the close of the disposition date. Reg. § 1.336-2(b)(1)(iii).

• Seller’s E&P and other attributes are typically adjusted to account for Target’s attributes, taking into account gain or loss on the deemed sale.

13



Consequences of a 336(e) Election – Taxable

Distributions

• Old Target is deemed to sell all its assets to an unrelated party for ADADP.

• Gains are recognized, but net losses are disallowed in proportion to the amount of stock distributed (vs. sold) to implement the policy of section 311(b).

• New Target is deemed to purchase the assets from an unrelated party for AGUB.

• Old Target is deemed to distribute the consideration deemed received for the assets to Seller (generally a section 332 liquidation).

• Seller is deemed to purchase from an unrelated party the New Target stock. Reg. §1.336-2(b)(1)(iv).

• Seller is deemed to distribute the New Target stock, and no gain or loss is recognized to Seller.

• The distributees take fair market value basis, as in any other taxable distribution.

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Consequences of a 336(e) Election – Taxable Spins

355(d)/(e) “Sale to Self”

• Old Target sells its assets to an unrelated person in a single transaction in exchange for ADADP. Reg. § 1.336-2(b)(2)(i)(A).

• Old Target acquires its assets from an unrelated person in exchange for AGUB. Reg. §1.336-2(b)(2)(ii)(A).

• Old Target does not liquidate and retains tax attributes. Reg. § 1.336-2(b)(2)(i)(A)(1).

• Seller distributes the stock of Old Target. Seller recognizes no gain or loss on the distribution. Reg. § 1.336-2(b)(2)(iii).

• Distributee shareholders do not take a cost basis in the stock, and the AGUB formula would produce a mismatch between amount realized and basis in the deemed asset sale.

• Seller’s distribution of the Target stock is given effect. Thus, Target’s tax attributes remain intact. Target’s earnings and profits are adjusted to reflect gain or loss on the deemed asset sale.

• Target’s gains in the deemed asset sale are recognized in full, but Target’s net losses are disallowed in proportion to the amount of stock distributed.

15



Comparison of Sections 336(e) and 338(h)(10)

• Section 338(h)(10) Trumps - Section 336(e) election is not available for any

transaction that qualifies for a section 338(h)(10) election

• Unlike section 338(h)(10), section 336(e) applies even if:

− Purchaser of Target stock is not a corporate purchaser

− Purchaser is not a single entity

− “Creeping” transactions within 12-month period

• Section 336(e) regulations are intended to be similar to the Section 338(h)(10)

regulations in principle:

− Allocation of consideration in the deemed asset sale

− Determination of Target’s basis in its assets from deemed asset sale

− Allocation of foreign taxes paid by New Target attributable to foreign taxable income

earned by Old and New Target during the foreign taxable year

− Basis and holding period of any stock retained by Seller

16



Section 338(h)(10) vs. Section 336(e)

Section 338(h)(10) Section 336(e)

Joint seller and buyer election Seller and target election by agreement

Election w/n 8.5 months Election on tax return(s)

Corporate purchaser Corporate or non-corporate acquirer(s)

Seller is U.S. corporation, and Target is

affiliated (but not necessarily consolidated);

or Target is S corporation

Seller is U.S. corporation, and Target is

affiliated (but not necessarily consolidated);

or Target is S corporation

12-month acquisition period 12-month disposition period

Sale of 80% vote and value (excluding

section 1504(a)(4) stock)

Sale and/or taxable distribution of 80%

vote and value (excluding section 1504(a)(4)

stock)

Related person restriction (section 318(a)

attribution)

Related person restriction (section 318(a)

attribution but not between partnerships

with < 5% partners)

Not available if Seller or Target is foreign Not available if Seller or Target is foreign

17



Tax Planning Opportunities

• If Seller has higher inside basis in its assets than outside basis in its stock, it is tax

advantageous for Target to be deemed to sell its assets and liquidate. Conversely, it

would be tax disadvantageous if Seller has higher outside basis in stock than inside basis

in its assets.

• Expansion of basis step-up opportunities in the context of stock purchases

• Conversion of Target (C or S corporation) into a noncorporate pass-through entity without

the Purchaser/Acquirer incurring significant additional Federal income tax

− Conversion by state statute – transaction is deemed to take the form prescribed for

conversion under the CTB regulations (see, e.g., Rev. Rul. 2004-59)

− New Target forms pass-through entity, transfers assets to such entity, and liquidates

with shareholder(s) receiving ownership interests in exchange for stock

− New Target liquidates by distributing interests in its assets to shareholder(s), who

contribute interests to a pass-through entity

− New Target’s shareholder(s) contribute stock to a pass-through entity, and New Target

liquidates and distributes its assets to such pass-through entity

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Example 1

• Purchaser desires to purchase assets of S corporation, but transfer of assets

and contracts require consents that are too expensive, difficult, or time

consuming to obtain

• Purchaser acquires at least 80% of stock of S corporation from its shareholders

over 12-month period

• Selling shareholders and S corporation make section 336(e) election

• Purchaser assumes liabilities of S corporation, but also the economic benefits of

stepped-up basis in assets of S corporation

• Purchaser causes S corporation to become an LLC taxable as a partnership or

disregarded entity, and operates free of restrictions on S corporations

20



Example 2

• Purchaser acquires at least 80% of stock of C corporation subsidiary in

a transaction that is not a QSP (but is a QSD for seller)

• Selling corporate parent and Target corporate subsidiary make section

336(e) election

• Purchaser obtains stock in the C corporation subsidiary, which has a

stepped-up basis in its assets

• Purchaser causes C corporation subsidiary to become an entity taxable

as a disregarded entity or a noncorporate pass-through entity

21



Contingent Liability Transactions

• AGUB equals cash paid plus “liabilities” assumed.

• “Liabilities” for this purpose does not include amounts which are not currently

deductible or amounts not borrowed from a third party.

• Assume that the value of the asset of a target corporation are worth 100, the

assets are associated with 20 of liabilities, and that the Purchaser pays 80 for

the stock of the Target.

• The AGUB would equal 80, which would become the ADADP.

• On the deemed liquidation of the Target after filing a conversion election, the

value of the assets distributed equals 100 but basis is limited to 80, which

potentially triggers 20 of gain!

• Types of liabilities that might arise

− Environmental and other contingent liabilities

− Deferred compensation (404(a)(5))

− Obligations to Perform Future Services (Pierce)

− Economic Performance (461(h))

22



Future Regulatory Guidance

• Treasury’s Priority Guidance Plans has list section 336(e) regulations for several years now

• Related-person restriction: transfers to “related persons” can be treated as dispositions included in a

QSD

− Current regulations include a 5-percent threshold for determining whether the Seller and a Purchaser

are related persons

− Thus, a partner owning a 5 percent interest in both the Seller and the Purchaser can prevent

application of the section 336(e) election.

− IRS is considering increasing attribution threshold (50%?)

• “Creeping” dispositions of stock occurring on different dates

− Current regulations include sales and dispositions of Target stock over a 12-month disposition period

− Too complicated?

• Application of netted disallowed loss rule on a group basis

− Current regulations only allow recognition of losses by Target on deemed sale of assets to extent of

gain recognized by Target

− IRS is considering whether all of the corporations that join in making a Section 336(e) elections as

part of a distribution should be allowed to determine the amount of loss on a group basis

23



Related Party Transactions

Qualified Stock Purchase

Corp. 2

Target

Corp. 1

Pension Fund

A

5%5%

24




Not A Qualified Stock Disposition

PE Firm

Target

Seller Corp.

Pension Fund

A

5%5%

25




Not A Qualified Stock Disposition?

Buyer P/S

Target

Seller Corp.

26



Kimball-Diamond Doctrine Partial Repeal

• Kimbell-Diamond Doctrine – Acquisition of stock of a target corporation by an acquirer followed by a

liquidation or merger or the target into the acquirer pursuant to an integrated transaction is treated as an

acquisition of the target corporation’s assets for the consideration paid in form the target corporation’s

shareholders

− KD doctrine repealed in relation to qualified stock purchase (“QSP”) of a target corporation under Section

338, but what about section 336(e) transactions?

− Under “asymmetric” approach, the “form” of Transaction applies:

» Target corporation’s shareholders treated as transferring stock in exchange for consideration provided by acquirer

» Target corporation is treated as transferring its assets to the acquirer by liquidation or merger

− Under “symmetric” approach, the “Step Transaction” doctrine applies:

− Acquirer treated as acquiring assets of target in exchange for consideration provided in form to the target

shareholders

» target corporation is treated as distributing the consideration to its shareholders pursuant to liquidation distribution

• Regulatory “Clean Up” NOT likely to expand applicability of election to transactions involving foreign

corporations

27


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