By Jorge Otoya, Bird Education Specialists in Taxation, LLC
A Trust goes in for a
ruling to address various partnership related issues dealing with the formation
of a securities partnership that resulted from certain trust
distributions. Below is a brief
summary of the facts and issues the IRS addressed, including a noteworthy
observation. Many representations
were made that appear to water down the value of the ruling:
Facts
A trust that holds,
cash, securities, and 100% interest in a limited liability company (treated as
a disregarded entity) that holds mainly securities is required to distribute
all of its assets less a contingency reserve to its beneficiaries as a result
of the death of all but one of the beneficiaries in a beneficiary group. The securities are actively traded
within the meaning of section 1092(d)(1) and will continue to be after the
distributions. Given the reserve,
it plans to make these distributions in steps. Step 1: Form
Series LLC X (Series X) and Series LLC Y (Series Y). The trust and the disregarded entity contribute to Series X
certain equity securities and to Series Y fixed income securities. Step 2: Trust will distribute out the
ownership in Series X and Series Y to the beneficiary groups. By default, two partnerships will be
formed upon the distribution with the beneficiary groups as the partners
because each Series X and Y will have multiple owners. Step 3: At the election of the
beneficiaries, the Trust will subsequently either (i) make subsequent in-kind
distributions to the beneficiary group for them to keep; or (ii) contribute the
in-kind distributions to the new partnership
1.) Taxpayer: On Step 1 formation, will Series X and
Y be treated as disregarded entities prior to distribution to
beneficiaries? IRS: Yes. (Taxpayer represented that each series
would be treated as a juridical entity under the Proposed Regulations.
2.) Taxpayer: On Step 2, will the formation of Series
X partnership and Series Y partnership be accomplished by a deemed distribution
of the assets of each series and a recontribution of those assets to a new
partnership by the beneficiaries?
IRS: Yes. Under Rev. Rul.
99-5 principles.
3.) Taxpayer: On Step
3, will the subsequent in-kind contributions to the new partnerships on behalf
of the beneficiaries be treated as a distribution of assets to the
beneficiaries followed by a subsequent contribution by those beneficiaries of
the distributed property to the existing partnerships? IRS..Yes, under the principles we used
to answer #2 above.
4.) Taxpayer: If Yes on
Step 2, is the partial-netting approach of aggregation reasonable under our
facts? IRS: Yes, but don’t play
games with it.
5.) Taxpayer: If Yes on
Step 2, can the new partnerships use aggregation on the property contribution
for purposes of section 704(c)?
IRS: Sure, but don’t play games with it and keep sufficient records to
comply with mixing bowl rules.
6.) Taxpayer: If Yes on
Step 2, are the beneficiaries treated as eligible partners even though their
contributions were deemed asset contributions? Under this designation, a partner does not recognize gain on
the distribution of marketable securities in excess of outside basis if other
requirements are satisfied. These
requirements are meant to weed out partnerships that are not fully engaged in
investment. IRS: Yes.
Observation:
At first glance, this
PLR does not seem to have wide spread applicability, given that it deals with
certain investment partnerships.
One item, however, is particularly noteworthy. Specifically, the IRS based its conclusion on Item 2 above
on the principles of Situation 1 of Revenue Ruling 99-5. The facts of Situation 1 include the
sale of 50% of the ownership interest in a single member limited liability
company without liabilities. This
is a taxable sale and there is some degree of uncertainty as to whether the
principles of Situation 1 would apply to a tax-deferred transaction. In this regard, this PLR gives us a recent
glimpse of the view of the IRS’s on this issue.
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