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What is an "disposition or acquisition" for purposes of 410(b)(6)(C)?


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For many years, individuals A, B, and C own Corp. X 1/3, 1/3, 1/3, while A and B own Corp. Y 50-50. Also for many years, Corp. Y has a 401(a) plan that has not been adopted by Corp. A. Assume no affiliated service group has ever existed among X and Y.

In 2020, C retires and Corp. X redeems C's stock. For remainder of 2020, through today, A and B each own 50% of both Corp. A and Corp. B, so Corp. A and Corp. B comprise a brother-sister controlled group of corporations under IRC sec. 414(b).

The text of IRC sec. 410(b)(6)(C) says that the 1- to 2-year grace period rule applies when a company "becomes, or ceases to be" a member of a controlled or affiliated service group, which would literally cover the above fact situation, especially when one considers that in the redemption Corp. X acquired C's stock. However, the caption of IRC sec. 410(b)(6)(C), which could be used by a court in interpreting the provision, says that the rule applies to "CERTAIN DISPOSITIONS OR ACQUISITIONS," and Treas. Reg. 1.410(b)-2(f) says that for purposes of the rule, "the terms 'acquisition' and 'disposition' refer to an asset or stock acquisition, merger, or other similar transaction involving a change in employer of the employees of the trade or business." Thus, at least arguably, the provision's caption and the reg narrow the application of the rule to only those situations in which an employer becomes or ceases to be a member of a controlled group as part of what we would otherwise refer to as a "merger or acquisition." Moreover, the legislative history (at least the TRA '86 Blue Book) of 410(b)(6)(C) would seem to support such a narrow(er) interpretation, because the first sentence of its discussion of the change to 410(b) is, "The Act contains a special transition rule for certain acquisitions or dispositions of a business."

I reviewed Q 11:2 of the 6th Edition of Derrin Watson's "Who's the Employer," and I think it quite reasonably punts on this question, so I am looking to see whether others have had experience with this issue in the marketplace or have experience with arguing the issue with IRS.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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There are many modes and canons of interpretation a lawyer might consider.

Among these, consider the whole-text canon and the presumption of consistent usage within a text, especially for a public-law statute.

If different sections within a statute (or in rules interpreting or implementing different portions of a statute) use a common word and use it, at least partially, without reference to a special definition, one might presume the word ought to have some logically consistent meaning across the whole of the statute.

If C’s shares in corporation X had been C’s capital asset, does anything in the Internal Revenue Code of 1986 (unofficially compiled as title 26 of the United States Code), or a rule or regulation under it, require C somehow in her tax return to report or treat the redemption as a disposition of the capital asset?  Does C have a capital gain, or a capital loss?

If X was (in 2020) a subchapter S corporation, did anything in its tax-information reporting show the change in shareholders?

If X is (in 2021) a subchapter S corporation, how will it apportion the income passed through to the remaining shareholders—to A and B 50/50?

If an unrelated purchaser buys X (not as purchases of assets from X, but rather as a purchase of all X corporation shares), would A and B (but not C) get the price the purchaser pays for the shares?

Following out possible consequences of X’s redemption of C’s shares might show that, whatever the legal form, the redemption might have been, economically, C’s disposition (and perhaps, in some senses, A’s and B’s acquisitions).

A presumption of consistent usage might be persuasive if other aspects about possible interpretations are in equipoise (or if this presumption outweighs other aids to interpretation).

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I think there's a strong case for the transition rule applying, even though the transaction isn't a typical "merger or acquisition."

  • The intent of the rule is to provide a coverage transition when different businesses with employees move into or out of a controlled group as a result of corporate transactions. Although not necessarily an acquisition or disposition of an entire business by a third party, the two entities here are nonetheless moving from standalone entities (each a separate "employer") into a controlled group (now combined as one single "employer"). So on its face it doesn't seem to be a clear violation of the spirit of the rule.
  • As a more stark example, if X was instead owned 99% by Individual C and 1% by an unrelated company, and X redeemed all 99% of C's stock to become a wholly owned subsidiary of the unrelated company, I think you would be hard-pressed to argue that's not a "similar transaction" to C's sale of stock to the unrelated company. 
  • Arguably Corporation X's redemption of C's stock is an "acquisition" of C's stock by X (and C's sale is a "disposition" of the same stock). 
  • Arguably A and B have "acquired" C's stock in the sense that their proportionate ownership of all outstanding shares has increased from 66% to 100%.
  • Even if not, I think it can be fairly characterized as a "similar transaction" based on the circumstances. If, instead of having X redeem C's stock, C sold his/her shares equally to A and B, that would have the same effect as the redemption and would fit more squarely into the "disposition" and "acquisition" terminology. 

I don't have any inside line on the IRS's interpretation, but I read the "similar transaction" provision to mean that, as long as the end result is the same as an acquisition or disposition, the procedural form of the transaction shouldn't change the analysis. 

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1 hour ago, EBECatty said:

As a more stark example, if X was instead owned 99% by Individual C and 1% by an unrelated company, and X redeemed all 99% of C's stock to become a wholly owned subsidiary of the unrelated company, I think you would be hard-pressed to argue that's not a "similar transaction" to C's sale of stock to the unrelated company. 

Agreed, but how about this as a "stark" example, the other way: A and B own X 50-50 and A, B, C, D, and E own Y 35-35-10-10-10. E dies and without any disruption to Y's business, pursuant to an unfunded cross-purchase buy sell agreement, E's 10% is put up for sale by E's estate to A, B, C, and D. C and D decline to purchase any shares, but A and B purchase all of them, in any proportion. Does the transition rule apply, or not? It's a very sympathetic situation for application of the transition rule, but not because what occurred seems like, as per the regulation, what we would typically think of as "an asset or stock acquisition, merger, or other similar transaction involving a change in employer of the employees of a trade or business," but because, at least without additional facts, the emergence of a controlled group in this example seems a trap for the unwary, making it sympathetic to allow the taxpayers a little time to catch wind of this tax ramification of their actions.

If you just read the operative text of 410(b)(6)(C), and do not let yourself be influenced by the caption, legislative history, or, arguably, the reg, you would say that the transition rule applies in the above situation. But that changes the rule from what I at least thought it was, i.e., a rule for corporate acquisitions and dispositions, to a free pass for up to two years seemingly almost any time a controlled group is formed.

Try this one: A and B own X 50-50 for years. Decide to form Y to pursue a new business, and own that 50-50 as well. Create and capitalize Y. That's an acquisition of shares, right? Does the resulting CG not count until the end of the following year? What if there is no A and B, just A, who owns X 100% and Y 100%?

Absent some other BenefitsLink regular's having experience of interacting with IRS over these issues (if you're out there, I hope you'll chime in), perhaps the only other approach that may shed a little light on the subject is to ask: Did others, like me, perhaps mistakenly, understand 410(b)(6)(C) from the get-go as a rule for corporate M&A, whether  by large or small companies, so that they are surprised by the potential reach of the rule if the text of the rule ("if a person becomes, or ceases to be") is all that is applied, or did you always see it as a rule that essentially delays the applicability of the controlled group rules to ANY new controlled group (except, perhaps, to simultaneously created entities)?

I have to say, Peter and EBECatty, that it's surprising to me that 35 years after the rule's enactment the IRS has not clarified this any more than it has, apparently.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Without having the 6th edition to compare, the 8th edition (2020) of Who's the Employer? seems to favor a broader interpretation regarding "non-M&A" transactions still getting the benefit of the transition rule. No concrete authority is cited beyond the statutory text. 

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2 hours ago, EBECatty said:

Without having the 6th edition to compare, the 8th edition (2020) of Who's the Employer? seems to favor a broader interpretation regarding "non-M&A" transactions still getting the benefit of the transition rule. No concrete authority is cited beyond the statutory text. 

Thanks, EBECatty. So no real change, which makes sense because I don't think there has been any guidance in between the two editions.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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