Introduction: Prior to St. 2003, c. 4, § 18, effective March 5, 2003, a qualified subchapter S subsidiary ("QSUB"), as defined under I.R.C. § 1361, as amended and in effect for the taxable year, was not subject to the entity level taxes imposed on certain S corporations under G.L. c. 63, § 32D (unless its parent was a Massachusetts S corporation subject to § 32D). Moreover, it was not subject to the financial institution excise under G.L. c. 63, § 2 if its parent was a Massachusetts corporate trust or some other entity that was not a financial institution. LR 01-9. Rather, all of its income was treated as though earned by and taxed to its parent. See e.g., LRs 99-17, 01-1, 01-9, 02-3, and 02-7.

Massachusetts S corporations, in contrast, have for many years been subject to entity level taxation under § 2 as financial institutions or under § 32D as Massachusetts S corporations, if certain threshold requirements specified in that section are met. Accordingly, corporations that qualified federally as S corporations that were subject to tax under G.L. c. 63, § 2 or § 32D began to reorganize as QSUBs of federal S corporation parents that, for Massachusetts purposes, were corporate trusts, partnerships, or other entities not subject to taxation under c. 63, in order to avoid taxation under §§ 2 and 32D. See, e.g., LRs 99-17, 01-1, 01-9, 02-3, and 02-7.

With the enactment of St. 2003, c. 4, § 18, a QSUB is subject to taxation under G.L. c. 63, § 32D, if (1) it has income that would have been taxed to it for federal income tax purposes had it been treated federally as a separate S corporation or (2) it has total receipts for the taxable year, computed under the rules for combining and aggregating total receipts at 830 CMR 62.17A.1(11)(e) and (f), of $6 million or more. G.L. c. 63, § 32D (a)(i) and (ii). Additionally, as stated in TIR 03-20, which explains St. 2003, c. 4, § 18, any QSUB that is not subject to the financial institution excise under G.L. c. 63, § 2 because its parent is not a financial institution, also is subject to taxation under G.L. c. 63, § 32D, as applicable.

Notwithstanding the above, a Massachusetts S corporation parent's items of income, loss, deduction, and credit, together with those of its QSUB(s), continue to pass through and be taxable to shareholders to the extent such pass through is required under G.L. c. 62, § 17A and 830 CMR 62.17A.1(5)-(7). See TIR 03-20. Additionally, a QSUB's income also continues to be taxed to its parent, if its parent is a non-S corporation parent such as a Massachusetts corporate trust or financial institution, or to its partners if it is a partnership. Id. Consequently, with the enactment of St. 2003, c. 4, § 18, the Massachusetts tax incentive to reorganize an S corporation as a QSUB of a corporate trust, partnership, or other entity parent has been largely eliminated.

As a result, many tax practitioners have sought Department of Revenue ("Department") guidance because their clients are contemplating reverting to their pre-LR 99-17 organizational structures, or reorganizing in some other way. Before the issuance of that ruling, most of these clients operated simply as stand-alone Massachusetts S corporations. This Directive discusses the income tax ramifications of various reorganizational options.

Issue 1: Unwinding of LR 99-17 Reorganizations - Downstream Merger of Massachusetts Corporate Trust Parent into QSUB

Will the merger of a Massachusetts corporate trust parent into its QSUB trigger the recognition of any taxable income to either entity or to the shareholders of the corporate trust?

Directive 1:

Merging a Massachusetts corporate trust parent into its QSUB will not trigger the recognition of any taxable income to either entity or to the shareholders of the corporate trust as long as the merger qualifies as a tax-free "F" reorganization for federal income tax purposes.

Discussion:

Federally the Massachusetts corporate trust parent is an S corporation. The Internal Revenue Service ("IRS") has indicated that it will allow taxpayers to treat the merger of an S corporation parent into its QSUB as a reorganization under I.R.C. § 368(a)(1)(F), i.e., a tax-free "F" reorganization, if the transaction otherwise satisfies the requirements of that subsection. Treas. Reg. § 1.1361-5(b)(3), Example 8. In Example 8, it is stated that the S corporation parent would merge into the QSUB under state law, causing the QSUB election to terminate, resulting in the formation of a new corporation for tax purposes into which the S corporation parent would merge. The formation of the new corporation for tax purposes and the merger of the S corporation parent into it would qualify as a tax-free "F" reorganization under Example 8, if the transaction otherwise satisfies the requirements of that subsection.

Massachusetts law generally adopts the federal provisions allowing for tax-free "F" reorganizations when the reorganization involves a corporate trust. See G.L. c. 62, § 8(a), wherein it is stated that a corporate trust is treated as a corporation for purposes of I.R.C. §§ 351 through 368, LR 02-7, and DOR-D 00-9. Accordingly, merging a Massachusetts corporate trust parent into its QSUB will not trigger the recognition of any taxable income to either entity or to the shareholders of the corporate trust as long as the merger qualifies as a tax-free "F" reorganization for federal income tax purposes.

Issue 2: Restoring the Pre-LR 99-17 Structure and Tax Treatment as Result of Downstream Merger

The purpose of merging the corporate trust into its QSUB generally would be to re-establish the Massachusetts organizational structure and tax treatment that typically applied to taxpayers before LR 99-17. Typically, prior to LR 99-17, taxpayers were classified as stand-alone S corporations for both federal and Massachusetts tax purposes. Will merging a corporate trust into its QSUB accomplish that goal?

Directive 2:

Generally yes. Restoring the organizational structure and tax treatment that typically applied to taxpayers before LR 99-17 can be accomplished using the above restructuring as long as it qualifies as a tax-free "F" reorganization for federal income tax purposes and the corporation formed as a result is eligible to treat itself as a federal S corporation. Every federal S corporation also may be a Massachusetts S corporation as long as it otherwise satisfies the requirements set forth in the definition of "Massachusetts S corporation" under 830 CMR 62.17A.1(2).

Discussion:

The IRS has indicated that in the event a federal S corporation ("Old Co") merges into its QSUB and the QSUB survives the merger under state law causing the formation of a new corporation for tax purposes ("New Co"), Old Co's S election under I.R.C. § 1362(a) will continue in effect and will be applicable to New Co without the necessity of filing a new election on behalf of New Co, provided that the merger qualifies as an "F" reorganization, and provided further that New Co meets the requirements of an S corporation under I.R.C. § 1361. See Priv. Ltr. Rul. 199945021 (Aug. 12, 1999); Rev. Rul. 64-250, 1964-2 C.B. 333.

Any corporation formed as a result of the merger of a corporate trust into its QSUB that is classified as a federal S corporation also will be classified as a Massachusetts S corporation as long as it otherwise satisfies the requirements set forth in the definition of "Massachusetts S corporation" under 830 CMR 62.17A.1(2).

For a discussion of the Massachusetts tax treatment of post-merger distributions from a Massachusetts S corporation that previously was a QSUB owned by a corporate trust, see DOR-D 04-2.

Issue 3: Filing Issues as Result of Downstream Merger in Directive 1

How should the Massachusetts S corporation formed as the result of the "F" reorganization described in Directive 1 above (formed as the result of the merger of a corporate trust parent into its QSUB) file a return and report income, gross receipts, property, payroll, sales and other relevant tax attributes for the taxable year in which the reorganization takes place? Additionally, are final returns required to be filed by the corporate trust and QSUB?

Directive 3:

A. The Massachusetts S Corporation. The Massachusetts S corporation must file Form 355S, S Corporation Excise Return, to report its corporate excise for the taxable year in which the reorganization takes place. In addition, the Massachusetts S corporation must file a Schedule SK-1, Shareholders' Massachusetts Information . Assuming that the IRS allows the S corporation formed as the result of the "F" reorganization described in Directive 1 above to retain the previously existing S corporation's taxpayer identification number when reporting its income to the federal government, it also may use such number (i.e., the previously existing corporate trust's taxpayer identification number) when filing its Form 355S with the Commonwealth.

B. The QSUB. For Massachusetts income tax purposes, a QSUB has always been required to file a Form 355S, as an independent taxpayer separate from its parent, to report the non-income measure of the corporate excise imposed under G.L. c. 63, § 32(a)(1) or § 39(a)(1), or the minimum corporate excise imposed under G.L. c. 63, § 32(b) or § 39(b), currently $456. More recently, pursuant to St. 2003, c. 4, § 18, effective March 5, 2003, the QSUB also is required to report on its Form 355S the income measure of the corporate excise under G.L. c. 63, § 32(a)(2), § 39(a)(2), and § 32D(i) and (ii), as applicable. Thus, the QSUB must file a final Form 355S (even though, as discussed in Directive 2, the same legal entity survives as a Massachusetts S corporation) to report any corporate excise it may owe for the taxable year in which the reorganization takes place. "Final return" should be clearly noted thereon. If the QSUB had obtained a separate federal taxpayer identification number for use in filing its Form 355S such words will serve as notice to the Department that the QSUB's federal taxpayer identification number is no longer applicable. More likely however, the QSUB used its corporate trust parent's taxpayer identification number in filing its Form 355S, in which case a second note should be added to the QSUB's final return stating that "the taxpayer identification number appearing on this return will continue to be used by the S corporation formed as the result of the F reorganization described in Directive 1 of Directive 04-1, when filing its Form 355S with the Commonwealth."

C. The Massachusetts Corporate Trust. The Massachusetts corporate trust is not required to file a final return in the taxable year in which the reorganization takes place. Rather, its items of income, loss, deduction, and credit, together with those of its QSUB, attributable to the period before they cease to exist for Massachusetts tax purposes are to be included on the Schedule SK-1 prepared by the Massachusetts S corporation. Moreover, the corporate trust's assets and liabilities, while it still existed for Massachusetts tax purposes, are to be included in determining the S corporation's corporate excise attributable to the non-income measure, assuming such items were acquired by the S corporation as a result of the reorganization and continue to be held by it on the last day of its taxable year. Additionally, the property, payroll, and sales of the corporate trust, while it still existed for Massachusetts tax purposes, are to be included by the S corporation in determining the latter's apportionment factors for purposes of computing its non-income measure of the corporate excise and completing its Schedule SK-1. Finally, the corporate trust's total receipts are to be combined with those of the QSUB and S corporation in determining whether and at what rate the latter two are subject to taxation under G.L. c. 63, § 32D(a)(ii) for the taxable year in which the reorganization takes place.

Discussion:

A. Computing Total Receipts. In determining whether and at what rate the Massachusetts S corporation and QSUB are subject to taxation under G.L. c. 63, § 32D(a)(ii) for the taxable year in which the reorganization takes place, their aggregated total receipts for such year are to be computed as stated in section II of TIR 03-20. Accordingly, the S corporation's "total receipts," as defined in G.L. c. 63, § 32D(b)(2)(a) and 830 CMR 62.17A.1(2), from the date of the conversion to the end of its taxable year are to be combined with those of the corporate trust (which would include the receipts of the QSUB) from the first day of its taxable year until the date of conversion. The aggregated total receipts of all such entities must include income taxable at the entity level under G.L. c. 63, § 32D(a)(i).

In computing the aggregated total receipts, each entity required to aggregate total receipts must first compute its total receipts separately for the taxable year in which the reorganization takes place. In computing the QSUB's total receipts, the annualization rule at 830 CMR 62.17A.1(11)(c) will apply, assuming the QUBS's taxable year is less then twelve months, which depends upon when the reorganization takes place. If the taxable year in which the reorganization takes place includes March 5, 2003, the QSUB must include in its calculation all of its receipts for such taxable year, without regard to the March 5, 2003 date. In computing the S corporation's total receipts, the above-noted annualization rule will not apply, as the reorganization is, for federal income tax purposes, an "F" reorganization and, thus, does not create a short taxable year for the S corporation in the year of the reorganization. DOR-D 00-9, footnotes 1 and 2. For Massachusetts income tax purposes, "taxable year" means "any fiscal or calendar year or period for which the corporation is required to make a return to the federal government." G.L. c. 63, § 30. See also G.L. c. 62, § 1.

B. Computing QSUB's Net Income Subject to Tax Under G.L. c. 63, § 32D. The QSUB must compute its net income subject to tax under G.L. c. 63, § 32D (a)(i) and (ii) of the corporate excise for purposes of its final Form 355S as specified in section III of TIR 03-20. Accordingly, assuming that the reorganization takes place in a taxable year that includes March 5, 2003, the QSUB must compute its net income based solely on its own items of income, loss, deduction, and credit for the period beginning March 1 or 5, 2003, and ending on the date it ceases to exist for Massachusetts tax purposes. Additionally, the QSUB may compute its net income on a pro rata basis. Alternatively, an actual accounting of the QSUB's net income for the period may be made. See TIR 03-20, section III, which provides a one time exception to the general rule that the income measure of the corporate excise may not be prorated. The exception is applicable only to a QSUB's taxable year that includes March 5, 2003.

In the event that the reorganization takes place in a subsequent year, the period for which the QSUB must compute its net income will begin on the first day of its taxable year and end on the date it ceases to exist for Massachusetts tax purposes. Also, an actual accounting of the QSUB's net income for the period must be made.

C. Computing QSUB's Non-Income Measure of Corporate Excise. In completing its final Form 355S, the QSUB must compute any non-income measure of the corporate excise it may owe based entirely on its own assets and liabilities. In determining the non-income measure of the excise for a short taxable year, it may be prorated by multiplying the excise by the number of calendar months (including partial months) in the taxable year and dividing the resulting amount by twelve.

D. Determining QSUB's Apportionment Factors. The QSUB must determine its apportionment factors for purposes of its final Form 355S as specified in section V.A. of TIR 03-20.

E. Computing Massachusetts S Corporation's Net Income Subject to Tax Under G.L. c. 63, § 32D. Generally, the Massachusetts S corporation must compute its net income for purposes of G.L. c. 63, § 32D (a)(i) and (ii) of the corporate excise in the year of the reorganization based solely on its own items of income, loss, deduction, and credit. However, because the S corporation was formed as a result of the "F" reorganization discussed in both Directives 1 and 2 above, the credit and net operating loss carryovers incurred by the QSUB before the reorganization may be applied to offset the Massachusetts S corporation's tax liability. Additionally, any unused amount of credit or loss may be carried over to the S corporation's succeeding taxable years. See 830 CMR 62.17A.1(3)(b)(3) and 830 CMR 63.30.2(9).

F. Computing Massachusetts S Corporation's Non-Income Measure of Corporate Excise. The Massachusetts S corporation must compute any non-income measure of the corporate excise it may owe in the year of the reorganization based not only on its own assets and liabilities but on those of the QSUB and corporate trust prior to the reorganization, assuming that such items were acquired by the S corporation as a result of the reorganization and continue to be held by it on the last day of its taxable year. The Massachusetts S corporation's non-income measure of the excise may not be prorated, because, as discussed in subsection A immediately above, the S corporation's taxable year is not a short taxable year. A short taxable year is the only case in which the General Laws specifically allows for proration of the non-income measure of the corporate excise based on the number of months in the short year. G.L. c. 63, §§32, 39.

The above notwithstanding, the Department will allow the Massachusetts S corporation to claim a one-time credit against any excise it may owe in the year of the reorganization attributable to its non-income measure equal to the non-income measure of the excise paid by the QSUB in such year as long as the following two requirements are met. First, the credit must be claimed by striking out one of the S corporation's unused credits on Form 355S, line 7 through 17, and adding on the dotted line next to the struck language the words "QSUB credit allowed under Directive 3 of Directive 04-1." Second, a copy of the QSUB's Form 355S must be attached to the Form 355S filed by the Massachusetts S corporation.

G. Completing Massachusetts S Corporation's Schedule SK-1 in the Year of the Reorganization.In completing a Schedule SK-1 for the taxable year in which the reorganization takes place, the Massachusetts S corporation must include thereon not only its own items of income, loss, deduction, and credit for the taxable year, but those of the QSUB and the corporate trust before they ceased to exist for Massachusetts income tax purposes.

H. Determining Massachusetts S Corporation's Apportionment Factors. The Massachusetts S corporation must determine its apportionment factors in the year of the reorganization for purposes of determining its income measure of the corporate excise under c. 63 based solely on its own property, payroll, and sales.

For purposes of determining its non-income measure, the S corporation must determine its apportionment factors based not only on its own property, payroll, and sales but on those of the QSUB and corporate trust prior to reorganization, assuming that such items were acquired by the S corporation as a result of the reorganization and continue to be held by it on the last day of its taxable year.

For purposes of determining a non-resident shareholder's distributive share of income, loss, deduction, and credit taxable in Massachusetts under G.L. c. 62, § 17A and 830 CMR 62.17A.1(6) in the year of the reorganization for purposes of Schedule SK-1, the S corporation must determine its apportionment factors by including the property, payroll, and sales of the QSUB and corporate trust before they ceased to exist for Massachusetts tax purposes.

Issue 4: Unwinding of LR 99-17 Reorganizations - Upstream Merger of QSUB into its Corporate Trust Parent

Will the unwinding of a LR 99-17 type reorganization by merging a QSUB into its corporate trust parent trigger the recognition of any taxable gain or loss to either entity? Additionally, will the merger qualify as a statutory merger under G.L. c. 156B, § 83?

Directive 4:

The answer to the first question is no. The unwinding of a LR 99-17 type reorganization by merging a QSUB into its corporate trust parent will not trigger the recognition of any taxable gain or loss to either entity. Thus, the QSUB will not recognize gain or loss upon distribution of its appreciated or depreciated property. Consequently, the corporate trust will not get a step up in basis in the assets transferred to it by the QSUB.

The answer to the second question is also no. Merging a QSUB into its Massachusetts corporate trust parent does not presently qualify as a statutory merger under G.L. c. 156B, § 83, as that section expressly allows only for the merger of a Massachusetts corporate trust into a corporation, not, as is the case at hand, the merger of a corporation into a corporate trust. However, effective July 1, 2004, merging a QSUB into its corporate trust parent will be allowed under Massachusetts law. See G.L. c. 156D, §§ 1.40 and 9.50.

Discussion:

Although the non-recognition of gain or loss and basis rules set forth in this Directive are identical to those that would have applied had the federal provisions under I.R.C. §§ 332 and 337 allowing for a tax-free liquidation of a subsidiary been allowed, those two sections do not represent the authority for this Directive. The tax-free nature of the unwinding of the QSUB into the corporate trust arises because there is now no liquidation to be taxed. Under Treas. Reg. § 1.1361-4, the original QSUB election in the earlier LR 99-17 transaction resulted in the deemed liquidation of the QSUB into the S corporation for federal income tax purposes whether the liquidation was governed by IRC §§ 332, 337 or 368. At the same time, for Massachusetts income tax purposes, the QSUB was deemed liquidated into the corporate trust. However, the deemed liquidation of the QSUB did not affect its taxation under the non-income measure of the corporate excise.

In computing gross income for Massachusetts income tax purposes, a corporate trust is not permitted to take advantage of the nonrecognition provisions of I.R.C. §§ 332 and 337. G.L. c. 62, § 8(a). Despite public written statements such as LRs 81-2, 84-25, and 95-6, for example, issued by the Department that state otherwise, for Massachusetts tax purposes, corporate trusts meeting the definition of G.L. c. 62, § 1(j) and falling within G.L. c.62, § 8(a), are generally taxable as resident natural persons under § 8, regardless of their treatment for federal tax purposes. G.L. c. 62, § 8(a). See also Minkin v. Commissioner of Revenue, 425 Mass. 174, 179 (1997); and Shafner v. Commissioner of Revenue, 392 Mass. 256, 258 (1984). Accordingly, for purposes of income and capital gains recognition, corporate trusts are treated as individuals. G.L. c. 62, § 8(a). Minkin at Id. An exception is as follows: corporate trusts are treated as corporations only for purposes of incorporation and reorganization under I.R.C. §§ 351 through 368. G.L. c. 62, § 8(a); Minkin at Id.

To the extent that the Department's past public written statements have stated otherwise, this Directive reaffirms the rule that the corporate non-recognition provisions of the Code that apply to corporate trusts are limited to those set forth in §§ 351-368. This change in policy will be applied prospectively from July 1, 2004.

Issue 5: Filing Issues as Result of Upstream Merger in Directive 4

Directive 4 involves the unwinding of a LR 99-17 reorganization by merging a QSUB into its corporate trust parent. How should the surviving corporate trust file a return and report income, gross receipts, property, payroll, sales and other relevant tax attributes for the taxable year in which the reorganization takes place? Additionally, is a final return required to be filed by the QSUB?

Directive 5 :

A. The Massachusetts Corporate Trust. The surviving corporate trust must file Form 3F, Income Tax Return of Corporate Trust, to report its income for the taxable year in which the reorganization takes place.

B. The QSUB. The QSUB must file a final Form 355S to report any corporate excise it may owe for the taxable year in which the reorganization takes place. "Final return" should be clearly noted on the return. In the event the QSUB used its corporate trust parent's taxpayer identification number in filing its Form 355S, a second note should be added to the QSUB's final Form 355S stating that "the taxpayer identification number appearing on this return will continue to be used by the surviving corporate trust when filing its required Form 3F."

Discussion:

A. The Massachusetts Corporate Trust. The surviving corporate trust must include in its return of income, Form 3F, for the taxable year in which the reorganization takes place, all income that it earns on its own account for the taxable year, plus all income earned by the QSUB up until it ceases to exist for Massachusetts tax purposes. Additionally, in determining the corporate trust's apportionment factors for purposes of its Form 3F, the corporate trust must take into account the property, payroll, and sales of the QSUB up until it ceases to exist for Massachusetts tax purposes.

B. The QSUB. In determining whether and at what rate the QSUB is subject to taxation under G.L. c. 63, § 32D(a)(ii) for the taxable year in which the reorganization takes place, its total receipts are to be computed as specified in section II of TIR 03-20. Accordingly, the QSUB's total receipts, computed from the first day of its taxable year until the date it ceases to exist for Massachusetts tax purposes, are to be combined with those of the corporate trust. The aggregated total receipts may be adjusted to avoid double counting but must include income taxable at the entity level under G.L. c. 63, § 32D(a)(i).

In computing the aggregated total receipts, each entity must first compute its total receipts separately for the taxable year in which the reorganization takes place. In computing the QSUB's total receipts for the taxable year in which the reorganization takes place, the annualization rule at 830 CMR 62.17A.1(11)(c) will apply, assuming the QSUB's taxable year is less then twelve months, which depends upon when the reorganization takes place. If the taxable year in which the reorganization takes place includes March 5, 2003, the QSUB must include in its calculation all of its receipts for such taxable year, without regard to the March 5, 2003 date.

For purposes of its final Form 355S, the QSUB must compute any net income subject to tax under G.L. c. 63, § 32D (a)(i) and (ii) of the corporate excise, any non-income measure of the corporate excise, and its apportionment factors as specified in subsections B,C, and D of the Discussion section in Directive 3 above.

Issue 6: Unwinding of LR 01-9 Reorganizations - Downstream and Upstream Mergers Involving a Financial Institution

A LR 01-9 type reorganization, just like a LR 99-17 type reorganization, involves the restructuring of a stand-alone Massachusetts S corporation by converting it into a wholly owned subsidiary, i.e., a QSUB, of a corporate trust holding company. The only factual difference between the two is that in LR 01-9, the stand-alone Massachusetts S corporation turned QSUB is a "financial institution" within the meaning of G.L. c. 63, § 1(e). Is this factual difference significant, or, will Directives 1, 2, 3, 4, and 5 above, applicable to LR 99-17 type reorganizations, apply to the unwinding of a LR 01-9 type reorganization?

Directive 6:

Notwithstanding the factual difference, the unwinding of a LR 01-9 type reorganization is generally no different from the unwinding of a LR 99-17 type reorganization. Thus, Directives 1, 2, and 4, will apply to the earlier case.

Directive 5, which discusses what returns to file and how to report income and other tax attributes as a result of a merger of a QSUB into its corporate trust parent, also will apply to the unwinding of a LR 01-9 type reorganization, as the surviving corporate trust will be taxed under G.L. c. 62, § 8 as a corporate trust, not as a financial institution under G.L. c 63, § 2. Corporate trusts generally fall outside the definition of financial institution in G.L. c. 63, § 1(a) through (e). TIR 03-20, section X. This was the case for the corporate trust in LR 01-9. As noted therein, it did not meet any of the definitions contained in sections (a) through (e) of § 1. Thus, both the surviving Massachusetts corporate trust and the QSUB will file returns and report income and other tax attributes for the taxable year in which the reorganization takes place as specified in Directive 5.

Directive 3, in contrast, which discusses what returns to file and how to report income and other tax attributes as a result of a merger of a corporate trust parent into its QSUB, applies only in part to the unwinding of a LR 01-9 type reorganization, as the Massachusetts S corporation formed as a result of the merger will be taxed as a financial institution under G.L. c 63, § 2, not as an S corporation. The QSUB, however, will file returns and report income and other tax attributes for the taxable year in which the reorganization takes place exactly as specified in Directive 3.

Discussion:

In unwinding a LR 01-9 reorganization as discussed in Directive 3 (by merging a corporate trust parent into its QSUB), the resulting S corporation which is also a "financial institution" within the meaning of G.L. c. 63, § 1, will not be subject to the non-income measure of the corporate excise imposed under G.L. c. 63, § 32(a)(1) or § 39(a)(1); the minimum corporate excise under G.L. c. 63, § 32(b) or § 39(b); or to the entity level tax under G.L. c. 63, § 32D. Rather, it will be subject to tax as a financial institution under G.L. c. 63, § 2. TIR 03-20, section X. Thus, it must file Form 63FI, Massachusetts Financial Institution Excise Return, not Form 355S, as stated in Directive 3. In addition, it must file Schedule SK-1.

In computing its net income subject to tax under § 2 for the taxable year in which the reorganization takes place, the financial institution should do so based solely on its own items of income, loss, deduction, and credit. Credit and net operating loss carryovers incurred by the QSUB before the reorganization can be used, as applicable, to offset the financial institution's tax liability. In completing its Schedule SK-1 and in determining its apportionment factors for purposes of Form 63FI and Schedule SK-1, the financial institution should proceed exactly as the S corporation is directed to proceed in Directive 3, in completing its Schedule SK-1 and in determining its apportionment factors for purposes of Form 355S and Schedule SK-1. See subsections G and H of the Discussion section in Directive 3.

Issue 7: Unwinding Reorganizations Exemplified by LRs 01-1, 02-3, and 02-7- Downstream Merger of Partnership Parent into its QSUB

Reorganizations exemplified by LRs 01-1, 02-3, and 02-7, just like a LR 99-17 type reorganization, involve, for federal income tax purposes, the restructuring of a stand-alone S corporation by converting it into a wholly owned subsidiary, i.e., a QSUB, of a federal S corporation parent. For Massachusetts income tax purposes, the only factual difference between LR 99-17 and the three rulings at issue is that in LR 99-17 the parent is a corporate trust, whereas, in the other three rulings the parent is a partnership.

Will the unwinding of a LR 01-1, 02-3, or 02-7 type reorganization, by merging a partnership parent into its QSUB, i.e., dissolving the partnership, trigger the recognition of any taxable income to the partners/shareholders?

Directive 7:

No taxable income will be recognized by the partners/shareholders for Massachusetts income tax purposes upon the distribution of property in complete dissolution of the partnership parent, i.e., in unwinding a LR 01-1, 02-3, or 02-7 type reorganization by merging a partnership parent into its QSUB.

Discussion:

Federally, the partnership parent is an S corporation and, thus, the merger would be identical to the one set forth in Treas. Reg. § 1.1361-5(b)(3), Example 8, discussed in Directive 1 above. Pursuant to Example 8, the IRS characterizes the merger of an S corporation parent into its QSUB as a tax free "F" reorganization.

For Massachusetts income tax purposes, the parent entity is not treated as a corporation as it is for federal income tax purposes. Furthermore, there is no prior authority in Massachusetts for the proposition that a partnership will be treated as a corporation for purposes of the Commonwealth's recognition of a federal "F" reorganization. LR 02-7. Nonetheless, for purposes of this Directive, no taxable income will be recognized by the partners/shareholders for Massachusetts income tax purposes upon the merger of a partnership parent into its QSUB.

Issue 8: Filing Issues as Result of Downstream Merger of Partnership Parent into its QSUB as in Directive 7

How should the Massachusetts S corporation formed as the result of the merger of a partnership parent into its QSUB file a return and report income, gross receipts, property, payroll, sales and other relevant tax attributes for the taxable year in which the reorganization takes place? Additionally, are final returns required to be filed by the partnership and QSUB?

Directive 8:

A. The Massachusetts S Corporation. The Massachusetts S corporation must file Form 355S to report its corporate excise for the taxable year in which the reorganization takes place as specified in Directive 3 above, with one obvious change. "Partnership" should be substituted for "corporate trust" every time the latter term appears in Directive 3.

B. The QSUB. The QSUB must file a final Form 355S to report any corporate excise it may owe for the taxable year in which the reorganization takes place also as specified in Directive 3.

C. The Massachusetts Partnership. The partnership is not required to file a final return in the taxable year in which the reorganization takes place.

Discussion:

The Massachusetts S corporation's and QSUB's total receipts, net income subject to tax under G.L. c. 63, § 32D, non-income measures of the corporate excise, Schedule SK-1s, and apportionment factors, as appropriate, are to be computed for the taxable year in which the reorganization takes place as specified in Directive 3 above.

Issue 9: Unwinding Reorganizations Exemplified by LRs 01-1, 02-3, and 02-7 - Upstream Merger of QSUB into its Partnership Parent

Will the unwinding of a Letter Ruling 01-1, 02-3, or 02-7 type reorganization by merging a QSUB into its partnership parent, i.e., liquidating the QSUB, trigger the recognition of any taxable income to the partners/shareholders?

Directive 9:

No taxable income will be recognized by the partners/shareholders for Massachusetts income tax purposes upon the unwinding of a Letter Ruling 01-1, 02-3, or 02-7 type reorganization by merging the QSUB into its partnership parent, i.e., liquidating the QSUB.

Discussion:

Federally, a QSUB is deemed liquidated upon the making of a valid QSUB election. Treas. Reg. § 1.1361-4. Consequently, the subsequent merger of a QSUB into its partnership parent for Massachusetts tax purposes will not trigger the recognition of any federal taxable income.

Issue 10: Filing Issues as Result of Upstream Merger of QSUB into its Partnership Parent as in Directive 9

Directive 9 involves the unwinding of a LR 01-1, 02-3, or 02-7 type reorganization by merging a QSUB into its partnership parent. How should the surviving partnership file a return and report income, gross receipts, property, payroll, sales and other relevant tax attributes for the taxable year in which the reorganization takes place? Additionally, is a final return required to be filed by the QSUB?

Directive 10:

A. The Partnership. The surviving partnership must file Form 3, Massachusetts Partnership Return, and Schedule 3K-1, Partner's Massachusetts Information, to report its income for the taxable year in which the reorganization takes place.

B. The QSUB. The QSUB must file a final Form 355S to report any corporate excise it may owe for the taxable year in which the reorganization takes place as specified in Directive 5 above. "Final return" should be clearly noted on the return. In the event the QSUB used its partnership parent's taxpayer identification number in filing its Form 355S, a second note should be added to the QSUB's final Form 355S stating that "the taxpayer identification number appearing on this return will continue to be used by the surviving partnership when filing its required Form 3."

Discussion:

A. The Partnership. The surviving partnership must include in its Form 3 and Schedule 3K-1 for the taxable year in which the reorganization takes place all income that it earns on its own account for the taxable year, plus all income earned by the QSUB before it ceased to exist for Massachusetts tax purposes. Additionally, in determining the partnership's apportionment factors, the partnership must take into account the property, payroll, and sales of the QSUB before it ceased to exist for Massachusetts tax purposes.

B. The QSUB. In determining whether and at what rate the QSUB is subject to taxation under G.L. c. 63, § 32D(a)(ii) for the taxable year in which the reorganization takes place, its total receipts are to be computed as specified in subsection B of the Discussion section in Directive 5 above. Also, for purposes of its final Form 355S, the QSUB must compute any net income subject to tax under G.L. c. 63, § 32D (a)(i) and (ii) of the corporate excise it may owe, any non-income measure of the corporate excise it may owe, and its apportionment factors as specified in subsection B.

Issue 11: Misapplied Estimated Tax Payments

Will the Department allow estimated tax payments made prior to a merger discussed above by an entity that is subsequently liquidated in the merger to be applied to the account of the surviving entity or to its shareholders?

Directive 11:

Yes. The Department will allow estimated tax payments made prior to a merger discussed above by an entity that is subsequently liquidated in the merger to be applied to the account of the surviving entity or to its shareholders.

Discussion:

In reallocating estimated payments to the proper accounts, the procedures set out in TIR 01-3 should be followed.

/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue

AL:LEM:pls

April 20, 2004

DD 04-1