Introduction: This Directive describes the proper Massachusetts tax treatment of distributions from a Massachusetts S corporation that previously was a qualified subchapter S subsidiary ("QSUB") owned by a corporate trust. In particular, this Directive discusses the tax treatment of distributions from a Massachusetts S corporation that restructured pursuant to Letter Ruling 99-17 and then reverted to a stand-alone Massachusetts S corporation through the merger of the corporate trust parent into the QSUB in a transaction that qualifies as an F reorganization under section 368(a)(1)(F) of the Internal Revenue Code.

Issue 1: What is the tax treatment of distributions from the S corporation to its shareholders after the merger?

Directive 1: The post-merger distributions will be taxed as distributions from the corporate trust pursuant to 830 CMR 62.8.2(5)(e)(1) through (2)(c) until all of these pre-merger accounts of the corporate trust are exhausted. Distributions from the S corporation thereafter shall be treated under the rules of 830 CMR 62.17A.1(10)(d) which provide for the taxation of distributions from a Massachusetts S corporation. Pre-merger amounts of C corporation earnings and profits derived from prior taxable years of the QSUB's predecessor S corporation when it was a C corporation will be treated as those of the S corporation and taxed pursuant to the provisions of 830 CMR 62.17A.1(10)(d).

Discussion: The ordering rules for post-merger distributions from the S corporation will be those found in 830 CMR 62.8.2(5)(e)(1) through (2)(c) until all categories listed thereunder are exhausted. Accordingly, distributions from the S corporation will be treated under the ordering rules as follows: (1) first, as a tax-free distribution of the QSUB's predecessor S corporation income that was previously taxed to the predecessor S corporation shareholders, (2) second, as a taxable distribution of tax-free earnings and profits of the corporate trust, and (3) third, as a distribution of previously taxed earnings and profits of the corporate trust, up to the amount of such previously taxed earnings and profits. Rules for the utilization of credits as provided under 830 CMR 62.8.2(4)(e) will apply to the distributions subject to the ordering rules. After all of the applicable pre-merger categories of the corporate trust have been exhausted pursuant to the ordering rules, the rules applicable to distributions from a Massachusetts S corporation under 830 CMR 62.17A.1(10)(d) will apply to all further distributions, including any distributions of C corporation earnings and profits derived from prior taxable years of the QSUB's predecessor S corporation when it was a C corporation.

Issue 2: What will be the post-merger basis of the shares of the S corporation?

Directive 2: The post-merger basis of the shares of the S corporation will be the carryover basis pursuant to Internal Revenue Code § 358.

Discussion: Assuming that the merger of the corporate trust parent into the QSUB occurs in a transaction that qualifies as an F reorganization under section 368(a)(1)(F) of the Internal Revenue Code, the basis of the shares of the corporate trust will carry over to the shares of the S corporation as provided in § 358 of the Internal Revenue Code. To the extent that distributions are treated as distributions from the corporate trust under the ordering rules of 830 CMR 62.8.2(5)(e), such distributions will have no effect on the basis of the shares of the S corporation.

/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue

AL:LEM:atf

February 13, 2004

DD 04-2