January 16, 2001
You have requested a letter ruling on behalf of the *************** ("Company") concerning the income tax consequences of a transaction involving a corporate reorganization that involves the creation of an S corporation and a qualified S corporation subsidiary ("QSUB"). This transaction is described in greater detail below.
Company is a Massachusetts corporation that has seven individual shareholders and one class of stock outstanding. Company and its wholly owned subsidiary, *************** ("Sub"), design and manufacture communications systems and equipment. Company made an S corporation election pursuant to Internal Revenue Code ("IRC" or "Code") § 1362 effective for its fiscal year beginning October 1, 1999 and ending September 30, 2000. Company also elected to treat Sub as a QSUB effective on this same date.
Company files returns in Massachusetts and other states. Sub does business solely within Connecticut.
B. Proposed Transaction.
Company's shareholders have proposed to reorganize by transferring all of their shares of Company to a General Partnership ["GP"], thereby making it wholly owned by GP. Partnership interests will represent each shareholder's ownership in the business. For federal tax purposes, GP will elect to be treated as a corporation under the "check the box" regulations. Further, GP will elect to be treated as an "S" corporation effective with the date of its formation and GP and Company will make elections to treat Company and Sub as QSUBs under IRC §1361(b)(3)(B)(ii).
The above series of transfers and elections will be treated as tax-free for federal income tax purposes and qualify as a reorganization described by IRC § 368(a)(1)(F). After the transfer, the shareholders will own interests in GP in the same proportion as they currently own shares in Company. Company represents that GP, in the absence of the check the box election, would be classified as a partnership for federal income tax purposes under Treas. Reg. §301.7701-2 (as in effect prior to January 1, 1997) and that it will lack all four of the corporate attributes listed in this regulation: centralized management, continuity of life, free transferability of interests and limited liability.
II. Rulings Requested
Company requests the following rulings:
For Massachusetts tax purposes, the effects of Company's proposed reorganization are that:
1. All of Company and Sub's items of income, gain, loss, deduction and credit will be treated as those of the GP.
2. The general partnership income will not be subject to the taxes imposed by G.L. c. 62. Instead, the income, gain, loss, deductions and credits of GP will flow through from GP to its partners based on their interests in GP.
3. Neither Company nor Sub will be subject to the net income measure of the corporate excise imposed under G.L. c. 63, § 32, nor to the entity level income tax imposed under G.L. c. 63, § 32D.
4. As a QSUB, Company will be subject to the greater of the non-income measure of the corporate excise or the minimum corporate excise imposed under G.L. c. 63, § 32. Similarly, Sub, also a QSUB, will be taxable in this same manner if it becomes subject to the corporate excise.
Under the General Laws, all domestic business, manufacturing, and research and development corporations are subject to the excise imposed by G.L. c. 63, § 32. The excise is comprised of several components (i.e., a minimum corporate excise; a property measure consisting of two alternate amounts, a tangible property amount or a net worth amount; and a net income measure), and is expressed as the minimum corporate excise or the combined property measure and net income measure, whichever is greater. However, in the case of a federal S corporation that is also a Massachusetts S corporation the net income measure of the corporate excise is determined under G.L. c. 63, § 32D. "Net income," as that term is used in G.L. c. 63, §§ 32, 39, and 32D, is defined, in relevant part, as "gross income less the deductions, but not the credits, allowable under the provisions of the Federal Internal Revenue Code, as amended and in effect for the taxable year." See G.L. c. 63, § 30.
General partnerships that are treated as S corporations for federal income tax purposes are not treated as S corporations for Massachusetts tax purposes. Instead, such partnerships are subject to tax in the same manner as other partnerships; i.e., income tax is imposed on its partners pursuant to G.L. c. 62, § 17. In Letter Ruling 99-13, the Commissioner ruled that a general partnership that elected to be treated as a corporation for federal income tax purposes would be treated as a partnership for Massachusetts purposes. That ruling concluded that a partnership could not be classified as a corporation because it does not fit the definition of a corporation under G.L c. 63, §§ 30(1) and 30(2).
The Code accords special "QSUB" status to a corporation that meets certain requirements including the fact that it is 100% owned by an S corporation parent when the parent elects this status for the sub. See IRC § 1361(b)(3)(B). Under the Code, a QSUB is not treated as a separate corporation, but rather all of its assets, liabilities, items of income and deduction are treated as belonging to its S corporation parent. See IRC § 1361(b)(3)(A)(i), (ii). For purposes of the corporate excise, a QSUB is a separate corporation that is subject to the greater of either the minimum excise or the property measure. See TIR 97-6. However, because a QSUB's items of income and deduction pass through for purposes of the Code, a QSUB is not taxable pursuant to the income measure of the corporate excise, i.e., G.L. c. 63, §§ 32 and 39, or pursuant to the entity level tax imposed under G.L. c. 63, § 32D. Rather, as is also true under the Code, these income tax attributes pass-through to the shareholders of the QSUB. See id.
You have also asked about the pass-through of state tax credits from a QSUB to individual partners that own an interest in a general partnership that owns the QSUB. The individual partners in the general partnership may claim only those credits that are allowed under chapter 62. A QSUB is a corporate excise taxpayer and may claim only those credits that are allowed under chapter 63. The general partnership may take into account the QSUB's activities when determining the credits of the individual partners under chapter 62. Alternatively, the QSUB may determine its credits separately and apply them to reduce the non-income measure of its corporate excise. However, the same activity cannot generate a credit for both the partners in the general partnership and the QSUB. Thus, when a QSUB engages in an activity that can generate a credit under either chapter 62 or chapter 63 (e.g., the Economic Opportunity Area credit under. c. 62, §6(g) or c. 63, § 38N), the general partnership and the QSUB may agree to take that activity into account in determining the credit for either the partners or the QSUB, but not both. In contrast, when a QSUB is engaged in activity that generates a credit under chapter 63 only (e.g., the investment tax credit under c. 63, § 31A or the business facility credit under c. 63, § 38E), the credit can be claimed only by the QSUB. See DD 00-9. See also 830 CMR 62.17.1(3)(d).
In this case, if Company reorganizes as stated, then all of Company's items of income, gain, loss and deduction will be treated as though realized by the partners in GP. In addition, although GP will be treated as an S corporation under the Code, for purposes of Massachusetts law the partners in GP will report their income pursuant to the partnership tax provision, G.L. c. 62, § 17. Further, Company will not be subject to the net income measure of the corporate excise under G.L. c. 63, § 32, nor to the entity level income tax imposed under G.L. c. 63, § 32D.
A QSUB is not subject to the net income measure of the corporate excise because net income for purposes of the excise is determined by reference to the Code, and a QSUB has no net income under the Code. However, a QSUB is a corporation for purposes of chapter 63 and so, when it is doing business in Massachusetts, it is separately subject to the greater of the property measure of the corporate excise or the minimum corporate excise. Accordingly, if Company reorganizes as stated, then it must file a corporate excise return to report the greater of: (i) any corporate excise attributable to its taxable tangible property or taxable net worth or (ii) the minimum corporate excise. This same analysis will also be true of Sub, in the event that Sub commences doing business in Massachusetts.
Unlike Company's items of income, gain, loss and deduction, credits generated by Company's activities are not merely treated as realized by the individual partners in GP. Rather, the application of these credits depends upon the nature of the credit and, in some instances, upon the agreement amongst the parties. In any case in which the credit is generated under the provisions of chapter 63 and there is no corollary credit under the provisions of chapter 62, the credit can only be claimed by Company against its corporate excise liability.
Very truly yours,
/s/Frederick A. Laskey
Frederick A. Laskey
Commissioner of Revenue