Page 66 - TaxAdviser_2022

under different reasoning. In Letter Rul- clarification from the IRS would be must be satisfied for stock to qualify as
ing 200709013 the IRS ruled that the beneficial (see NYSBA Tax Section QSBS. Of these requirements, perhaps
change in status of the legal borrower Rep’t No. 1383 and NYSBA Tax Section the most difficult to apply is the active
from a corporation to a DRE, and on a letter to IRS Commissioner Charles business requirement, which mandates
later date from a DRE to a partnership, Rettig, “Comments on Workout-Related that at least 80% (by value) of the assets
resulted in a modification of the debt Relief in Response to COVID-19” of the corporation must be used in the
held by the legal borrower (because there (Aug. 17, 2020)). The issuance of Letter active conduct of one or more qualified
was a change in obligor), but that modi- Ruling 202050014 simply reiterates the trades or businesses. A qualified trade
fication was not a significant modifica- need for additional guidance from the or business is defined through exclu-
tion because the transaction qualified for IRS as to how to reconcile the treatment sion, with a laundry list of categories of
exceptions under Regs. Sec. 1.1001-3(e) under these various letter rulings. businesses that may not be treated as
(4)(i). In Letter Ruling 200630002, the qualified trades or businesses. Among
IRS held that there was not a significant Key factor in entity structure these excluded businesses is any trade or
modification when the legal borrower Even though there are unresolved issues, business involving the performance of
converted from a corporation to a DRE; Letter Ruling 202050014 confirms to services in the field of brokerage services
however, the IRS in Letter Ruling taxpayers that the IRS may treat debt (Sec. 1202(e)(3)(A)). There is no defini-
200630002 did not articulate why there issued by a DRE as nonrecourse debt tion of “brokerage services” in Sec. 1202
was not a significant modification or to the regarded owner, at least for the or its regulations.
whether the IRS considered this a purposes of Regs. Sec. 1.1001-2. The Letter Ruling 202114002 involves a
change in obligor. Finally, in Letter conclusion also gives additional impor- corporation that assists clients in obtain-
Ruling 200315001, the IRS ruled that a tance to how taxpayers structure a new ing various types of insurance policies.
legal borrower’s conversion from a cor- borrowing. Taxpayers should strongly In the business line that is the subject of
poration to a DRE did not even result in consider these letter rulings when try- the ruling, the corporation enters into
a modification because the legal rights ing to determine whether they want to contracts with insurance companies to
and obligations referred to in Regs. Sec. structure a borrowing with a regarded sell policies to customers in exchange for
1.1001-3(c) are determined under state entity as the legal borrower or whether commissions from the insurance compa-
law, and the conversion from a corpora- they prefer to have a DRE be the legal nies. These contracts require the corpo-
tion to a DRE would not affect the legal borrower of the debt. ration to perform certain administrative
rights or obligations between the debt From Jack Stringfield, J.D., Washing- services, including reporting incidents,
holders and the borrower. ton, D.C. claims, suits, and notices of loss to the
These letter rulings are important for insurance company and cooperating
two reasons. First, any taxpayer looking Letter ruling provides clarity to facilitate any investigation, adjust-
to restructure its borrowings so that the on Sec. 1202 definition of ment, settlement, and payment of any
legal borrower is a DRE should consider brokerage services claim. The corporation is also required
the effect of these letter rulings before Sec. 1202 allows shareholders to ex- to keep records of all transactions and
pursuing any debt restructuring. Second, clude gain from the sale of qualified correspondence with the insureds and
although the Regs. Sec. 1.1001-3 letter small business stock (QSBS) from to make those records available to the
rulings are issued under a different set of income. Many requirements at both insurance companies for examination,
regulations, the questions whether the the shareholder and corporate level inspection, verification, and audit.
debt issued by a DRE is considered re-
course or nonrecourse and who the obli-
gor is for tax purposes are relevant under
Regs. Secs. 1.1001-2 and 1.1001-3. As
previously noted by the New York State
IMAGE BY CANJOENA/ISTOCK rulings are a little unclear exactly who
Bar Association (NYSBA) Tax Section,
given that the Regs. Sec. 1.1001-3 letter

the obligor is when a debtor converts
from a corporation to a DRE and
whether the debt is considered chang-
ing from recourse to nonrecourse, some

www.thetaxadviser.com February 2022 19