Page 78 - TaxAdviser_Jan_Apr23_Neat

one class of stock if all outstanding regardless of the language in the
shares of stock of the corporation corporation’s governing provisions.
confer identical rights to distribu- But is this consistent with the regula-
tion and liquidation proceeds. tions? One relevant question to ask
is what is meant by the “general rule”
The regulations then elaborate on language in Regs. Sec. 1.1361-1(l)(2)
how to analyze if there are identical (i). Does the general rule of looking to
distribution and liquidation rights. Regs. the corporation’s governing provisions
Sec. 1.1361-1(l)(2)(i) provides a general mean that the four exceptions speci-
rule that the focus is on the corporation’s fied in the regulations are the only
governing provisions: four exceptions, or can other excep-
tions also be recognized?
The determination of whether all First, we look to the actual lan-
outstanding shares of stock confer guage in the statute and the regula-
identical rights to distribution and tions. Then we look to the legislative
liquidation proceeds is made based history and subsequent history to
but Agreement 3 retained the same on the corporate charter, articles of provide any assistance in making
partnership provisions that affected the incorporation, bylaws, applicable this determination.
distribution and liquidation rights that state law, and binding agreements The plain language of the statute
appeared in Agreement 2. relating to distribution and liquida- does not provide any help in inter-
On date 6, Agreement 3 was tion proceeds (collectively, the gov- preting what a single class of stock is,
amended to create Agreement 4, which erning provisions). as no definition is provided. The plain
provided for identical distribution and language of Regs. Sec. 1.1361-1(l)
liquidation rights to the shareholders. The regulation defines “binding (2)(i) is very specific in that the de-
The letter ruling provided for agreements relating to distribution and termination is “made based on” the
S election termination relief effective liquidation proceeds” to include only governing provisions. The preamble
date 4, when the second shareholder contracts that have a principal purpose to the regulations does not provide
was added to the S corporation. This is to circumvent the one-class-of-stock any insight into what is meant by
a unique interpretation, as the relief was requirement (id.). Note that there is no “made based on.” Does this mean we
not effective as of date 3 when Agree- principal-purpose requirement for the can only look to the four corners of
ment 2 was in effect with the single corporate charter, articles of incorpora- the governing provisions, or are we al-
shareholder. The letter ruling seems to tion, bylaws, or applicable state law to lowed to consider the actual facts and
imply that a wholly owned S corpora- create a second class of stock. circumstances, too?
tion could not have more than one class The regulations then provide four It appears from the regulations and
of stock, regardless of the language in specific rules with respect to whether recently issued Rev. Proc. 2022-19
the corporation’s governing provisions. stock confers identical rights to distri- (see the preceding item) that a four-
While it might stand to reason that if bution and liquidation proceeds when corners analysis of the governing
there is only one shareholder, then there there is (1) a state law requirement for documents is required, and no facts
can be only one class of stock, that payment and withholding of income outside the governing documents
is not necessarily what the Code and tax; (2) buy-sell and redemption agree- should be considered. The regulations
regulations provide, as discussed next. ments; (3) distributions that take into provide in Example 6 that a govern-
account varying interests in stock during ing document modifying the normal
The rules on determinations
PHOTO BY ROC CANALS/GETTY IMAGES In general, an S corporation’s governing Are there other exceptions not tax burdens was not allowed, even
per share distribution policy to allow
a tax year; or (4) the special rule for Sec.
of a second class of stock
338(h)(10) elections.
for an adjustment to different state
documents must provide for equal dis-
though it would have resulted in equal
provided for in the regulations?
after-tax distribution rights (Regs. Sec.
tribution and liquidation rights. Regs.
Sec. 1.1361-1(l)(1) states:
As noted earlier, the IRS seemed to
1.1361-1(l)(2)(vi)). (The inability to
imply in Letter Ruling 201822003
use facts outside the agreement may
be the reason it was not allowed, but
[With certain exceptions], a cor-
that if there is only one shareholder,
poration is treated as having only
February 2023 23
www.thetaxadviser.com there can be only one class of stock, the reasoning is not explained.) It is