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In the past a significant number of Massachusetts businesses have been organized as corporate trusts because of the favorable manner in which these trusts were taxed by the Commonwealth.  Although many of these trusts were (and are) taxed as corporations under the Internal Revenue Code and therefore subject to the unfavorable provisions of the Code governing the taxation of corporations, prior to January 1, 2009, the effective date of Chapter 173 of the Acts of 2008, corporate trusts organized under Chapter 182 of the Massachusetts General Laws received the more favorable tax treatment available to individuals.  As a result of this Act, corporate trusts will be treated as the same form of entity for Massachusetts income tax purposes as they are for federal income tax purposes for taxable years commencing on or after January 1, 2009, and many of them will be taxed as corporations.

Corporate trusts that were relevant for federal income tax purposes prior to January 1, 1997 were generally taxed as corporations under then existing treasury regulations governing the classification of entities.  Effective January 1, 1997, these regulations were revised so that a corporate trust organized after that date would be treated as an “eligible entity” that could elect to be taxed either as a partnership or a corporation.  Trusts already in existence on that date and taxed as corporations retained that status and continue to be taxed as corporations.  Therefore, for taxable years commencing after January 1, 2009, corporate trusts will be treated either as a partnership or a corporation for Massachusetts tax purposes depending on their federal classification.

Prior to 1971 corporate trusts were not subject to tax in Massachusetts unless they elected to be taxed in which event they were taxed at the rates imposed on individuals, and the dividends paid to shareholders were not taxed.  A great many businesses were organized to take advantage of the combination of the favorable rates imposed on individuals and the absence of the two levels of tax imposed on corporations.  Although many of these trusts were liquidated in contemplation of the revision, in 1986, to federal law that allowed corporations to avoid the tax at the corporate level in connection with a liquidation,[i] a considerable number of these trusts continue to exist today.

Also, a significant number of corporate trusts were created as the result of Department of Revenue Letter Ruling 99-77, which advised that a company could avoid the Massachusetts tax imposed on large S corporations having gross income in excess of $6 million by restructuring as a qualified S corporation subsidiary (“Qsub”) of a corporate trust that elected to be taxed as an S corporation and treat the former S corporation as a Qsub.  The letter ruling stated that, because a corporate trust was not taxed as a corporation, it was not subject to the corporate level tax and, because the subsidiary was a disregarded entity in accordance with Technical Information Release 97-6, the income of the subsidiary would be included in the income of the parent trust free of the corporate level tax.

Because a corporate trust that is taxed as a corporation is now subject to the income measure of the Massachusetts Corporate Excise Tax, there is no longer any significant advantage in continuing to operate as a trust, and, because it is not clear that the trustees and shareholders of a corporate trust have limited liability, there is a potentially significant disadvantage in doing so.  Therefore, owners of these trusts may wish to restructure them as corporations by means of an F reorganization that will enable a surviving corporation to preserve all of its tax attributes, including its S election,[ii] its taxable year and the ability to carry back net operating losses.[iii]

Owners wishing to restructure a corporate trust as a corporation should be aware of a proposed Treasury regulation that, if and when published as a final regulation, will provide explicit guidance regarding the requirements for a transaction to qualify as an F reorganization.  Under Prop. Reg. §1.368-2(m)(1)(i), an F reorganization must satisfy the following requirements: (i) all of the stock of the resulting corporation, including stock issued before the transfer is issued in respect of the stock of the transferring corporation; (ii) there is no change in the ownership of the corporation in the transaction, except a change that has no effect other than that of a redemption of less than all of the shares of the transferring corporation; (iii) the transferring corporation completely liquidates in the transaction; and (iv) the resulting corporation does not hold any property or have any tax attributes (including those specified in section 381(c)) immediately before the transfer.[iv]  This regulation will affect transactions occurring on or after the date that they are published in the federal register; however, given the lack of clear and consistent authority regarding the requirements that must be satisfied to qualify a transaction as an F reorganization, it seems advisable to structure future transactions to satisfy the foregoing requirements.

A stand alone corporate trust should have no difficulty satisfying these requirements either by merger or conversion.  It will be more complicated to restructure a corporate trust that is a holding corporation for a Qsub because a downstream merger into Qsub cannot satisfy the limitation against holding property or having tax attributes.  Therefore, it appears that an upstream merger of the Q sub into the parent corporate trust and the conversion of the trust to a corporation will be the appropriate transaction.  Fortunately Prop. Reg. §1. 368-2(m)(3) seems to contemplate this transaction by allowing a series of related transactions that together result in a mere change in the form of one corporation to qualify as an F reorganization.

At the state level, the Massachusetts Department of Revenue has contemplated the foregoing transaction in Directive 04-1, which expressly acknowledges that an upstream merger of a Qsub with its parent corporate trust will qualify as an F reorganization in accordance with MGL c. 62, §8A; provided that the transaction qualifies as an F reorganization under federal law.[v]  However, owners and advisors should be aware of Directive 08-4 from the Department, which authorizes the Commissioner to treat an upstream merger of a Qsub into a corporate trust that is followed by sale or deemed sale of its assets as a taxable sale of the assets by the Qsub if it determines that the purpose of these transactions is avoidance of tax.[vi]  The directive also provides that the transactions will be presumed to be in avoidance of tax if the sale or deemed sale occurs within two years of the merger unless that taxpayer can demonstrate that the subsequent sale was independent of a prior merger or liquidation and was not part of a plan to avoid taxes.             

[i]  IRC § 336(a) prior to its amendment by the Tax Reform Act of 1986.

 [ii]  Rev. Rul. 64-250, 1964-2 C.B. 333.

 [iii]  IRC §381(b); Treas. Reg. §1.381(b)-1(a)(2).

 [iv]  Prop. Reg. §1.368-2(m)(1)(ii) contains the following limited exceptions to the forgoing requirements: (i) the transferring company is not required to dissolve and may retain a nominal amount of assets to preserve its legal existence and (ii) the resulting corporation may issue a nominal amount of stock other than stock in respect of the transferring corporation and may hold a nominal amount of assets to facilitate its organization or preserve its existence as a corporation and may have tax attributes related to holding those assets.  The resulting corporation may also hold the proceeds of borrowings undertaken in connection with the transaction.

[v]  Directive 04-1 also allows a downstream merger to qualify as an F reorganization for Massachusetts tax purposes if the transaction satisfies federal requirements.  This benefit will not be available if the requirements set forth in Prop. Reg. §1.368(m) apply.

[vi] As described in TIR 97-6, a sale or deemed sale of the assets of a Qsub is taxable to the Qsub, and the income from the sale must also be included in the income of the parent trust in computing its taxable income.  An upstream merger that qualifies as an F reorganization is not taxable and would enable the subsequent sale by the trust to be taxed only at the trust level.