Rev. Rul. 89-20

1989-1 C.B. 170, 1989-7 I.R.B. 6.

                       Internal Revenue Service

                                 Revenue Ruling

           PERSONAL HOLDING COMPANY; RULES FOR DETERMINING OWNERSHIP

                          Published: February 13, 1989

Section 542. - Definition of Personal Holding Company, 26 CFR 1.542-3: Stock ownership requirement.

  Personal holding company; rules for determining ownership. For purposes of classifying a corporation as a personal holding company under the stock ownership requirement in section 542(a)(2) of the Code, stock that is attributed from one person to another under the family and partnership rules of section 544(a)-(2), is not taken into account a second time either as stock of the person who owns it directly or as stock of a third person to whom it is also attributable. In the event that stock is owned directly by one person and is attributed to another, the first person may be counted among the five largest individual shareholders by virtue of attribution to that person of ownership of stock that is directly owned by others and that has not otherwise been taken into account for purposes of section 542(a)(2).

  This ruling involves two factual situations, each dealing with a publicly held corporation. In each situation, the corporation's stock is held by a relatively few number of individuals, some of whom are related by blood and some of whom own interests in the same partnership.

  ISSUES. At issue is the application of the stock attribution rules for purposes of determining whether either corporation is a personal holding company. In the first situation, the Service asks whether, if ownership of stock in a corporation is attributed from one person to another under the family and partnership attribution rules of section 544(a)(2), the stock may be taken into account a second time, either as stock of the person who owns it directly or as stock of a third person to whom it is also attributable.

  If the answer to the first question is 'no,' the Service said, and if the stock owned directly by one person is attributed to another, then 'may the first person nevertheless be counted among the five largest shareholders by virtue of attribution to that person of ownership of stock that is directly owned by others and that is not otherwise taken into account for purposes of section 542(a)(2)?'

  HOLDINGS. The Service held that in the first situation, the stock attributed from one person to another may not be taken into account a second time.

  With respect to the second situation, the Service ruled that a person may be counted among the five largest shareholders by virtue of attribution, even though the person's direct stock holdings are disregarded.

  ANALYSIS. While it indicated that Rev. Rul. 82-107, 1982-1 C.B. 103,  'demonstrates implicitly that stock may not be taken into account more than once,' the Service relied most heavily on regulation section 1.544-3(a), which illustrates the application of section 544(a)(2). According to the Service, the regulation directs the initial identification of the largest shareholder, by direct ownership and attribution. Once stock is counted for the largest shareholder, it is excluded from a second consideration. Once stock has been counted, either directly or indirectly, it is excluded from consideration for other shareholders.

  In the instant ruling's second situation, the Service emphasized that, even if all stock directly owned by an individual is attributed to other stockholders before the individual is considered for section 544 purposes, the individual can still qualify as one of the five largest stockholders purely through constructively owned stock, which is held by other individuals and which has not yet been counted in the section 544 calculations.

ISSUES

  For purposes of classifying a corporation as a personal holding company under the stock ownership requirement in section 542(a)(2) of the Internal Revenue Code --

  (1) If ownership of stock in the corporation is attributed from one person to another under the family and partnership ownership rules of section 544(a)(2), may the stock be taken into account a second time either as stock of the person who owns it directly or as stock of a third person to whom it is also attributable?

  (2) If not, and if the stock owned directly by one person is attributed to another, may the first person nevertheless be counted among the five largest shareholders by virtue of attribution to that person of ownership of stock that is directly owned by others and that is not otherwise taken into account for purposes of section 542(a)(2)?

FACTS CCA SITUATION 1

  X is a publicly held corporation and has 1,000 shares of outstanding stock, all of which are common and are of equal value. A owns 200 shares of X stock; A's child, F, owns 80 shares of X stock; A's sibling, B, owns 50 shares of X stock; B's spouse, G, owns 45 shares of X stock. C, D, and E are unrelated to A, B, F, or G, and each owns 40 shares of X stock. No other shareholder owns more than 40 shares of X stock, and all other shareholders are unrelated. CCA SITUATION 2

  Y is a publicly held corporation and has 1,000 shares of outstanding stock, all of which are common and of equal value. L owns 50 shares of Y stock; L's sibling, K, owns 110 shares of Y stock; L's child, M, owns 45 shares of Y stock; M's partner in Q partnership, P, owns 55 shares of Y stock; M's spouse, N, owns 40 shares of Y stock. R, S, T, and U are unrelated to K, L, M, N, Q, and P, and R, S, T, and U each owns 70, 70, 70, and 60 shares, respectively, of Y stock. No other shareholder owns more than 40 shares of Y stock, and all other shareholders are unrelated.

LAW AND ANALYSIS

  Section 541 of the Code imposes on the undistributed personal holding company income of every personal holding company a personal holding company tax equal to 28 percent (38.5 percent in the case of tax years beginning in 1987) of the undistributed personal holding company income.

  Section 542(a) of the Code provides that a corporation will be classified as a personal holding company if (1) at least 60 percent of its adjusted ordinary gross income (as defined in section 543(b)(2)) for the tax year is personal holding company income, and (2) if at any time during the last half of the tax year more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.

  Section 544 of the Code provides rules for determining stock ownership. Section 544(a)(2) provides that for purposes of determining whether a corporation is a personal holding company, insofar as such determination is based on stock ownership under section 542(a)(2), an individual shall be considered as owning the stock owned, directly or indirectly, by or for the individual's family or by or for the individual's partner. For purposes of section 544(a)(2), the family of an individual includes only the individual's brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.

  Section 544(a)(5) of the Code and section 1.544-6(a)(3) of the Income Tax Regulations provide that stock constructively owned by an individual by reason of the application of the family and partnership rule provided in section 544(a)(2) shall not be considered as actually owned by such individual for the purpose of again applying such rule in order to make another individual the constructive owner of such stock.

  Rev. Rul. 82-107, 1982-1 C.B. 103, demonstrates implicitly that stock may not be taken into account more than once. That ruling concerns an individual to whom stock is attributed from the individual's partners in two different partnerships. With the attribution taken into account, the individual is the largest shareholder of the corporation. One of the partners whose stock is attributed to that individual, however, owns directly more stock than is owned directly by any other shareholder. Despite that fact, the partner's stock is taken into account by virtue of its attribution to the individual, and the partner is not treated as one of the five largest individual shareholders.

  The example is section 1.544-3(a) of the regulations illustrates the application of section 544(a)(2) of the Code, relating to constructive ownership by reason of family and partnership ownership. The example indicates that it is necessary first to identify the five individuals, for purposes of section 542(a)(2), that own the largest number of shares, directly and constructively.

  For purposes of identifying the five largest individual shareholders, it is necessary to identify the individual shareholder who owns the largest number of shares, directly and constructively. In identifying the next largest individual shareholder, the largest individual shareholder's stock ownership, direct and constructive, is excluded from consideration. Similarly, to determine the next largest individual shareholder, the shareholders' stock that has been counted previously is excluded from consideration. After the five largest individual shareholders are identified in this way, the value of the largest five individuals' shares are added together to determine whether their total value exceeds 50 percent of the value of the corporation's outstanding stock for purposes of section 542(a)(2).

  In the example in section 1.544-3(a) of the regulations, an individual, DBW  (D's brother's wife), is not identified as being one of the five largest individual shareholders. This omission is significant since that individual directly and constructively owns 170 shares, a number of shares that is not less than the number owned by some of the individuals that are identified as being among the five largest individual shareholders (A, B, and EWB). Because DB (D's brother) owns directly and constructively more shares than DBW, DBW's shares are allocated to DB for purposes of identifying the five largest individual shareholders and of determining whether five or fewer individual shareholders own more than 50 percent in value of the corporation's outstanding stock.

  In Situation 1, under the constructive stock ownership provisions of section 544(a)(2) of the Code, A is considered to own 330 shares of X stock, 200 directly and 130 constructively from A's child, F, and from A's sibling, B. F is considered to own 280 shares, 80 directly and 200 constructively from A. B is considered to own 295 shares, 50 directly and 245 constructively from A and from B's spouse, G. G is considered to own 95 shares, 45 directly and 50 constructively from B. No shares are attributed to C, D or E, who own directly 40 shares each.

  With 330 shares, A is the largest individual shareholder of X. The shares owned directly by F and B are thus attributed to A. The shares owned by A, F, and B cannot be taken into account again, directly or indirectly, in determining the five largest individual shareholders.

  G in the present situation differs from DBW in the example in section 1.544- 3(a) of the regulations in that DBW's shares were counted by her spouse, DB, to make him the major shareholder. In the present situation, G is not a person whose shares can be attributed to A. Thus, G's shares have not been counted towards A's total. G's family consists of B and G. Although B is in A's family and G's family, as well as B's own family, B's shares have been counted by A and cannot be recounted for attribution to G. Thus, with the 45 shares owned directly, G is the second largest individual shareholder of X for purposes of section 542(a)(2) of the Code.

  The next three largest individual shareholders of X are C, D, and E, each of whom owns 40 shares of X, or a total of 120 shares. Therefore, the five largest individual shareholders of X are A, G, C, D, and E. They own 495 shares, which do not represent more than 50 percent in value of X's outstanding stock. Therefore, X does not meet the stock ownership requirement of section 542(a)(2) of the Code and is not a personal holding company.

  In Situation 2, under the constructive ownership provisions of section 544(a)(2) of the Code, L is considered to own 205 shares of Y stock, 50 directly and 155 constructively from L's sibling, K, and L's child, M. K is considered to own 160 shares of Y stock, 110 directly and 50 constructively from L. M is considered to own 190 shares of Y stock, 45 directly and 145 shares constructively from L, N, and P. N is considered to own 85 shares of Y stock, 40 directly and 45 constructively from M; P is considered to own 100 shares of Y stock, 55 directly and 45 constructively from M. No shares have been attributed to R, S, T, or U, who directly own 70, 70, 70, and 60 shares, respectively, of Y stock.

  With 205 shares, L is the largest individual shareholder of Y. The shares owned directly by K and M are thus attributed to L. The shares owned by K, L, and M cannot be taken into account again, directly or indirectly, in determining the five largest individual shareholders.

  The fact however, that M's shares have been attributed to L does not preclude M from being counted among the five largest individual shareholders for purposes of section 542(a)(2) of the Code, provided that section 544(a)(4) attributes to M a sufficient amount of Y stock.

  M constructively owns 95 shares of Y from N and P. The 95 shares that M constructively owns are counted in determining whether M is among the five largest individual shareholders for purposes of section 542(a)(2) of the Code. As a result, M is the second largest individual shareholder of Y. The next three largest individual shareholders of Y are R, S, and T, each of whom owns 70 shares of Y, or a total of 210 shares. Therefore, the five largest individual shareholders of Y are L, M, R, S, and T. They own 510 shares, which represent more than 50 percent in value of Y's outstanding stock. Therefore, Y meets the stock ownership requirement of section 542(a)(2) of the Code.

HOLDING

  For purposes of classifying a corporation as a personal holding company under the stock ownership requirement in section 542(a)(2) of the Code, stock that is attributed from one person to another under the family and partnership rules of section 544(a)(2), is not taken into account a second time either as stock of the person who owns it directly or as stock of a third person to whom it is also attributable. In the event that stock is owned directly by one person and is attributed to another, the first person may be counted among the five largest individual shareholders by virtue of attribution to that person of ownership of stock that is directly owned by others and that has not otherwise been taken into account for purposes of section 542(a)(2).

DRAFTING INFORMATION

  The principal author of this revenue ruling is Patrick McGroarty of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Mr. McGroarty on (202) 566-6321 (not a toll-free call).

Rev. Rul. 89-20, 1989-1 C.B. 170, 1989-7 I.R.B. 6.