IRS Concludes Equity Interests Are Nonqualified Preferred Stock

The IRS concluded in an internal legal memorandum (ILM 201716045) that certain equity interests were properly treated as nonqualified preferred stock under Section 351(g)(2).

In the ILM, the corporate taxpayer held interests in two subsidiaries (Sub 1 and Sub 2). In Year 1, the taxpayer contributed the stock of Sub 2 to Sub 1 in exchange for Class A stock of Sub 1 and other property. The holders of Class A stock were entitled to dividends equal to a percentage of the dividends paid to the common shareholders of Sub 1. Upon liquidation of Sub 1, the holders of Class A stock were entitled to the face value of the Class A stock in addition to a "redemption premium" equal to a percentage of the increase in value of the common shares of Sub 1. Sub 1 had income in Year 1 and losses in Year 2 and Year 3.