IRS Private Letter Ruling 200927014 (March 20,2009), presents an interesting fact pattern. The two individuals who own all of the shares of X, an S corporation, will each transfer their shares to two LLCs. They will manage their LLCs and retain all rights to profits, losses and distributions. But each of them will also transfer certain management rights to Y. It is not clear whether Y is an individual or an entity. These rights include the right to participate in management of the LLCs, the right to vote on their business activities, merger or sale of substantially all of their assets, borrow money, make distributions, liquidate the LLCs, amend their operating agreements, and transfer their interests to others. Y would also appoint new managers if the shareholders die while acting as managers. All of these actions would indirectly affect the S corporation. Y is not a member of either LLC.
The IRS held that the transfer of the S corporation's shares to the LLCs and the role of Y in the management of the LLCs would not cause the corporation to lose its S corporation status. For tax purposes Y is not considered a member of either LLC and each LLC will be treated as owned, respectively, by the two former shareholders of X. The shares of X are treated as owned directly by the two individuals. The LLCs will be disregarded entities for tax purposes.
It appears from the ruling that Y will participate in management but not have sole responsibility for management. It is not clear if Y has control, but the tenor of the ruling suggests that the outcome was not be dependent on control, but on the determination that for tax purposes membership status is based solely on the right to the economic interest in the LLC.