Information Release

CF 1992-03 - Application of Ohio Revised Code Section 5733.053 ("Transferor Statute") to the Merger of a C Corporation into an S Corporation - September 24, 1992

The Department has received several questions regarding the franchise tax effects of a merger of a C corporation into an S corporation where prior to the merger the C corporation and the S corporation were brother-sister corporations owned by the same individual or family. Specifically, does the income of the C corporation prior to the merger escape taxation? Or, instead, does the ORC section 5733.053 transferor statute apply to the surviving S corporation? That is, must the S corporation file a franchise report and include on that report the income of the merged C corporation even though the S corporation is otherwise exempt from the franchise tax under ORC section 5733.09(B)?

The Department maintains that the ORC section 5733.053 transferor statute applies to the merger of a C corporation into an S corporation and that ORC section 5733.09 does not exempt from the franchise tax the income which is attributable to the surviving S corporation from a C corporation. Therefore, an S corporation must file a franchise report (form FT-1120) and must include on that report the income of the merged C corporation if on January 1 prior to the merger the two corporations met the ownership or control requirements of division (A) of ORC section 5733.052 for a combined report (or if on January 1 prior to the merger the two corporations would have met the ownership or control requirements of division (A) of ORC section 5733.052 had both corporations existed on that date). Furthermore, in our view brother-sister corporations which are owned by the same individual, family, or estate do meet the ownership requirement for a combined report set forth in ORC section 5733.052.

ORC section 5733.09(B) provides as follows:

"A corporation that has made an election under subchapter S, chapter one, subtitle A, of the Internal Revenue Code for its taxable year under such code is exempt from the tax imposed by this chapter that is based on that taxable year."

ORC section 5733.09(B) does not grant an S Corporation a blanket exemption from the franchise tax. Rather, a corporation is exempt from any franchise tax that is based on a taxable year for which the federal S election is in effect. Conversely, a corporation is not exempt from franchise tax which is based on a taxable year for which the federal S election is not in effect.

ORC section 5733.09 does not exempt from the franchise tax the income earned by a C corporation in a taxable year prior to its S election because the tax is not based on a taxable year for which the federal S election is in effect. Likewise, ORC section 5733.09 does not exempt from the franchise tax the income earned by a C corporation which is attributed to an S corporation pursuant to ORC section 5733.053 because the tax is not based on a taxable year for which the federal S election is in effect. Rather, the tax is based on the income earned by a C corporation during the C corporation's accounting period.ORC section 5733.09(B) exempts corporations from paying corporate franchise tax for taxable years in which S corporation income has been recognized for federal income tax purposes since such income passes through to the corporations' shareholders and may be subject to the Ohio personal income tax. C corporation income, on the other hand, does not pass through, and no franchise tax exemption for such income is warranted.

ORC section 5733.053 provides in pertinent part:

(C) For purposes of valuing its issued and outstanding shares of stock under division (B) of section 5733.05 of the Revised Code, a taxpayer subject to this section shall add to its net income allocated or apportioned to this state, its transferor's net income allocated or apportioned to this state. The taxpayer shall add such income in computing its tax for the same tax year or years that such income would have been reported by the transferor if the transfer had not been made and the transferor had remained subject to the tax imposed by this chapter on the first day of January of the tax year.

The taxpayer and the transferor each has its own federal taxable year, and such years may not coincide. Where there has been no transfer, ORC section 5733.09(B) exempts an S corporation from tax measured by income from its own federal taxable year and from tax on its net worth at the end of such year. Where there has been a transfer, ORC section 5733.09(B) likewise exempts an S corporation from tax measured by income from its own federal taxable year and from tax on its net worth at the end of such year. However, ORC section 5733.053 requires an S corporation to add the C corporation income of its transferor as a measure of tax, to which ORC section 5733.09 does not apply, but no net worth addition is required. As a result, the S corporation has a tax measured solely by the C corporation income of the transferor.

Similarly, if an S corporation were to transfer assets or equity to a C corporation and if ORC section 5733.053 applies, ORC section 5733.09(B) would exempt the C corporation from tax measured by the S corporation (the transferor) income, leaving the C corporation with tax measured solely by income from its own taxable year and by its net worth at the end of such year.

EXAMPLE

Mr. X owns all of the outstanding stock of C Inc., a C corporation with a fiscal year end of March 31. On December 1, 1991 Mr. X formed S Inc. which immediately elected S corporation status. S Inc. has a calendar year end. On December 31, 1991 C Inc. merged into S Inc. with S being the survivor.

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C Inc. is not subject to either the 1992 or the 1993 franchise tax because C Inc. ceased to exist on December 31, 1991. However, S Inc. is subject to both the 1992 and 1993 franchise tax on the income attributed to S Inc. from C Inc. pursuant to ORC section 5733.053 notwithstanding the fact that S Inc. is an S corporation and is otherwise exempt from the franchise tax. S Inc. would have met the ownership or control requirements of division (A) of ORC section 5733.052 for a combined report with C Inc. if both corporations had existed on January 1 immediately before and after the merger and if the merger had not been made (the Department maintains that brother-sister corporations which are owned by the same individual or family meet the ownership requirements for a combined report). S Inc. is subject to the franchise tax on the income attributed to it from C Inc. because that income is not based on a taxable year for which the federal S election is in effect. The income attributed to S Inc. from C Inc. is based on C's accounting periods 4/1/90 to 3/31/91 and 4/1/91 to 12/31/91 for which no S election was in effect. S Inc. is subject to the 1992 franchise tax based on the income earned by C Inc. during the period 4/l/90 to 3/31/91. S Inc. is subject to the 1993 franchise tax based on the income earned by C Inc. during the period 4/1/91 to 12/31/91.

Tax Information Releases are not "Opinions of the Tax Commissioner" within the meaning of ORC section 5703.53, Accordingly, the Tax Commissioner is not bound by this release. Nevertheless, the above discussion does reflect the Income Tax Audit Division's interpretation of the law.

For further assistance please call 614-433-7862.