Corporate Separations (Portfolio 776)

Tax Management Portfolio, Corporate Separations, No. 776-4th, analyzes the tax consequences of corporate separations and distributions under §355. Section 355 applies to two different types of situations. In the first, a corporation divides into separate corporations by transferring one or more of its businesses to a newly formed subsidiary and distributes that subsidiary's stock to its shareholders. 

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Tax Management Portfolio, Corporate Separations, No. 776-4th, analyzes the tax consequences of corporate separations and distributions under §355. Section 355 applies to two different types of situations. In the first, a corporation divides into separate corporations by transferring one or more of its businesses to a newly formed subsidiary and distributes that subsidiary's stock to its shareholders. The second situation is a distribution to a corporation's shareholders of all or most of the stock of an existing subsidiary. Although the first transaction can constitute a reorganization (a divisive (D) reorganization under §368(a)(1)(D)) and the second does not, §355 applies to both if its requirements are met.

This portfolio analyzes the statutory and nonstatutory requirements for qualifying under §355: (1) the distributing corporation must control the corporation whose stock is distributed; (2) stock or securities of the controlled corporation must be distributed (although boot is also permitted under a related provision, §356); (3) the distribution must not be a device for distributing earnings and profits; (4) after the distribution both corporations must conduct an active business that has been conducted for at least five years and has not been acquired in a taxable transaction within that time; (5) an amount of stock constituting control of the controlled corporation must be distributed; (6) the transaction must have a corporate business purpose; and (7) the continuity of interest requirement must be met.

This portfolio also analyzes the tax consequences to the corporations and the shareholders of a transaction that meets all of the requirements of §355. The shareholders who receive stock (other than nonqualified preferred stock), and to some extent, securities, of the controlled corporation do not recognize gain or loss on the distribution, except to the extent that they also receive property other than stock and securities of the controlled corporation. Subject to potentially-significant exceptions, both the distributing and the controlled corporation generally receive nonrecognition treatment in the transaction. The portfolio also discusses the tax consequences if a distribution of controlled corporation stock fails to meet the requirements of §355, as well as the reporting requirements for §355 transactions.


Candace A. Ridgway

Candace A. Ridgway, B.A. (cum laude), University of Connecticut; MBA, Arizona State University; J.D. (magna cum laude), Cornell Law School; LL.M. (Taxation, with distinction), Georgetown University Law Center; member, District of Columbia Bar; member, New York State Bar; member, American Bar Association, Tax Section.

Table of Contents

Detailed Analysis

I. Spin-Offs - Purpose and Policy

Introductory Material

A. Legislative Policy

B. Judicial Policy

C. Regulatory Policy

D. IRS Ruling Policy

II. Basic Requirements for Tax-Free Spin-Off

Introductory Material

A. Distribution

1. To Shareholders with Respect to Stock

a. Spin-Offs, Split-Offs, Split-Ups

b. Bargain Sales

c. Disqualified Shareholders

2. To Security Holders in Exchange for Securities

B. All (or Controlling) Stock and Securities of Controlled

1. Controlled Subsidiary

2. Distribution of Controlling Stock

3. “Stock” vs. Other Interests

a. Rights, Warrants, Etc.

b. Nonqualified Preferred Stock

c. Recently Acquired Stock

4. Distribution of Boot

5. New or Existing Controlled

C. Not a Device

D. Distributing and Controlled in Active Business

E. Nonstatutory Requirements

1. Continuity of Interest

2. Continuity of Business Enterprise

3. Business Purpose

F. Disqualified Distributions

G. Disqualified Investment Companies

1. In General

2. Disqualified Investment Company Defined

3. Investment Asset Defined

a. In General

b. Exceptions to the Definition of Investment Assets

(1) Active Trade or Business Exceptions

(2) Mark-to-Market Exception

(3) 20% Controlled Entity Exception

(4) Exception for Interest in a Partnership

III. Control

A. Control “Immediately Before” the Spin-Off

1. In General

2. Acquisition as Part of Spin-Off Plan

a. Adjustments to Voting Power

b. Ownership Shifts

3. Post-Spin-Off Dispositions

B. Distribution of Control

1. Minimum Distribution Required

2. Period of Distribution

3. Retention of Stock or Securities

a. Acceptable Retentions

b. Unacceptable Retentions

(1) Retention of Recently Acquired Stock in Subsidiary

(2) Retention to Keep Practical Control

c. Retention by Affiliate

4. Post-Spin-Off Loss of Control

C. Control Immediately After

IV. Stock vs. Boot

Introductory Material

A. Money and Other Items

B. Stock Rights and Warrants

C. Stock of Controlled

D. Securities of Controlled

E. Accrued Interest

V. Device

Introductory Material

A. Reason for Device Test

B. Post-Spin-Off Dispositions as Evidence of Device

1. Non-prearranged Dispositions

2. Prearranged Dispositions

C. Post-Spin-Off Dispositions That Do Not Indicate Spin-Off Is a Device

1. Reorganizations

2. Dispositions Without Consideration

3. Redistribution by a Corporate Distributee

4. Disposition of Stock in Distributing and Controlled

D. Nature and Use of Assets

1. Assets Not Used in a Trade or Business Meeting the Requirements of § 355(b)

2. Shift of Assets

3. Related Function

E. Termination of Business After Spin-Off

F. Objective Factors Indicating a Spin-Off Is Not a Device

1. Corporate Business Purpose

2. Distributing Publicly Traded and Widely Held

3. Distribution to Domestic Corporate Shareholders

G. Transactions Ordinarily Not Considered a Device

1. Absence of Earnings and Profits

2. Redemptions and Non-Pro Rata Spin-Offs

VI. Active Business

A. Framework of § 355(b)

B. Active Business vs. Passive Investments

1. Portfolio Securities

a. General Rule

b. Dealers in Securities

2. Finance Business

3. Real Estate

a. Vacant Land

b. Improved Real Estate

c. Owner-occupied Real Estate

4. Use of Independent Contractors

5. Use of Employees of Affiliates

6. Partnership Activities

C. Active Business Conducted by Separate Affiliated Groups (or by a Subsidiary or Successor)

1. Separate Affiliated Groups (or Holding Companies) - § 355(b)(2)(A)

a. In General

b. “Substantially All” Requirement (Pre-May 18, 2006 Law)

c. Controlled Corporate Subsidiary (Pre-May 18, 2006 Law)

d. Separate Affiliated Groups (SAGs) (Post-May 17, 2006 Law)

e. Proposed § 355 Active Business Regulations

(1) The Theory

(a) Corporate Divisions

(b) Corporate Acquisitions

(2) The Practice

(a) Treatment of SAG Members As “Divisions” of Single Corporation

(i) Stock vs. Asset “Expansion”

(ii) Dispersed Business Activities

(iii) Partnership's Business Assets/Activities

(b) Stock/Business Acquisitions - Out

(i) Taxable Acquisition from Non-SAG Affiliate

(ii) Taxable Acquisition of § 1504 Control of § 368(c) - Controlled Controlled

(iii) Nontaxable Acquisitions Not For Distributing Stock

(c) Stock/Business Acquisitions - In

(i) Fractional Shares

(ii) Taxable Acquisition by Controlled from Distributing

(iii) Taxable Acquisition of Distributing by Distributee Corporation

(iv) Taxable Acquisition of § 368(c) Control Stock of Controlled (DSAG Member)

(d) Multi-Step and Indirect Acquisitions - Do the Math

2. Liquidating Distributing - § 355(b)(1)(B) Split-Up

3. Continuation of Business by Successor Corporation

D. Ownership of Active Business Assets

1. Proportion of Active Business Assets

2. Nature of Non-Active Business Assets

E. Five-Year Requirement of § 355(b)(2)(B)

1. In General

2. When Business Begins

3. Interruption in Business

4. Change in or Expansion of Business

F. Dividing a Single Business

1. “Vertical” Divisions

2. Functional Divisions

3. Owner-Occupied Real Estate

G. Acquisition of Active Business

1. Acquisition of Business Assets

a. Recognition of Gain or Loss

b. Acquisitions from Related Corporations

c. Tax-Free Acquisition Following Taxable Acquisition

2. Acquisition of Controlling Stock Interest

a. Acquiring Control in One or More Taxable Transactions

b. Acquiring Control by Redemption

c. Acquisition of Stock from Acquired Corporation

d. Tax-Free Acquisition Following Taxable Acquisition

e. Acquiring Control from Related Corporations

3. Acquiring Stock of Distributing

VII. Continuity Requirements

Introductory Material

A. Continuity of Interest

1. In General

2. Taxable Dispositions

3. Nontaxable Dispositions - Reorganizations, Etc.

a. Successive Spin-Offs

b. Spin-Off Followed by Stock Drop-Down

c. Spin-Off Followed by Acquisition of Distributing

d. Post-Spin-Off Acquisition of Controlled

e. Post-Spin-Off Acquisitions by Distributing or Controlled

4. Post-Spin-Off Stock Issuances

B. Continuity of Business Enterprise

VIII. Business Purpose

Introductory Material

A. Business Purpose and “Device”

B. Corporate vs. Shareholder Purposes

1. In General

2. Exchanges Between Shareholders or Security Holders

C. Valid Business Purposes

1. Shareholder Conflicts, Etc.

2. Purposes Related to Employees

3. Cost Savings

4. Fit and Focus

5. Credit Issues; Raising Capital/Acquisition Currency

6. Compliance with Laws

7. Preparing for a Reorganization

8. Competition

9. Risk Reduction

10. Reducing State or Foreign Taxes

11. Miscellaneous

D. Invalid Business Purposes

1. Reduction of Federal Taxes

2. Purpose that Can Be Accomplished Without a Spin-Off

IX. Tax Consequences of Spin-Off to Distributing

A. Recognition of Gain or Loss

1. Qualified Spin-Off

a. Distributions Not in a Reorganization

b. Distributions in a Reorganization

c. Transfers to Subsidiary

d. Consolidated Return Items

2. Disguised Sales: Distributions Following Stock Purchases

a. In General

b. Statutory Framework and Detailed Rules

(1) Disqualified Distribution

(2) Disqualified Stock

(3) 50% or Greater Interest

(4) Acquired by Purchase

(a) In general

(b) Reorganizations and § 351 Transfers

(i) Reorganizations and § 351 Generally

(ii) Triangular Reorganizations

(5) The Five-Year Period

(6) “Deemed Purchase” and Other Timing Rules

3. Disguised Sales: Dispositions in Connection with Distribution

a. In General

b. Section 355(e) - Statutory Framework and Detailed Rules

(1) Applicable Distribution - In General

(2) Excepted Acquisitions

(3) Prohibited Plan or Series of Related Transactions

(a) Agreement, Understanding, Arrangement, or Substantial Negotiations

(b) Plan or Non-Plan Factors

(c) Safe Harbors

(d) Special Rules

(4) Prohibited Acquisition

(5) Successor Rules and Other Regulations

(a) “Successors”

(b) “Predecessors”

(i) Definitions

(ii) Treatment of Acquisitions Involving Predecessors or Successors

(iii) Section 355(e) Gain Recognition When Acquisitions Involve Predecessors

c. Section 355(f) - Intragroup Spin-Offs

d. Restructuring After the 1997 Act

4. Foreign Corporations

B. Basis of Distributing's Assets

C. Earnings and Profits of Distributing

1. Controlled Is Subsidiary that Received Assets from Distributing

a. Fair Market Value Rule

b. Net Basis (or Alternative) Rule

c. Other Methods

2. Distribution of a Subsidiary without Asset Transfer under § 368(a)(1)(D)

D. Net Operating Loss Carryover

E. Subchapter S Status

F. Expenses of Spin-Off

X. Tax Consequences of Spin-Off to Controlled

A. Gain or Loss

B. Basis of Assets

C. Earnings and Profits

D. Net Operating Loss Carryover

E. Other Attributes

F. Consolidated Return Items

XI. Tax Consequences to Shareholders

A. Recognition of Gain or Loss - Qualified Spin-Off

1. Distribution of Boot - Stock Surrendered

2. Distribution of Boot - No Stock Surrendered

3. Gifts or Payments of Compensation

4. Cash In Lieu of Fractional Shares

B. Basis After Spin-Off

1. Allocation of Total Basis

a. In General

b. Consolidated Groups

c. Allocation of Basis Among Shares of Stock or Securities

(1) In General

(2) Allocation of Boot

2. Basis of Boot

C. Holding Period

D. Section 306 Stock

XII. Consequences of Taxable Spin-Off

Introductory Material

A. To Shareholders

1. In General

2. Transactions Qualifying Under § 302

3. Direction of Spin-Off

4. Basis of Controlled Stock

B. To Distributing

1. Gain Taxed to Distributing

2. Effect on Earnings and Profits

3. Basis

C. To Controlled

XIII. Information to Be Filed After a Spin-Off

A. By Distributing

B. By Shareholders

Working Papers

Working Papers

Table of Worksheets

Other Resources

Worksheet 1 Diagrams of Corporate Separation Mechanics

Worksheet 2 Diagrams of “Disguised Sale” Transactions

Worksheet 3 Sample Client Memorandum

Worksheet 4 Directors' Resolution Approving Spin-off

Worksheet 5 Shareholders' Resolution Approving Spin-off

Worksheet 6 Agreement and Plan of Reorganization and Corporate Separation

Worksheet 7 Section 355 Ruling Checklist: Rev. Proc. 96-30, 1996-1 C.B. 696

Worksheet 8 Revised Section 355 Ruling Checklist: Rev. Proc. 2003-48, 2003-29 I.R.B. 86

Worksheet 9 Information Statement to IRS by Company

Worksheet 10 Allocation of Earnings and Profits in Connection with Corporate Separation

Worksheet 11 Letter Advising Shareholders of Impending Spin-off

Worksheet 12 Letter Advising Shareholders of Details of Consummated Spin-off

Worksheet 13 Information Statement to IRS by Shareholders

Worksheet 14 S. Rep. No. 33, 105th Cong., 1st Sess. 139 (1997) Senate Report on the Revenue Reconciliation Act of 1997 (Excerpts)

Worksheet 15 H.R. Rep. No. 220, 105th Cong., 1st Sess. (1997), Conference Report on 1997 Tapayer Relief Act (Excerpt)

Worksheet 16 S. Rep. No. 174, 105th Cong., 2d Sess. 173 (1998) Senate Report on the Internal Revenue Service Restructuring and Reform Act of 1998 (Excerpts)

Worksheet 17 Alternatives to Morris Trust - Variations and Combinations of Tracking Stock/Section 351 Concepts*

Worksheet 18 The Anti-Morris Trust Rules-By Example

Worksheet 19 Preamble and Temporary Regulations (Former) on Anti-Morris Trust Rules T.D. 8960, 66 Fed. Reg. 40590 (8/3/01); For Distributions Occurring after August 3, 2001 and before April 27, 2002

Worksheet 20 Preamble to Anti-Morris Trust Temporary Regulations T.D. 8988, 67 Fed. Reg. 20632 (4/26/02)




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