A corporation can divide itself into two or more corporations in a tax‑free transaction under § 355. This can be done as a spin‑off (distribution of subsidiary stock to shareholders), a split‑off (exchange of stock), or a split‑up (distribution of all assets to shareholders who then form new corporations).
But § 355 imposes strict requirements. The distribution must not be used principally as a device to distribute E&P. § 355(a)(1)(B). There must be a corporate business purpose. Reg. § 1.355‑2(b). Both the distributing and controlled corporations must be engaged in an active trade or business that has been conducted for five years. § 355(b).
Helvering v. Elkhorn Coal Co., 95 F.2d 732 (4th Cir. 1937), shows what happens when you try to use a division to avoid the “substantially all” requirement of a C reorganization. Elkhorn transferred unwanted assets to a new subsidiary, distributed the subsidiary’s stock, then transferred its remaining assets to an acquiring corporation. The court held the transaction was not a tax‑free reorganization – the distribution of the subsidiary’s stock prevented the later transfer from being a C reorganization.
But Commissioner v. Morris Trust, 367 F.2d 794 (4th Cir. 1966), held that a spin‑off followed by a merger can be tax‑free. The taxpayer owned a bank and an insurance business. Banking laws prohibited the acquiring bank from owning the insurance business. So the taxpayer spun off the insurance business to its shareholders, then merged the bank into the acquiring bank. The court held the spin‑off was tax‑free under § 355.
Congress later added § 355(e) to prevent “Morris Trust” transactions that are part of a plan to acquire a 50% or greater interest in the distributing or controlled corporation. But if there’s a valid business purpose, they can still work. Rev. Rul. 2003‑79, 2003‑29 I.R.B. 80, approved a “reverse Morris Trust” where a corporation transferred a business to a new subsidiary, spun it off, and then the subsidiary merged into an unrelated acquirer.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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