Requirements of a Tax Free Corporate Division

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If a corporate split-up transaction does not meet the requirements of IRC section 355, the transfer of assets by the distributing corporation is treated as a taxable sale, and the distribution of the stock of the controlled corporation is treated as a taxable dividend.  In order for a distribution of stock of a controlled corporation to qualify under IRC section 355 as a tax-free transaction, the following requirements must be met:

(1)   The distributing corporation must control the corporation whose stock it distributes (“controlled corporation”) immediately before the distribution.  For purposes of these rules, control means ownership of (a) stock possessing at least 80% of the combined voting power of all classes of stock entitled to vote, and (b) 80% of the shares of each other class of the corporation's stock.


(2)  The distributing corporation must distribute all the stock of the controlled corporation it held immediately before the distribution.  However, if it can show that tax avoidance is not a principal purpose for retaining part of the stock of the controlled corporation, the distribution will be tax-free so long as a controlling interest in the controlled corporation's stock is distributed.

(3)  The transaction must not be used principally as a device for distributing the earnings and profits of either the distributing corporation or the controlled corporation.


(4)  The active trade or business requirement of IRC section 355(b) must be satisfied by both the distributing corporation and the controlled corporation.


(5)  There must be a corporate business purpose for the distribution.  Some examples of business purpose include: cost savings, risk reduction, resolution of management or other problems, providing equity interests to key employees, facilitating credit or borrowing, preparing for security offerings, preparing for transactions with competitors, getting ready for purchase of the distributing corporation, facilitating a purchase or acquisition  by the distributing corporation or the controlled corporation.


(6)  The distributing corporation must distribute only stock or securities of the controlled corporation to a shareholder in exchange for his stock.   However, if the other requirements listed above are met, and other property is distributed, the distribution will be tax-free except to the extent of the other property distributed


(7) The distribution or series of distributions is not part of a transaction after which either the distributing corporation or a controlled corporation is a disqualified investment corporation and a person holds immediately after the transaction a 50% or greater interest in any disqualified investment corporation that they did not hold immediately before the transaction.

If any one of the above requirements is not met, the transaction will fail to qualify as a tax-free reorganization, and the distributing corporation and/or the shareholders will be subject to income tax.  Call or email me at 937-223-1130 or Jsenney@pselaw.com if you have any questions about how to properly structure a tax-free corporate division or other reorganization transaction.


AND ONE MORE THING.  The local chapter of American Red Cross is organizing a gala, Putting on the Glitz, as a fundraiser to benefit disaster relief and preparedness in the Miami Valley. The event will take place Saturday, April 27, 2013 with the theme, "Providing Hope Like a Bridge Over Troubled Water."   The event is being run like a fashion show.  Jeff Senney is participating/competing in the show.   You can donate/vote for Jeff as “top model” by clicking on the donate link. Thanks for your support for this great cause