Final sec. 355(d) regulations.

• Author: Packard, Pamela
• Position: Divisive distributions and spin-offs

A divisive distribution's usefulness was hampered by Sec. 355(d)'s enactment, following the repeal of the General Utilities doctrine by the Tax Reform Act of 1986. A divisive distribution (Distribution) is a spin-off, split-off or split-up.

Sec. 355(d) disqualifies a spin-off if, immediately thereafter, any person owns "disqualified stock" constituting 50%-or-more ownership in either the parent (Distributing) or the spun-off subsidiary (Controlled). Disqualified stock includes any stock purchased during the five years preceding the spin-off (the five-year period).

A disqualification imposes a corporate-level tax, but no shareholder tax. The final regulations, generally effective for distributions after Dec. 20, 2000, correct many unexpected hardships under the proposed regulations. The final regulations appear to be very taxpayer-friendly and provide greatly desired definitional clarity.

Purpose Exception

The final regulations continue the approach of the proposed regulations, which made an exception for distributions that do not violate Sec. 355(d)'s purposes. A distribution does not violate Sec. 355(d)'s purposes if it meets two tests. First, it does not increase a disqualified person's direct or indirect ownership in Distributing or Controlled. Second, it does not provide a disqualified person with a purchased basis in any Controlled stock.

A "disqualified person" is any person who, immediately after a distribution, holds disqualified stock in Distributing or Controlled that constitutes a 50%-or-greater interest. The final regulations clarify that the term "disqualified person" includes only a person who meets that definition because of its own purchase of "disqualified stock" (or who receives stock in Controlled with respect to stock that the person purchased).

The final regulations also modify the definition of disqualified stock. Distributing or Controlled stock acquired by purchase within the five-year period (including stock indirectly acquired by purchase) will no longer be considered as purchased if (and when) the basis resulting from that purchase is eliminated.

Basis in a corporation's stock is eliminated if and when it would no longer be taken into account by any person in determining gain or loss on a sale or exchange of that corporation's stock. For example, a direct purchase by Distributing of all Controlled stock, followed by a distribution of that stock, would have been a disqualified distribution under the proposed...