In a private letter ruling (PLR 201341004), the IRS ruled that a valid spinoff had occurred notwithstanding that some of the distribution was related to hook stock in the parent. According to the facts of the letter ruling, a consolidated group's common parent (Distributing) was a public company with one class of voting common stock outstanding. A subsidiary of Distributing (Sub) established a grantor trust (Trust) that owned stock in Distributing (the hook stock).

To separate two distinct business lines, Sub moved certain business assets into a newly created corporation (Controlled) and distributed all the stock of Controlled to Distributing. Distributing then distributed that stock pro rata to its shareholders. Trust received stock in Controlled from the distribution because of the hook stock it owned in Distributing.

The IRS ruled that the distribution was a tax-free spinoff under Section 355. Generally, in a tax-free spinoff, Distributing would have been required to distribute all the stock and securities it held in Controlled immediately before the distribution. If Distributing retained some Controlled stock, Distributing could still have received tax-free treatment under Section 355 if:

  • distributing distributed an amount of stock in Controlled constituting control within the meaning of Section 368(c), and
  • distributing could establish to the satisfaction of the IRS that the retention of any Controlled stock was not to pursue a plan that had as one of its principal purposes to avoid federal income tax.  

By implication, the amount of hook stock must not have negated Section 368(c) control.

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