The IRS recently ruled in a private letter ruling (PLR 201551009) on the implications of gain
recognition under Section 751 in the context of a Section 355
spinoff.
Under the PLR, a parent corporation (Distributing) and its wholly
owned subsidiary corporation (Subsidiary) owned collectively all of
the outstanding interests in an entity treated as a partnership
(LP). LP owned Business A, which was housed in several limited
liability companies (LLCs) that were disregarded as separate from
LP. Distributing and LP engaged in the following steps:
First, LP contributed various assets (including disregarded
entities) that comprised Business A to a newly formed C corporation
(Controlled) in a transaction intended to qualify as tax-free under
Section 351. Second, LP distributed the stock of Controlled to
Distributing in a distribution in partial redemption of
Distributing’s interest in LP, in which gain may have been
recognized under Section 751. Third, Distributing, in turn,
distributed Controlled’s stock to Distributing’s
shareholders in a transaction intended to qualify as a tax-free
spinoff under Section 355.
Section 355(a) generally provides that a distributing corporation
can distribute stock and securities of a controlled corporation to
its shareholders tax-free. Section 355(a)(1)(B), however, limits
the general rule when the distribution is used principally as a
device for the distribution of earnings and profits of the
distributing corporation or the controlled corporation. The active
trade or business requirements of Section 355(b) further enforce
the prohibition of a distribution principally used as this type of
device.
Section 355(b)(2)(B) provides that an active trade or business must
be actively conducted by both the distributing corporation and the
controlled corporation throughout the five-year period ending on
the date of the distribution. Section 355(b)(2)(C) provides that
such active trade or business cannot be acquired within the
five-year period in a transaction in which gain or loss was
recognized in whole or in part.
Distributing acquired Controlled, which owned Business A, in a
taxable distribution in which gain may have been recognized under
Section 751. Though the PLR didn’t provide a detailed
analysis, the IRS nevertheless concluded that the gain recognition
from the Section 751 distribution wouldn’t prevent the
distribution of Controlled by Distributing to its shareholders from
satisfying the active trade or business requirements of Section
355(b).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.