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Spin-Off Corporate-Level Tax Triggers (§§ 355(d), 355(e), 355(g))

This checklist guides practitioners through the corporate-level gain triggers that can override § 355 nonrecognition. Use it whenever a spin-off, split-off, or split-up involves recent stock acquisitions, prearranged mergers, or investment-heavy corporations.

Step 1. § 355 Corporate-Level Gain Framework

"No gain or loss shall be recognized to a corporation on the distribution (not in partial liquidation) to which this section applies." (§ 355(c)(1))

• § 355(c)(1) general nonrecognition.
  • No gain or loss is recognized to Distributing on any distribution to which § 355 applies. (§ 355(c)(1))
  • This is the baseline rule. The corporate-level gain triggers in §§ 355(d), (e), and (g) override this default.
• § 355(c)(2) gain on non-qualified property.
  • If Distributing distributes property other than "qualified property" (defined in § 355(c)(2)(B) as stock or securities of Controlled) and FMV exceeds basis, gain is recognized as if sold at FMV. (§ 355(c)(2)(A))
  • "Qualified property" is limited to stock or securities of Controlled. Any other property distributed triggers gain to the extent of appreciation.
• § 361(c)(2) parallel rule for reorganizations.
  • In a divisive D reorganization, the same qualified-property framework applies. If Controlled stock is not "qualified property," gain is recognized under § 361(c)(2)(A). (§ 361(c)(2))
  • This ensures parity between standalone § 355 distributions and divisive reorganizations.
• § 355(c)(3) exclusion of §§ 311 and 336.
  • Sections 311 and 336 do not apply to § 355 distributions. The gain mechanism is entirely through §§ 355(c)(2) and 361(c)(2). (§ 355(c)(3))
  • This ensures the § 355 framework controls and prevents duplicative gain recognition.
• The § 355(d) and § 355(e) override.
  • Both provisions operate by denying "qualified property" status to Controlled stock. (§ 355(d)(1)) (§ 355(e)(1))
  • When they apply, § 355(c)(2)(A) or § 361(c)(2)(A) triggers gain recognition as if Distributing sold the stock at FMV.
• CAUTION.
  • Only GAIN is recognized in a § 355 distribution.
  • Loss is never recognized, even when § 355(d) or § 355(e) applies and gain is triggered.

Step 2. § 355(d) Statutory Mechanism and Trigger

"In the case of any disqualified distribution, any stock or securities in the controlled corporation shall not be treated as qualified property for purposes of subsection (c)(2) or section 361(c)(2)." (§ 355(d)(1))

• § 355(d)(1) operative rule.
  • In a "disqualified distribution," any stock or securities in Controlled "shall not be treated as qualified property" for purposes of § 355(c)(2) or § 361(c)(2). (§ 355(d)(1))
  • This operates identically to the § 355(e) denial of qualified property status but with a different triggering mechanism.
• § 355(d) enacted by OBRA 1990.
  • § 355(d) was added by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508, § 11321(a), effective for distributions after October 9, 1990.
  • NOT by TRA 1997 (which enacted § 355(e)). Do not confuse the two statutes.
• The disqualified distribution definition.
  • A "disqualified distribution" means any § 355 distribution where, immediately after the distribution, (A) any person holds "disqualified stock" in Distributing constituting a 50% or greater interest, OR (B) any person holds disqualified stock in Controlled constituting a 50% or greater interest. (§ 355(d)(2))
  • This is a two-pronged test. Either prong satisfied triggers the rule. Both prongs are tested independently.
• All-or-nothing gain recognition.
  • If a disqualified distribution occurs, the ENTIRE Controlled stock distributed triggers gain. (§ 355(d)(1))
  • There is no partial or proportional recognition. Distributing recognizes gain as if it sold the Controlled stock at FMV.
• EXAMPLE.
  • Distributing D owns all of Controlled C.
  • Shareholder A purchased 60% of D's stock for cash within the 5-year period.
  • D distributes all of C's stock to its shareholders pro rata.
  • Immediately after, A holds disqualified stock in D constituting 60% (a 50% or greater interest).
  • The distribution is disqualified. D recognizes gain as if it sold all C stock at FMV.

Step 3. Disqualified Stock and the Five-Year Purchase Lookback

Step 3A. Definition of Disqualified Stock

• Disqualified stock in Distributing.
  • Any stock in Distributing acquired by purchase during the 5-year period ending on the distribution date is "disqualified stock." (§ 355(d)(3)(A))
  • This includes both direct purchases and indirect acquisitions through attribution.
• Disqualified stock in Controlled.
  • Two categories apply. (1) Any stock in Controlled acquired by purchase during the 5-year period, OR (2) any stock in Controlled received in the distribution to the extent attributable to Distributing stock (or securities) acquired by purchase during the 5-year period. (§ 355(d)(3)(B))
  • The second category is the "taint carries through" rule. Purchased Distributing stock taints the Controlled stock received on distribution.
• The taint carries through.
  • If a shareholder purchased Distributing stock within 5 years and receives Controlled stock on that purchased Distributing stock, the Controlled stock received is disqualified. (§ 355(d)(3)(B)(ii))
  • This prevents shareholders from cleansing purchased stock through a § 355 distribution.
• The five-year period.
  • Ends on the distribution date and begins five years earlier, but IN NO EVENT earlier than October 10, 1990. (Treas. Reg. § 1.355-6(a)(4))
  • The October 10, 1990 floor corresponds to the OBRA 1990 effective date.

Step 3B. Purchase Elimination Rules

• Purchase elimination when basis is eliminated.
  • Disqualified stock ceases to be disqualified when the basis from the purchase is eliminated (e.g., through a § 332 liquidation or § 368(a)(1)(A) merger where the purchased basis is replaced by carryover basis under § 334(b)(1) or § 362(b)). (Treas. Reg. § 1.355-6(b)(2)(iii)(A))
  • The key is that the purchaser's original basis in the target stock must no longer determine the basis of any asset.
• Deemed purchase elimination.
  • Stock deemed purchased under § 355(d)(8) ceases to be treated as purchased when the basis resulting from the underlying purchase is eliminated. (Treas. Reg. § 1.355-6(b)(2)(iii)(B))
  • This parallels the direct purchase elimination rule for attributed ownership.
• EXAMPLE of elimination.
  • P purchases 70% of D. Within 5 years, P liquidates D under §§ 332/337(a).
  • P's basis in D subsidiary stock is determined under § 334(b)(1) (not by reference to P's basis in D).
  • The deemed purchase is eliminated. A subsequent distribution by the D subsidiary is not a disqualified distribution. (Treas. Reg. § 1.355-6(b)(2)(iii), Example 7)

Step 4. Definition of "Purchase" and Related Exceptions

Step 4A. General Definition

• Purchase means any acquisition where.
  • (i) Basis is NOT determined by reference to the transferor's adjusted basis and NOT under § 1014(a) (inheritance), AND (ii) the property is NOT acquired in an exchange to which § 351, 354, 355, or 356 applies. (§ 355(d)(5)(A))
  • The definition has two negative conditions. Both must be satisfied for an acquisition to be a "purchase."
• What is NOT a purchase.
  • § 351 transfers, § 354 exchanges, § 355 distributions, § 356 exchanges, § 1036(a) stock-for-stock exchanges, § 305(a) stock distributions with § 307(a) basis, and inherited property with § 1014(a) basis are all excluded. (Treas. Reg. § 1.355-6(d)(2))
  • These exceptions ensure tax-free and non-recognition transactions do not create disqualified stock.

Step 4B. § 351 Exchanges Treated as Purchases

• Cash, marketable securities, and transferor debt trigger purchase treatment.
  • A § 351 exchange is treated as a purchase to the extent property is acquired in exchange for cash, cash items, marketable stock or securities, or debt of the transferor. (§ 355(d)(5)(B))
  • This prevents boot in a § 351 exchange from cleansing the taint of a purchase.
• Affiliated group exception.
  • A § 351 exchange is NOT treated as a purchase if transferor and transferee are members of the same affiliated group before the exchange, the cash/securities/debt were not acquired from a nonmember in a related § 362(a)/(b) transaction, and they do not cease to be an affiliated group pursuant to a plan including the § 351 exchange. (Treas. Reg. § 1.355-6(d)(3)(v))
  • Applies only to DOMESTIC corporations.
• Active business exception.
  • Cash or marketable securities transferred as part of an active trade or business and not exceeding the reasonable needs of the business are NOT treated as purchases. (Treas. Reg. § 1.355-6(d)(3)(iv))
  • This exception is narrow and requires a genuine active business context.

Step 4C. Transferred Basis Rule

• Transferred basis treated as purchased on original date.
  • If a person acquires property from another person who acquired it by purchase, and basis is determined by reference to the transferor's basis, the acquirer is treated as having purchased on the date the transferor purchased. (§ 355(d)(5)(C))
  • This prevents taint from being eliminated through non-recognition transfers.
• EXAMPLE.
  • A purchases all of T stock. T merges into D in a § 368(a)(1)(A) reorganization, and A exchanges T stock for D stock.
  • A is treated as having purchased the D stock on the date A purchased the T stock. (Treas. Reg. § 1.355-6(e)(3) Example)

Step 5. The 50-Percent Threshold and Attribution Rules

Step 5A. The 50-Percent Test

• 50% of vote OR value.
  • A "50-percent or greater interest" means stock possessing at least 50% of the total combined voting power OR at least 50% of the total value of shares of all classes of stock. (§ 355(d)(4))
  • The test is satisfied by EITHER voting power OR value. It is an alternative, not a cumulative, test.
• All shares within a class have same value.
  • For purposes of the value test, all shares within a class are treated as having the same value. (Treas. Reg. § 1.355-6(c)(2))
  • This simplifies valuation by avoiding intra-class value differentiation.

Step 5B. Attribution from Entities

• § 318(a)(2) with 10% substitution.
  • § 318(a)(2) applies to determine stock ownership, substituting "10 percent" for "50 percent" in § 318(a)(2)(C), and treating any reference to stock as including securities. (§ 355(d)(8)(A))
  • The 10% threshold (rather than § 318's usual 50%) dramatically expands attribution.
• Deemed purchase through entity interests.
  • If a person purchases an interest in an entity and is treated as holding stock by reason of that interest, such stock is treated as acquired by purchase on the later of the entity purchase date or the stock purchase date by the entity. (§ 355(d)(8)(B))
  • This prevents avoidance through entity-level acquisitions.
• EXAMPLE.
  • A purchases 60% of Partnership P. P owns 100% of T stock.
  • A is deemed to have purchased 60% of T stock on the date A purchased the P interest. (Treas. Reg. § 1.355-6(e)(1) Example 1)

Step 5C. Aggregation of Related Persons

• Related persons treated as one person.
  • A person and all persons related within the meaning of § 267(b) or § 707(b)(1) are treated as one person. (§ 355(d)(7)(A))
  • This includes family members, controlled entities, and certain partners.
• Persons acting pursuant to a plan or arrangement.
  • Two or more persons who have a formal or informal understanding to make a coordinated acquisition of stock are treated as one person. (§ 355(d)(7)(B)) (Treas. Reg. § 1.355-6(c)(4)(ii))
  • A public offering is generally NOT a plan or arrangement if each investor makes an independent decision.
• Subsequent exchanged-basis exception.
  • If persons do not act pursuant to a plan when acquiring stock in a first corporation, a subsequent exchanged-basis acquisition in a second corporation does not cause aggregation. (Treas. Reg. § 1.355-6(c)(4)(iv))
  • This limits the reach of the aggregation rule to planned coordinated acquisitions.

Step 5D. Options

• Options generally NOT treated as exercised.
  • Options are generally not treated as exercised for purposes of determining disqualified stock ownership. (Treas. Reg. § 1.355-6(c)(3))
  • This is the default rule and limits the scope of the attribution rules.
• Option treated as exercised if.
  • (i) deemed exercise would cause a person to be a disqualified person, AND (ii) immediately after the distribution, based on all facts and circumstances, it is reasonably certain the option will be exercised. (Treas. Reg. § 1.355-6(c)(3))
  • This exception prevents options from being used to avoid § 355(d) through near-certain future acquisitions.

Step 6. The Purpose Exception and Critical Safe Harbor

"A distribution is not a disqualified distribution if the effect of the distribution is neither to increase nor decrease ownership of the distributing corporation or the controlled corporation." (Treas. Reg. § 1.355-6(b)(3))

• The two-pronged purpose test.
  • Even if mechanically a disqualified distribution, the distribution is NOT disqualified if BOTH of the following are true. (Treas. Reg. § 1.355-6(b)(3))
  • (A) The effect is NOT to increase ownership (combined direct and indirect) in Distributing or Controlled by a disqualified person, AND (B) the effect is NOT to provide a disqualified person with a "purchased basis" in Controlled stock.
• "Purchased basis" defined.
  • Basis in Controlled stock that is disqualified stock, UNLESS both the Controlled stock and Distributing stock are treated as acquired by purchase SOLELY under the attribution rules of § 355(d)(8). (Treas. Reg. § 1.355-6(b)(3))
  • If the Distributing stock was directly purchased, the Controlled stock carries purchased basis.
• "Disqualified person" defined.
  • Any person (after applying aggregation and attribution) that immediately after the distribution holds disqualified stock in Distributing or Controlled constituting a 50% or greater interest. (Treas. Reg. § 1.355-6(b)(3))
  • This aggregates all related persons and attributed ownership.
• EXAMPLE where purpose exception does NOT apply.
  • A purchases 60% of D. D distributes C pro rata. A's C stock is received with respect to purchased D stock, so it carries purchased basis.
  • A's ownership in C is the same proportionate interest as A's ownership in D (60% direct before, 60% direct after). The distribution does NOT increase A's ownership.
  • However, prong (B) is violated because A receives purchased basis. RESULT. Disqualified distribution. (This is Example 2 from Treas. Reg. § 1.355-6(b)(3)(vi))
• EXAMPLE where both prongs satisfied.
  • A purchases 60% of T. T merges into D in a § 368(a)(1)(A) reorg. A exchanges T stock for D stock. D distributes C to D1.
  • Under attribution, A is treated as having purchased D and D1 stock. A's basis in C received by D1 is NOT purchased basis because D1 stock was treated as acquired by purchase SOLELY under attribution.
  • A's ownership does not increase. RESULT. NOT a disqualified distribution. (Treas. Reg. § 1.355-6(b)(3)(vi), Example 6)
• Cash in lieu of fractional shares.
  • Disregarded if solely to avoid inconvenience and not separately bargained for. (Treas. Reg. § 1.355-6(b)(3)(iv))
  • This is a de minimis exception for administrative convenience.

Step 7. Anti-Avoidance Rule and § 355(d)(6) Risk Suspension

"The running of any period of time set forth in paragraph (3)(A) shall be suspended during any period as determined by the Secretary pursuant to which the holder of the stock has taken any action which has the effect of diminishing the risk of loss with respect to such stock." (§ 355(d)(6))

• The Commissioner's override authority.
  • Notwithstanding any provision of § 355(d), the Commissioner may treat any distribution as a disqualified distribution if the distribution or another transaction is structured with a principal purpose to avoid the purposes of § 355(d). (Treas. Reg. § 1.355-6(b)(4))
  • The Commissioner may disregard intermediaries, related persons, and pass-through entities formed or availed of with such purpose.
• EXAMPLE of anti-avoidance.
  • B wholly owns D, which wholly owns C. With a principal purpose to avoid § 355(d), A purchases 45 of 100 D shares. D distributes C to A and B pro rata.
  • D then redeems 20 of B's D shares. C redeems 20 of B's C shares. After redemption A owns 45 of 80 D shares (56.25%).
  • The Commissioner may treat A as owning 50% or greater disqualified stock despite the engineered redemption. (Treas. Reg. § 1.355-6(b)(4) Example)
• § 355(d)(6) suspension for diminished risk.
  • The running of the 5-year period is suspended during any period when the holder's risk of loss is substantially diminished by an option, short sale, special class of stock, or any other device or transaction. (§ 355(d)(6))
  • This prevents taxpayers from tolling the 5-year period through hedging or similar risk-diminishing transactions.

Step 8. § 355(e) Statutory Mechanism and the Morris Trust Response

"If stock or securities of the controlled corporation are acquired by purchase (as defined in paragraph (5)) in a qualified purchase during the period beginning 2 years before and ending 2 years after the date of the distribution, then, notwithstanding any provision of this chapter, the distribution is treated as part of a plan pursuant to which 1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or any controlled corporation." (§ 355(e)(2)(B))

• § 355(e)(1) operative rule.
  • If § 355(e) applies to a distribution, any stock or securities in Controlled "shall not be treated as qualified property" for purposes of § 355(c)(2) or § 361(c)(2). (§ 355(e)(1))
  • Same mechanism as § 355(d) but different trigger. § 355(d) looks at purchased stock. § 355(e) looks at planned acquisitions.
• Enacted by TRA 1997.
  • § 355(e) was added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, § 1012, effective generally for distributions after April 16, 1997. (H.R. Rep. No. 105-220, at 67-68 (1997))
  • It was Congress's direct response to "Morris Trust" transactions.
• The Morris Trust case.
  • In Commissioner v. Mary Archer W. Morris Trust, 367 F.2d 794 (4th Cir. 1966), aff'g 42 T.C. 779 (1964), a state bank operated both banking and insurance businesses.
  • It formed a subsidiary, transferred the insurance assets to it, distributed the subsidiary's stock to shareholders, then merged into a national bank.
  • The Fourth Circuit held the spin-off qualified under § 355 because there was literal compliance with § 355(b)(1)(A) immediately after the distribution, strong business purpose (compliance with banking law), and continuity of interest.
  • This "spin-merge" structure became known as a "Morris Trust transaction."
• The leveraged Morris Trust epidemic.
  • By the mid-1990s, corporations used leveraged Morris Trust structures to effectively sell businesses without corporate-level tax.
  • Notable examples included Viacom/TCI (1996), Raytheon/GM defense electronics (1996), and Knight Ridder/Disney newspapers (1997).
  • These involved pre-spin borrowing, separating debt from operations, and prearranged acquisitions.
• Congressional response.
  • Congress stated. "The recent transactions that raise concerns have very little to do with individual shareholder tax planning. Rather, they are prearranged structures designed to avoid corporate-level gain recognition. In essence, these transactions resemble sales." (H.R. Rep. No. 105-220, at 67-68 (1997))
  • This statement guides the interpretation of § 355(e) as targeting prearranged acquisitions.

Step 9. The "Plan" Requirement and Rebuttable Presumption

Step 9A. The Three-Element Test

• § 355(e)(2)(A) elements.
  • § 355(e) applies when (i) the distribution is one to which § 355 applies, AND (ii) the distribution is "part of a plan (or series of related transactions) pursuant to which 1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or any controlled corporation." (§ 355(e)(2)(A))
  • Both elements must be satisfied. The second element is the heart of the § 355(e) inquiry.
• General facts-and-circumstances standard.
  • Whether a distribution and acquisition are part of a plan is determined based on all the facts and circumstances. (Treas. Reg. § 1.355-7(b)(1))
  • No single factor is determinative. The inquiry is holistic.
• Intent standard for post-distribution acquisitions.
  • Distribution and acquisition are part of a plan if Distributing, Controlled, or their controlling shareholders intended, on the date of the distribution, that the acquisition or a similar acquisition occur in connection with the distribution. (Treas. Reg. § 1.355-7(b)(1))
  • This is a subjective intent test applied to the distributing party and its controllers.
• The critical rule for post-distribution acquisitions.
  • For acquisitions (other than public offerings) after a distribution, the distribution and acquisition can be part of a plan ONLY IF there was an agreement, understanding, arrangement, or substantial negotiations regarding the acquisition during the 2-year period ending on the date of the distribution. (Treas. Reg. § 1.355-7(b)(2))
  • This is the "super safe harbor" gateway. Without pre-distribution negotiations, post-distribution acquisitions cannot be part of a plan.

Step 9B. The Rebuttable Presumption

• The 4-year presumption window.
  • If one or more persons acquire a 50% or greater interest in Distributing or Controlled during the period beginning 2 years before and ending 2 years after the distribution date, the acquisition is PRESUMED to be pursuant to a plan. (§ 355(e)(2)(B))
  • The taxpayer bears the burden of rebutting this presumption through contrary evidence.
• Plan factors tending to show a plan EXISTS.
  • Eight regulatory factors. (1) agreement/understanding/arrangement/substantial negotiations regarding acquisition during 2-year period before distribution, (2) for public offerings. discussions with investment banker during 2-year period, (3) for pre-distribution acquisitions. same regarding distribution, (4) controlling shareholder overlap between Distributing/Controlled and acquiror during 2-year period, (5) distribution motivated by business purpose to facilitate acquisition, (6) Distributing/Controlled discussed acquisition with investment banker and distribution motivated by potential acquisition, (7) acquisition and distribution within 6 months, (8) debt allocation made acquisition likely. (Treas. Reg. § 1.355-7(b)(3))
  • The more factors present, the harder it is to rebut the presumption.
• Plan factors tending to show NO plan.
  • Seven regulatory factors. (1) no discussions of acquisition before distribution (non-public offering), (2) no discussions with investment banker before distribution (public offering), (3) identifiable unexpected change in market/business conditions after distribution caused acquisition, (4) no discussions of distribution before acquisition (pre-distribution acquisition), (5) unexpected change after acquisition caused distribution, (6) distribution motivated by business purpose OTHER THAN facilitating acquisition, (7) distribution would have occurred at approximately same time and in similar form regardless of acquisition. (Treas. Reg. § 1.355-7(b)(4))
  • These factors support rebutting the presumption.

Step 10. The Nine Safe Harbors Under Treas. Reg. § 1.355-7(d)

"A distribution and an acquisition are not part of a plan (or series of related transactions) if the requirements of one of the safe harbors in paragraph (d) of this section are satisfied." (Treas. Reg. § 1.355-7(c))

• Safe Harbor I.
  • Distribution motivated in whole or substantial part by a business purpose OTHER THAN facilitating an acquisition. (Treas. Reg. § 1.355-7(d)(1))
  • Acquisition occurs more than 6 months after distribution.
  • No agreement/understanding/arrangement/substantial negotiations during period beginning 1 year before and ending 6 months after distribution.
• Safe Harbor II.
  • Distribution NOT motivated by business purpose to facilitate acquisition. (Treas. Reg. § 1.355-7(d)(2))
  • Acquisition more than 6 months after distribution.
  • No negotiations during period beginning 1 year before and ending 6 months after.
  • No more than 25% of acquired corporation's stock acquired or subject to negotiations during that period.
• Safe Harbor III.
  • Acquisition more than 2 years before distribution. (Treas. Reg. § 1.355-7(d)(3))
  • No agreement/understanding/arrangement/substantial negotiations concerning distribution at time of acquisition or within 6 months thereafter.
• Safe Harbor IV.
  • Acquisition after distribution. (Treas. Reg. § 1.355-7(d)(4))
  • No agreement/understanding/arrangement concerning acquisition at time of distribution.
  • No negotiations within 1 year after distribution.
• Safe Harbor V (pre-distribution acquisitions).
  • Distribution is pro rata. (Treas. Reg. § 1.355-7(d)(5))
  • Acquisition (not public offering) occurs after date of public announcement regarding distribution.
  • No discussions by Distributing/Controlled with acquirer regarding distribution on or before date of first public announcement.
  • Limitations. Does NOT apply if acquirer is a controlling or 10% shareholder after acquisition through distribution date. Does NOT apply if aggregate acquisitions equal 20%+ of vote or value.
• Safe Harbor VI (public offerings before distribution).
  • Public offering acquisition before distribution is NOT part of a plan. (Treas. Reg. § 1.355-7(d)(6))
  • Applies if it occurs before first disclosure event (if stock not listed on established market immediately after) or before first public announcement (if stock listed on established market immediately after).
• Safe Harbor VII (public trading).
  • Acquisition of stock listed on an established market is NOT part of a plan. (Treas. Reg. § 1.355-7(d)(7))
  • Applies if immediately before or after transfer, none of transferor, transferee, or any coordinating group is the acquired corporation, a controlling or ten-percent shareholder, a member of the acquired corporation's controlled group, or an officer or director of the acquired corporation.
• Safe Harbor VIII (compensatory acquisitions).
  • Stock acquired in connection with performance of services under § 83 or § 421(a)/(b) is NOT part of a plan (if stock not excessive relative to services). (Treas. Reg. § 1.355-7(d)(8))
  • Limitation. Does not apply if acquirer or coordinating group is a controlling or ten-percent shareholder immediately after acquisition.
• Safe Harbor IX (retirement plans).
  • Stock acquired by a qualified retirement plan (§ 401(a) or § 403(a)) of Distributing or Controlled (or § 414 related employer) is NOT part of a plan. (Treas. Reg. § 1.355-7(d)(9))
  • Limitation. Does not apply to the extent aggregate plan acquisitions during the 4-year period beginning 2 years before the distribution exceed 10% of total voting power or value.
• The "super safe harbor."
  • A post-distribution acquisition can be part of a plan ONLY IF there was an agreement, understanding, arrangement, or substantial negotiations regarding the acquisition during the 2-year period ending on the date of the distribution. (Treas. Reg. § 1.355-7(b)(2))
  • If this condition is not met, the acquisition CANNOT be part of a plan under any theory.
• TRAP.
  • Meeting a safe harbor means the distribution and acquisition are NOT part of a plan.
  • But safe harbors have specific limitations. Review each limitation carefully.
  • A compensatory acquisition (Safe Harbor VIII) loses protection if the acquirer becomes a 10% shareholder.

Step 11. § 355(e) Coordination with § 355(d) and § 361

• Mutual exclusivity with § 355(d).
  • § 355(e) does NOT apply to any distribution to which § 355(d) applies. (§ 355(e)(2)(D))
  • The two provisions are mutually exclusive. A distribution subject to § 355(d) is insulated from § 355(e).
• The escape hatch.
  • If a distribution escapes § 355(d) under the purpose exception (Treas. Reg. § 1.355-6(b)(3)), it may still be subject to § 355(e) if a plan involving a 50% acquisition exists.
  • This is because the purpose exception treats the distribution as "not a disqualified distribution," which means § 355(d) literally does not apply, opening the door to § 355(e).
• Affiliated group exception.
  • A plan is NOT treated as described in § 355(e)(2)(A)(ii) if immediately after completion, Distributing and all Controlled corporations are members of a single affiliated group under § 1504 (without regard to § 1504(b)). (§ 355(e)(2)(C))
  • This protects internal restructurings within an affiliated group.
• § 361(c) destruction of D reorganization qualification.
  • If Controlled stock is not "qualified property" under § 361(c)(2)(B) because § 355(e) applies, the distribution does not qualify under § 355. (§ 368(a)(1)(D)) (§ 361(c)(2))
  • If the distribution does not qualify under § 355, the D reorganization requirement that stock be "distributed in a transaction which qualifies under section 354, 355, or 356" is not satisfied.
  • The ENTIRE transaction may fail as a D reorganization, causing both Distributing and shareholders to recognize gain.
• § 355(e)(3)(B) asset acquisition look-through.
  • If the assets of Distributing or Controlled are acquired by a successor in a Type A, C, or D reorganization, the acquiring corporation's shareholders are treated as acquiring the stock of the target corporation. (§ 355(e)(3)(B))
  • This prevents avoidance of § 355(e) by structuring acquisitions as asset deals rather than stock deals.

Step 12. § 355(g) and the Disqualified Investment Corporation Rule

Step 12A. Statutory Mechanism

• § 355(g)(1) operative rule.
  • § 355 (and so much of § 356 as relates to § 355) shall NOT apply to any distribution which is part of a transaction if (A) either Distributing or Controlled is, immediately after the transaction, a "disqualified investment corporation," AND (B) any person holds, immediately after the transaction, a 50% or greater interest in any disqualified investment corporation, but only if such person did NOT hold such an interest immediately before the transaction. (§ 355(g)(1))
  • Both conditions (A) and (B) must be satisfied. Condition (B) requires a CHANGE in 50% ownership.
• Enacted by TIPRA 2005.
  • § 355(g) was added by the Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. 109-222, § 202, 120 Stat. 345, effective for distributions after May 17, 2006. (TIPRA 2005, Pub. L. 109-222, § 202, 120 Stat. 345, effective for distributions after May 17, 2006)
  • This is the most recently enacted of the three corporate-level gain triggers.
• § 355(g) applies only to non-pro rata distributions.
  • In a pro rata spin-off, all shareholders maintain proportionate interests, so no person acquires a 50% interest they did not already hold. (PLR 200905018 (Oct. 21, 2008))
  • Condition (B) is never satisfied in a pro rata distribution. § 355(g) targets split-offs and split-ups.
• Complete denial of § 355 treatment.
  • Unlike § 355(d) and § 355(e) (which trigger corporate-level gain but leave shareholders tax-free), § 355(g) causes § 355 to NOT APPLY AT ALL.
  • Both Distributing and shareholders may recognize gain.

Step 12B. Definition of Disqualified Investment Corporation

• The two-thirds threshold.
  • A "disqualified investment corporation" means any Distributing or Controlled corporation if the FMV of its "investment assets" is 2/3 or more of the FMV of all assets of the corporation. (§ 355(g)(2)(A))
  • For distributions during the one-year period after May 17, 2006, the threshold was 3/4.
• Investment assets defined.
  • Seven categories. (I) cash, (II) stock or securities in a corporation, (III) interest in a partnership, (IV) debt instrument or other evidence of indebtedness, (V) option, forward or futures contract, notional principal contract, or derivative, (VI) foreign currency, (VII) any similar asset. (§ 355(g)(2)(B)(i))
  • The definition is extraordinarily broad and captures most financial assets.
• No working capital exclusion.
  • Cash and working capital related to an active trade or business ARE investment assets under § 355(g). (§ 355(g)(2)(B)(i))
  • This is a critical trap. Accounts receivable arising in the ordinary course after the distribution may be excluded per PLR 200905018, but cash on hand at distribution counts.

Step 13. Investment Asset Exceptions and Computation

Step 13A. The Four Statutory Exceptions

• Financial business exception.
  • Investment assets do not include assets held for use in the active and regular conduct of a lending or finance business (within the meaning of § 954(h)(4)), a banking business through a bank or similar institution, or an insurance business licensed by an applicable insurance regulatory body. (§ 355(g)(2)(B)(ii))
  • Applies only if substantially all of the income of the business is derived from persons not related under § 267(b) or § 707(b)(1).
• Marked-to-market exception.
  • Investment assets do not include securities held by a dealer in securities to which § 475(a) applies. (§ 355(g)(2)(B)(iii))
  • This exception applies only to dealers subject to mark-to-market accounting.
• 20% controlled entity exception and look-through.
  • Investment assets do not include stock and securities in a "20-percent controlled entity" (corporation where Distributing/Controlled owns directly or indirectly stock meeting § 1504(a)(2) requirements, substituting "20 percent" for "80 percent"). (§ 355(g)(2)(B)(iv))
  • The parent is treated as owning its ratable share of the subsidiary's underlying assets.
• Active business partnership exception and look-through.
  • Investment assets do not include partnership interests if one or more partnership trades or businesses would satisfy the § 355(b) active trade or business requirement (disregarding the 5-year requirement). (§ 355(g)(2)(B)(v))
  • The parent is treated as owning its ratable share of the partnership's underlying assets.

Step 13B. Practical Computation

• The five-step computation.
  • 1. Inventory all assets of Distributing and Controlled at FMV immediately after the transaction.
  • 2. Classify each asset using the seven investment asset categories and four exceptions.
  • 3. Apply look-through rules for 20% controlled entities and active business partnerships.
  • 4. Compute the ratio. Investment assets FMV divided by total assets FMV.
  • 5. Test condition (B). If a person holds 50% or greater in a DIC after who did not hold 50% before, § 355(g) applies.
• CAUTION.
  • No Treasury Regulations have been issued under § 355(g).
  • The computation relies entirely on statutory text and the limited IRS guidance available (notably PLR 200905018 and Rev. Proc. 2017-52 representations).
  • Practitioners must make good-faith judgments about classification without regulatory guidance.
• Rev. Proc. 2017-52 representations.
  • For ruling purposes, taxpayers must represent either (a) investment assets are less than 2/3 of total gross assets, (b) trade or business assets are 10% or more of investment assets, or (c) the investment-to-business ratio is not three times or more for one corporation versus the other. (Rev. Proc. 2017-52, Appendix A, § 3.03(15))
  • These representations provide practical safe harbors for taxpayers seeking rulings.

Step 14. Predecessor and Successor Rules Under Treas. Reg. § 1.355-8

"For purposes of this subsection, any reference to the distributing corporation or the controlled corporation shall include a reference to any predecessor or successor of such corporation." (§ 355(e)(4)(D))

• Statutory authorization.
  • § 355(e)(4)(D) (added by AJCA 2004) provides that any reference to Distributing or Controlled includes a reference to any predecessor or successor. (§ 355(e)(4)(D))
  • This statutory look-through prevents taxpayers from avoiding § 355(e) through corporate restructurings before or after the distribution.
• Treas. Reg. § 1.355-8 (T.D. 9888, Dec. 2019).
  • Final regulations implementing the predecessor/successor rules.
  • These regulations provide detailed definitions and limitation rules.
• Predecessor of Distributing (POD).
  • A corporation is a Predecessor of Distributing if it is a "Potential Predecessor," the Relevant Property Requirement is satisfied, the Reflection of Basis Requirement is satisfied, and the Division of Relevant Property Requirement is satisfied. (Treas. Reg. § 1.355-8(b))
  • Each requirement must be independently satisfied.
• Successor.
  • A corporation is a Successor of Distributing or Controlled if it acquires property from Distributing or Controlled in a § 381 transaction after the distribution. (Treas. Reg. § 1.355-8(c))
  • The § 381 requirement limits the definition to corporate acquisitions with carryover basis.
• Gain limitation rules.
  • The POD Gain Limitation Rule limits gain to the inside gain in the POD's relevant property. (Treas. Reg. § 1.355-8(d)-(e))
  • The Distributing Gain Limitation Rule limits gain to the inside gain in Distributing's assets.
• Purpose.
  • These regulations target "synthetic spin-offs" where assets are transferred through a chain (P to D to C) and then distributed, followed by an acquisition of P.
  • § 355(e) applies even though P was never formally the "Distributing" corporation.

Step 15. Step-Transaction and Anti-Abuse Doctrines

"The fact that stock or securities of the controlled corporation are disposed of by the distributees, or that the controlled corporation issues additional stock or securities, shall not be taken into account for purposes of determining whether the transaction qualifies under section 368(a)(1)(D)." (§ 368(a)(2)(H)(ii))

• Rev. Rul. 98-27 limits step-transaction.
  • The IRS announced it will not apply any formulation of the step-transaction doctrine to determine whether Controlled was a controlled corporation immediately before the distribution solely because of any post-distribution acquisition or restructuring. (Rev. Rul. 98-27, 1998-1 C.B. 1159)
  • Before this ruling, the IRS applied step-transaction aggressively under Rev. Rul. 70-225 to reorder steps and treat post-distribution acquisitions as occurring before the distribution.
  • The ruling applies only to the § 355(a)(1)(D) control requirement. Step-transaction may still apply to pre-distribution steps and to other aspects of the transaction.
  • Rev. Rul. 98-44, 1998-2 C.B. 315 formally declared Rev. Rul. 70-225 obsolete.
• § 368(a)(2)(H)(ii) codification.
  • If the requirements of § 355 are met, the fact that shareholders dispose of Controlled stock or that Controlled issues additional stock shall not be taken into account for purposes of determining whether the transaction qualifies under § 368(a)(1)(D). (§ 368(a)(2)(H)(ii))
  • This statutory provision codifies the holding of Rev. Rul. 98-27.
• Where step-transaction still applies.
  • Step-transaction can still collapse pre-distribution steps lacking independent business purpose.
  • It can recharacterize transactions without genuine substance (following Gregory v. Helvering, 293 U.S. 465 (1935), where the Supreme Court held that a transaction that complies literally with statutory reorganization requirements but lacks genuine business purpose and substance can be recharacterized).
  • It can attack the § 368(a)(1)(D) control requirement in certain circumstances.
• Business purpose requirement.
  • A transaction must be carried on for one or more real and substantial corporate business purposes germane to the business of Distributing, Controlled, or the affiliated group. (Treas. Reg. § 1.355-2(b))
  • This is a foundational requirement for all § 355 transactions.
• Device test.
  • The transaction must not be used principally as a device for distributing earnings and profits. (§ 355(a)(1)(B))
  • Post-distribution sales by distributees are NOT evidence of a device UNLESS pursuant to an arrangement negotiated or agreed upon prior to the distribution.
• Economic substance doctrine (§ 7701(o)).
  • Codified in 2010, a transaction must have both objective economic substance and subjective business purpose.
  • Application to § 355 is somewhat duplicative because § 355 already contains its own anti-abuse provisions.

Step 16. Distributing's Due Diligence Obligations

• Determination of stockholders.
  • Distributing must determine whether a disqualified person holds stock in Distributing or Controlled. (Treas. Reg. § 1.355-6(f)(1))
  • This requires reasonable inquiry into the ownership structure.
• SEC filing knowledge.
  • Distributing is deemed to know information contained in SEC filings (Schedule 13D, 13G, etc.). (Treas. Reg. § 1.355-6(f)(2))
  • Constructive knowledge through public filings is imputed to Distributing.
• Less-than-five-percent shareholder presumption.
  • Absent actual knowledge to the contrary, Distributing may presume that no less-than-five-percent shareholder purchased stock during the 5-year period. (Treas. Reg. § 1.355-6(f)(4))
  • This presumption does NOT apply if such shareholder is related to a non-less-than-five-percent shareholder, acted pursuant to a plan with such shareholder, or holds stock attributed to such shareholder.
• The 5% threshold for presumption.
  • A "less-than-five-percent shareholder" is a person that at no time during the 5-year period holds directly (applying only Treas. Reg. § 1.355-6(c)(3)(ii) for options, NOT § 355(d)(7) or (8)) stock possessing 5% or more of vote or value.
  • The attribution and aggregation rules of § 355(d)(7) and (8) do NOT apply to this determination.
• TRAP.
  • For public companies, document your reliance on SEC filings and the less-than-five-percent presumption contemporaneously.
  • If actual knowledge of a purchase exists, the presumption does not apply.
  • Failure to document may result in the presumption being challenged.

Step 17. Reporting, Disclosure, and Documentation

• § 6043(b) reorganization reporting.
  • Every corporation that is a party to a reorganization shall make a return setting forth the terms and such other information as the Secretary may require. (§ 6043(b))
  • This is the general reporting requirement for all reorganizations including § 355 distributions.
• Form 1120 disclosure.
  • Attach a statement to the return describing the date of distribution, name and EIN of Controlled, FMV and adjusted basis of Controlled stock distributed, business purpose, and whether the distribution is part of a plan of reorganization.
  • Detailed disclosure supports the return position and starts the statute of limitations.
• Gain recognition reporting.
  • If § 355(d) or § 355(e) applies and gain is recognized, report the gain on Schedule D (Form 1120) as gain from the sale of the distributed property.
  • The gain is computed as if Distributing sold the Controlled stock at FMV.
• Document retention under Circular 230.
  • § 10.22 requires practitioners to retain records adequate to support work product.
  • For § 355 transactions, retain board resolutions, corporate minutes, valuation reports, tax opinions, plan of reorganization, merger or acquisition agreements, E&P allocation calculations, basis allocation schedules, and evidence of any § 355(e) analysis (including safe harbor documentation).
• Proposed Form 7216 withdrawn.
  • Under proposed regulations published January 2025, "covered filers" would have been required to file Form 7216 throughout a 5-year reporting period.
  • These regulations were withdrawn by the IRS on September 29, 2025. No current multi-year filing requirement exists.
• The § 355(e) statute of limitations.
  • If § 355(e) applies, the statute of limitations does not expire before the later of the normal expiration date or 3 years from the date the taxpayer notifies the IRS that the distribution occurred. (§ 355(e)(4)(E))
  • This extended statute protects the government's ability to assess tax after the plan becomes clear.