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Nontaxable Divisive Reorganizations Can Protect Shareholders from Tax Burdens

October 4, 2022

It’s common for a corporation of any size to divide and become two or more separate corporations. This is typically done by transferring assets to a new or existing subsidiary corporation and distributing the new company’s stock to the distributing corporation’s shareholders. This is called a corporate reorganization.

But taxable reorganizations can create an unnecessary tax burden on all parties involved. According to the current Internal Revenue Code, any property transfer by one taxpayer to another in exchange for property materially differing in kind is generally taxable.1   Consequently, if the stock is distributed to its shareholders, the distributing company recognizes a taxable gain, and the shareholders recognize a taxable dividend on the distribution.

However, if the transactions are structured as a nontaxable reorganization, neither the distributing corporation nor the shareholders recognize any gain.

Nontaxable Divisive Reorganizations can be structured as “Spin-Offs, Split-Offs, and Split-Ups.”2

A “Spin-off” is a distribution of the subsidiary’s stock on a pro-rata — or evenly distributed — basis to the distributing company’s shareholders. After the spin-off, the distributing corporation’s shareholders own both the original company and the subsidiary’s shares, but the distributing corporation no longer owns the subsidiary’s shares.

A “Split-off” is a distribution of the subsidiary’s stock, usually non-pro rata, to one or more of the distributing company’s shareholders. Those transferee shareholders then exchange and surrender their shares in the distributing company. The result is that one shareholder group owns the original company, while another shareholder group owns the new organization. As in a spin-off, the distributing company no longer owns the subsidiary.

In a “Split-up,” the distributing company is liquidated and distributes the stock of at least two subsidiary corporations to its shareholders. A split-up may involve either a pro rata or a non-pro rata disproportionate distribution of the controlled corporation’s stock to the distributing corporation’s shareholders. After the split-up, the original distributing company no longer exists.

If a nontaxable reorganization is in your company’s future, take extra care and have your attorney consult the Code. A divisive reorganization in the form of a spin-off, split-off, or split-up can protect all parties from paying unnecessary taxes.

[1] 26 USC §61, et. seq. Hereafter, the “Code.”
[2] Sections 355 and 368(a)(1)(D)

About the Author

Howard L. Richshafer

Howard L. Richshafer

Howard Richshafer joined Wood + Lamping in 2008

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