Breaking Up Tax-Free: Mastering Section 355 Spin-offs and Divestitures
Under the general rules, if a corporation distributes the stock of a subsidiary to its shareholders, it is treated as a taxable dividend. Section 355 provides a powerful exception that allows for "Tax-Free" divestitures. If a corporation meets the strict "Active Trade or Business" (ATB) tests and has a valid business purpose, it can spin off a division or a subsidiary into a separate company without the corporation or the shareholders paying a single dollar in tax. This is the primary tool used by public companies to "unlock value" and by private companies to resolve shareholder disputes. Our Corporate Advisory Group specializes in navigating the five-year history requirements of Section 355.
The Five-Year Active Trade or Business Rule
To qualify for Section 355, both the distributing corporation and the spun-off subsidiary must have been engaged in an "Active Trade or Business" for at least five years before the distribution.
Crucially, neither business can have been acquired in a taxable transaction during that five-year window. We provide the forensic operational audits needed to prove that each division was a real business with its own employees and management. We also help families navigate the "Split-Off"—where one shareholder takes the parent and the other takes the subsidiary—terminating their partnership tax-free. Our advisory ensures that your corporate "breakup" is defensible against IRS agents who look for "Device" transactions (where a spin-off is used to hide a disguised dividend).
The "Business Purpose" and "Continuity of Interest" tests
Unlike a simple merger, a Section 355 spin-off must be driven by a non-tax business purpose, such as satisfying a lender\'s requirement, resolving a shareholder feud, or focusing management resources.
Furthermore, the shareholders must maintain a "Continuity of Interest" in both companies for a period following the spin. A quick sale of either company after the spin-off can retroactively disqualify the entire tax-free nature of the deal. We architect "Spin-off Narratives" and coordinate post-spin merger protections (such as Morris Trust transactions) to ensure that your long-term strategic goals don\'t create an immediate $100M tax liability. Our goal is to ensure that your corporate architecture is legally optimized for separation and independent growth.