Is a Stock Spin-off Taxable?

A financial segment about spin-off stocks catches your eye and, with a remote in hand, you turn it up. The segment title is “Is a Stock Spin-off Taxable?” The advisor states that understanding the tax implications is critical to making informed decisions and here’s what prudent investors should know.

A stock spin-off is taxable or tax-free depending on the terms and conditions of the spin-off. Spin-off tax treatment is influenced by transaction specifics and jurisdiction and to address Is a stock spin-off taxable? we must examine the two scenarios, here’s the breakdown:

Tax-Free Spin-off

Shareholders enjoy the benefits of a tax-free spin-off when the transaction meets the requirements of Section 355 of the Internal Revenue Code. The Section requirements are:

Business Purpose: The pending spin-off must be transacted for a valid business purpose. It can not be used as a vehicle to avoid taxes.

Shareholder Control – The firm performing the spin-off, known as the parent company, must distribute 80% of the voting power and 80% of the non-voting stock (each class) of the spun-off company to the parent firm’s shareholders.

Active Business Trade – Five years prior to the spin-off, the parent company and the to-be-spun-off division or subsidiary must be an ongoing business concern. Immediately after the spin-off, both firms must be actively engaged in business or trade.

Continuity of Interest – Parent company shareholders must maintain a continued ownership interest in the new spun-off entity. Section 355 mandates at least 50% of the value of the distributed shares be held by parent firm shareholders post-spin-off.

Tax-Free Spin-off Scenario

Company A (parent company) spins off its division, Company X (spin-off) and the transaction meets Section 355 requirements.
Company A will receive the new Company X spin-off shares without incurring a tax obligation.
The shareholders allocate their Company A tax basis between their current Company A shares and the newly received Company X spin-off shares.

Is a stock spin-off taxable? A stock spin-off is tax-free when these requirements are satisfied. The tax basis of the parent firm is allocated between its existing shares and their portion of the new spin-off shares. The holding period is a blending of the new spin-off share holding period and the parent company’s existing share holding period.

Taxable Spin-off

A spin-off is considered a taxable event if it does not meet Section 355 requirements meaning shareholders are taxed on any gains realized from the difference between the spin-off shares market value and the parent company’s share tax basis. The spin-off share holding period begins on the day after the distribution.

Taxable Spin-off Scenario

Company A (parent company) spins off its division, Company X (spin-off) but the transaction does not qualify under Section 355.
The share distribution will be taxed, and shareholders will incur a tax liability based on the spin-off shares’ fair market value.

Is a stock spin-off taxable? The complex spin-off tax implications may or may not be taxable. Meeting Section 355 requirements and jurisdiction domicile are major influences on the transaction’s tax treatment and the shareholder’s net profits.