You’re sipping coffee at your monthly investment club meeting and spin-off stocks are the topic. Various companies are discussed when the Treasurer suggests a 355 spin-off. Silence and blank stares fill the room. 

What is a 355 spin-off? 

Read on to discover a hidden pocket of opportunity that you absolutely have got to know…

What is a 355 Spin-Off?

A 355 spin-off is a tax-free spin-off where a corporation can separate or spin-off a division or subsidiary by distributing the shares of a subsidiary to existing shareholders without triggering a taxable event for the spin-off shareholders or the distributing company’s shareholders.

Under Section 355 D of the Internal Revenue Code (IRC), this type of spin-off is a tax-efficient way to reward shareholders tax free. The unique feature of the code is the distributing firm shareholders and the spin-off shareholders share the tax benefits.

What is a 355 spin-off? A 355 spin-off is a tax-free corporate event resulting in two separate, independently operating companies, provided certain requirements are met. Here are the requirements:

Business Continuity – The parent company, the firm spinning off the division or subsidiary, and the spun off firm, the company being separated from the parent company, must be engaged in active business or trade for a minimum of five years prior to the spin-off.

Shareholder Interest Continuity – A continuity of shareholder interest must continue post-spin-off. The shareholders of the spin-off firm must continue to hold a significant stake in both the spin-off and the parent company.

Business Determination – Tax avoidance cannot be the main motivator for creating the spin-off. The newly formed company must have a legitimate business purpose such as a dedicated focus on core operations or increased operational efficiency to enhance shareholder value.

Non-Device Requirement – The 355 spin-off cannot be used exclusively as a stock distribution delivery system for the parent company’s earnings, dividends, and profits.

Active Business Conduct – The spin-off must engage in active business pursuits or trade immediately post-spin-off. The firm’s ability to amass passive investments such as marketable equity securities and fixed-income securities will be curtailed.

Independent Entity Status – The spin-off must operate as an independent standalone entity possessing its own board, management team, assets, ongoing operations, and employees.

Control Distribution – The parent firm must distribute shares and relinquish control of the spin-off to the new entity shareholders through a tax-free qualified transaction as specified under the IRC, Section 355 D.

Ownership and Voting Rights – The parent company distributes 80% of the spin-off stock to its parent shareholders. These shareholders receive spin-off stock pro rata.

The parent firm shareholders typically have voting control in the parent and spin-off companies. Spin-off firm voting control is acquired through the parent company’s significant ownership of spin-off shares.

What is a 355 spin-off? A 355 spin-off is a tax-free spin-off. It is a tax-free vehicle to establish an independently operated, but not independently owned, entity under specific IRC requirements.

What is a 355 spin-off? In the short-term, it is a tax-free capital gains transfer with parent and spin-off firm long-term capital appreciation.

Read next: How Does a Spinoff Dividend Work?

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