What Is a Taxable Spinoff?

A taxable spinoff is a divestiture of a subsidiary or division by a publicly-traded company, which will be subject to capital gains taxation. To qualify as a taxable transaction, the parent corporation must divest through direct sale of the division or th💯e assets it contains. The profits made from the sale will be taxed as capital gains.

Understanding Taxable Spinoffs

A spinoff occurs when a 澳洲幸运5官方开奖结果体彩网:parent corporation separates part of its business to create a new business 澳洲幸运5官方开奖结果体彩网:subsidiary and distributes shares of the new entity to its current shareholders. The subsidiary will become completely independent from the parent corporation, operating entirely on its own. If a parent corporation distributes the stock of the subsidiary to its shareholders, the distribution is generally taxable to the shareholder as a 澳洲幸运5官方开奖结果体彩网:dividend payout.

In this case, 澳洲幸运5官方开奖结果体彩网:ordinary income tax 🍷equal to the fair market value of the stock received is imposed on investors. In addition, the parent corporation is taxed on the built-in gain (the amount the asset has appreciated) in the stock of the subsidiary.

The tax in this case is a 澳洲幸运5官方开奖结果体彩网:capital gains tax equal to the fair market value of the distributed shares less the parent company’s inside basis in the stock. When cash is received in lieu of 澳洲幸运5官方开奖结果体彩网:fractional shares in the spinoff, the fractional shares are generally taxable to shareh𓄧olders.

A taxable spinoff will bring in liquid assets to the company, usually in the form of cash. The downside of this transaction comes from the decrease in income from the capital gains tax. If a parent company wishes to avoid taxation, it may consider a 澳洲幸运5官方开奖结果体彩网:tax-free spinoff. Section 355 of the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Code (IRC) provides an exemption to taxing transactions from spinoffs, allowing a corporation to spin off or distribute shares of a subsidiary in a transaction that is tax-free to both shareholders and the parent company. 

When a Spinoff Is Taxed

A spinoff is taxed when the company outright sells the subsidiary. This can include the company being bought by another company or when the company is sold via an 澳洲幸运5官方开奖结果体彩网:initial public offering (IPO).

When such events occur, there are two levels of tax that need to be paid. An ordinary tax would be applied at the shareholder level, which would be equal to the fair market value (FMV) of the stock received. In many ways, it is similar to a dividend payout. A capital gains tax may also be applied on the stock sale at the level of the company equal to the FMV of the stock, minus the company's inside basis in the stock.

There are also cases when a spinoff may be taxed simply because it didn't adhere to the tax-free spinoff requirements listed below.

Tax-Free Spinoff

There are typically two ways that a company can undertake a tax-free spinoff of a business 🍌unit🌳. First, a company can choose to simply distribute the new shares (or at least 80%) of the division to existing shareholders on a pro-rata basis.

The second way a company can avoid any capital gains from divestiture is by giving current shareholders the option to exchange shares of the parent company for an equal stock position in the spun-off company or to maintain their existing stock position in the parent company. This means the shareholders are free to choose whichever company they believe offers the best potential 澳洲幸运5官方开奖结果体彩网:return on investment (ROI) going forward.

The IRS has certain requirements for companies to be able to spin off tax-free. T♑hey are control, device, active trade or business, and distributi𝕴ons.

Control requirements stipulatꦓe that the corporations must own stock possessing at least 80% of the total combined voting power of all classes of the stock of that corporation. There are different measures for deter🍃mining voting control but are usually determined by the ability to elect directors.

Device requirements for tax-free spinoffs mean the spinoff cannot be used as a device for the sole purpose of distributions of earnings and profꦛits. This is determined on a case-by-case basis and considers all aspects of the spinoff.

The active trade section requires both the pre-existing company and the newly spun-off company to qualify as what the IRS calls an "active trade or business" immediately once the deal is finalized. This also requires that both businesses are actively engaged in business.

The distribution requirements mean that the IRS requires the pre-existing company to distribute all stocks and securities held in the newly spun-off company in specific ways. Usually, this is for the company to distribute at least 80% of the shares to existing shareholders on a pro-rata basis. The second involves the stock options given to shareholders explained above, where they can choose either the pre-existing company or the new company to invest in.

Special Considerations

Because of the availability of a tax benefit under Section 355, most spin-offs are 🍌conducted in order to take advantage. R🦄ather than incur an additional tax burden through a taxable spin-off, businesses may often find that it makes more sense to pursue some other form of divestiture if the benefits of the divestiture .

This also means that corporate income tax rates may influence firms’ decisions to divest and how. Cuts to corporate income tax rates in the U.S. under the Tax Cuts and Jobs Act of 2017, signed by President Trump, may have changed this calculus somewhat in favor of such as subsidiary stock sales or asset sales. 

Real-World Example

One of the 澳洲幸运5官方开奖结果体彩网:largest corporate spinoffs of all time occurred in 2008, when Altria Group Inc. (MO) spun off Philip Morris International Inc. (PM), spinning off 100% of the shares of Philip Morris. In this case, each Altria shareholder received one share of Philip Morris stock for every share of outstanding Altria common s🃏tock.

They split due to concerns over payouts to shareholders as well as the mounting pressure of smoking lawsuits. However, on Altria's website, they state that they spun off Philip Morris as "management believed that the spinoff would enable each of Altria's international and domestic tobacco businesses to focus exclusively on realizing its own opportunities and addressing its own challenges, thereby building long-term shareholder value."

On Jan. 30, 2008, Altria authorized the spinoff. By March of the same year, Philip Morris shares were distributed to shareholders on record of Altria that held shares during the distribution date. This was a non-taxable spinof𝕴f example as most spinoffs are conducted in order to be tax-advantaged.

The Bottom Line

Most companies who spin off portions of their companies will do so in a tax-free w🦋ay. There are enormous tax benefits to not selling a company outright, therefore most companies will fulfill the IRS requirements for spinning off portions of their company in a tax-free way.