Internal Revenue Service Alters Its View on Section 355 Spin-Offs

The Internal Revenue Service ("IRS") recently issued important guidance identifying new positions the IRS is considering on critical aspects of tax-free spin-offs, and significantly expanding the information that taxpayers must supply to obtain an advance ruling confirming their spin-off's tax-free status.

On May 1, 2024, the IRS issued Notice 2024-38 (the "Notice") identifying new positions it contemplates taking on critical aspects of section 355 "tax-free" spin-offs, and it issued Revenue Procedure 2024-24 (the "Rev. Proc.") updating the representations and related information a taxpayer must supply to obtain a private letter ruling (an "advance ruling") confirming a spin-off's tax-free status.

Whether a company contemplating a spin-off seeks an advance ruling from the IRS, or proceeds instead on opinion of counsel, the Notice and Rev. Proc. contain important new insights regarding the IRS's substantive positions on spin-offs.

The Notice identifies several high-profile spin-off issues with which the IRS is concerned, including:

  • "Monetization" or "value extraction" transactions occurring as part of a spin-off, including the assumption by the controlled company ("Controlled") of distributing company ("Distributing") debt and Distributing's replacement of its own debt with debt or other consideration from Controlled;
  • Delayed distributions of Controlled stock and debt; and
  • The extent of the ongoing relationships between Distributing and Controlled after the spin-off.

The Rev. Proc. updates, and significantly expands, the submission requirements necessary to obtain an advance ruling. In particular, many of these updates relate to:

  • Questioning Controlled's assumption of Distributing liabilities and other transactions in which Distributing satisfies its own liabilities using Controlled stock or securities, including the timing of Distributing's distribution of these items.
  • Restricting Distributing from satisfying newly issued debt with Controlled stock or securities.
  • Limiting Distributing's ability to retain Controlled stock or securities or delay the distribution of these items to a future date.
  • Scrutinizing continuing relationships between Distributing and Controlled after the spin-off.

The IRS's new focus on the issues presented in the Notice and Rev. Proc. will add further complexity to this area of the law and, in many cases, will lengthen the advance ruling process. Finally, even taxpayers proceeding solely on opinion of counsel must now conduct additional analysis, based on this new guidance, to confirm the tax-free qualification of their spin-off.

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