On January 13, 2025, the IRS released proposed regulations through REG-116085-23 that would require multiyear tax reporting for Section 355 corporate separations and related transactions. The IRS concurrently released draft Form 7216, on which taxpayers would report information to satisfy the new rules and identify potential compliance issues. This article provides details on the draft form, which contains questions on a variety of §355 requirements, including an entire page of requests devoted to the active trade or business (ATB) and nondevice requirements.
Current Rules
Under current Treasury Regulation (Treas. Reg.) §1.355-5(a) and (b), the distributing corporation and any significant distributees in a §355 transaction must include informational statements with their federal tax returns for the year of the transaction. Distributees in §355 transactions may be “significant distributees” if they own at least 5% of publicly traded distributing corporations or at least 1% of privately held distributing corporations. The required statements must identify the corporations involved in the tax-free spinoff and report property received and exchanged.
Proposed Rules & Form 7216
Proposed Treas. Reg. §1.355(a)(1) provides that “covered filers” must file a Form 7216 for the taxable year in which the first distribution occurs and for each of the five taxable years after the taxable year in which the “control distribution” occurs. The term “covered filer,” defined under proposed Treas. Reg. §1.355(b)(1), includes taxpayers that are required to file a specified federal income tax return and that are:
- A distributing corporation or a person that, immediately before the first distribution, was a U.S. shareholder with respect to a controlled foreign corporation that is the distributing corporation;
- A controlled corporation or a person that, immediately before the first distribution, was a U.S. shareholder with respect to a controlled foreign corporation that is the controlled corporation;
- A significant distributee or a person that, immediately before the first distribution, was a U.S. shareholder with respect to a controlled foreign corporation that is a significant distributee; or
- Any other person required by the commissioner to file Form 7216 (or any successor form) in accordance with instructions, guidance, or publications published in the Internal Revenue Bulletin.
The current draft of Form 7216, Multi-Year Reporting Related to Section 355 Transactions, is seven pages long and broadly requests information related to a variety of §355 requirements. Draft instructions were not available on the IRS’ website at the time of publication. The draft form requires detailed information related to the ATB and nondevice requirements in §355.
Proposed ATB Reporting
The distributing and controlled corporations in a §355 transaction must generally engage immediately after the distribution in the active conduct of a trade or business to satisfy the ATB requirement. To be treated as such, a corporation must be engaged in the active conduct of a trade or business that has been actively conducted throughout and has not been acquired within the five-year period ending on the date of the distribution. However, Treas. Reg. §1.355-3(b)(3)(ii) provides that an acquisition may be disregarded, provided that the acquisition does not constitute the acquisition of a new or different business.
Accordingly, the draft Form 7216 asks for the following information for both the distributing and controlled corporations:
- Whether (the return filer must check “Yes” or “No”), during the ATB five-year period, the corporation purchased, created, or acquired any business relied on by the corporation to satisfy the ATB requirement.
- If “Yes,” whether the corporation is relying on the Treas. Reg. §1.355-3(b)(3)(ii) (described above) to establish satisfaction of the ATB requirement.
The draft form’s ATB questions also ask for the following for both the distributing and controlled corporations:
- Whether, after the control distribution date, any assets of any business on which the corporation relied to satisfy the ATB requirement have been sold or otherwise disposed of.
- If “Yes,” the total fair market value (FMV) of the disposed assets.
- The total FMV of the remaining assets comprising the business on which the corporation relied to satisfy the ATB requirement.
- Whether any amounts (not necessarily the proceeds) have been invested in nonbusiness assets.
- Whether, after the control distribution date, any business relied on by the corporation to satisfy the ATB requirement has been temporarily or permanently ceased, or whether the operations of any such business have been reduced.
- The total FMV of business assets of trade(s) or business(es) on which the corporation relied to meet the ATB requirement, as a percentage of the total FMV of the corporation’s gross assets.
The requests above may be related to “continuity of business enterprise” (COBE) requirements that apply to §355 transactions. Business assets are those used in a trade or business that satisfy the ATB requirement, while nonbusiness assets are those that do not. Cash and other liquid assets are a common example of nonbusiness assets. COBE requires that the issuing corporation either continue the target corporation’s historic business or use a significant portion of the target corporation’s historic business assets in a business.1 In general, the determination of the portion of a corporation’s aassets considered “significant” is based on the relative importance of the assets to operation of the business. COBE regulations emphasize that the net FMV of those assets should be considered in this determination.2
Proposed Nondevice Reporting
To meet the criteria of §355, a transaction may not be used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both (a “device”). The regulations provide that determinations of whether a transaction was used principally as a device should be made from all of the facts and circumstances, including the presence of all device factors and nondevice factors.3
The draft Form 7216’s nondevice questions ask for the following information for both the distributing and controlled corporations:
- The total FMV of the corporation’s nonbusiness assets as a percentage of the total FMV of all the corporation’s assets.
- The total FMV of business assets of trade(s) or business(es) on which the distributing corporation relied to meet the ATB requirement, as a percentage of the total FMV of all the corporation’s gross assets.
- The total FMV of the corporation’s nonbusiness assets as a percentage of the total FMV of all the corporation’s gross assets, excluding the corporation’s nonbusiness assets immediately after the control distributing date.
The nondevice requests above may be related to the “nature and use of asset” regulations under Treas. Reg. §1.355-2(d)(iv). Under the nature and use of asset regulations, the determination of whether a transaction was used principally as a device takes into account the nature, kind, amount, and use of the assets of the distributing and the controlled corporations (and corporations controlled by them) immediately after the transaction.4 The existence of nonbusiness assets is evidence of device, and the strength of the evidence of device may depend on the ratio for each corporation of the value of nonbusiness assets to the value of business assets. A difference in this ratio between the distributing and controlled corporation(s) may also increase the strength of the evidence of device.5
Additional nondevice requests may be related to the “subsequent sale or exchange of stock” regulations under Treas. Reg. §1.355-2(d)(iii):
- Whether the corporation’s separate affiliated group acquired any corporation stock during the tax year (following the first distribution date).
- Whether the filer sold, exchanged, transferred by gift, or otherwise disposed of any stock in, or securities of, the corporation during the tax year (after the first distribution date).
- The total FMV of the disposed stock and securities (if any).
Under the subsequent sale or exchange of stock regulations, a sale or exchange of stock of the distributing or the controlled corporation after the distribution may be evidence of device. The greater the percentage of the stock that changes hands after the distribution, the stronger the evidence of device. Also, the shorter the period of time between the distribution and the changing of hands, the stronger the evidence of device.6 A subsequent sale or exchange pursuant to an arrangement negotiated or agreed upon before the distribution is considered substantial evidence of device.7
Facilitative Transaction Costs
Under Treas. Reg. §1.263(a)-5(a)(4), a taxpayer must capitalize an amount paid to facilitate reorganizations, including those described in §368 and distributions of stock by the taxpayer as described in §355, without regard to whether the transaction comprises a single step or a series of steps carried out as part of a single plan and without regard to whether gain or loss is recognized in the transaction.
Accordingly, the draft Form 7216 asks for the following information for both the distributing and controlled corporations:
- Whether (the return filer must check “Yes” or “No”) the corporation paid any costs to facilitate the §355 transaction.
- If “Yes,” the total amount of facilitative costs for the tax year.
- Whether the corporation treated the facilitative costs as subject to Regulations §1.263(a)-5.
- Whether the corporation treated the facilitative costs as subject to §162(k).
Section 162(k)(1) provides that no deduction otherwise allowable shall be allowed for any amount paid or incurred by a corporation in connection with the reacquisition of its stock or of the stock of any related person. Under §162(k)(2), §162(k)(1) does not apply to certain specific deductions and redemptions of stock of certain regulated investment companies. In a preamble to proposed regulations on deducting and capitalizing expenditures under §263(a), the IRS clarified that, while the term reorganization, as used in Treas. Reg. §1.263(a)-5(a)(4), is broad enough to encompass stock redemptions, the treatment of costs incurred in connection with a stock redemption is specifically prescribed by §162(k).8
Conclusion
The proposed §355 reporting rules would require taxpayers to report a greater amount of information across a broader scope of details than the current rules require. The new draft form dramatically expands the information furnished to the IRS as part of a tax-free spinoff over several years. While the regulations are not final, the IRS favors increasing §355 reporting and may finalize the proposed additions or similarly deepened rules in the future. Taxpayers and practitioners should consider the proposed reporting rules and draft Form 7216 when planning §355 transactions and comply with the current rules.
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- 1Treas. Reg. Sec. 1.368-1(d)(1).
- 2Treas. Reg. Sec. 1.368-1(d)(3)(iii).
- 3Treas. Reg. Sec. 1.355-2(d)(1).
- 4Treas. Reg. Sec. 1.355-2(d)(2)(iv)(A).
- 5Treas. Reg. Sec. 1.355-2(d)(2)(iv)(B).
- 6Treas. Reg. Sec. 1.355-2(d)(2)(iii)(A).
- 7Treas. Reg. Sec. 1.355-2(d)(2)(iii)(B).
- 8Federal Register 2002, 67 FR 77701 Guidance Regarding Deduction and Capitalization of Expenditures.