26 U.S.C. § 355 — Distribution of stock and securities of a controlled corporation

(a) Effect on shareholders and bondholders. (1) General rule. If a company (called the "distributing corporation") gives its shareholders, with respect to their stock, or gives its bondholders, in exchange for their bonds, solely stock or securities of a company it controls (called the "controlled corporation") right before the split — and (B) the deal wasn't used mainly as a way to disguise handing out the distributing or controlled corporation's earnings and profits (the fact that shareholders later sell their stock doesn't by itself prove this, unless that sale was arranged beforehand) — and (C) both companies satisfy the active-business test in subsection (b) — and (D) the distributing corporation gives away either all of its stock and securities in the controlled corporation, or at least a controlling amount as defined in section 368(c), while satisfying the Secretary that any stock it kept wasn't kept mainly to avoid federal income tax — then the shareholder or bondholder owes no tax and reports no income on receiving that stock or securities. (2) This tax-free rule applies no matter whether the distribution is spread evenly among all shareholders, whether the shareholder gives up any of their old stock in the distributing corporation, or whether it's part of a formal reorganization plan. (3) Limits. (A) This tax-free treatment doesn't apply if the controlled-corporation bonds received have a bigger principal amount than the bonds surrendered, or if bonds are received with none surrendered. (B) Stock in the controlled corporation that the distributing corporation itself acquired through a taxable deal within the 5 years before the distribution doesn't count as qualifying stock — it's instead treated as ordinary taxable property. (C) None of this tax-free treatment applies to the portion of anything received that represents interest that built up on bonds since the holder's holding period began. (D) "Nonqualified preferred stock" — the same riskier category defined in section 351(g)(2) — received for stock that wasn't already that type doesn't count as tax-free stock or securities. (4) Cross-references point to section 356 for taxing property received that doesn't qualify under this subsection, and to section 61 for taxing the accrued-interest portion described in paragraph (3)(C). (b) Active business requirement. (1) The tax-free rule in subsection (a) applies only if either (A) both the distributing corporation and each controlled corporation being distributed are actively conducting a trade or business right after the distribution, or (B) right before the distribution the distributing corporation held nothing but stock or securities in its controlled corporations, and each controlled corporation is actively conducting a trade or business right after the distribution. (2) A corporation counts as "actively conducting a trade or business" only if: (A) it's genuinely engaged in a trade or business; (B) that trade or business has been actively conducted throughout the full 5-year period ending on the distribution date; (C) it wasn't acquired during that 5-year period in a transaction where gain or loss was taxed; and (D) control of a corporation already running that business either (i) wasn't acquired by any receiving corporation, or by the distributing corporation, directly or through other corporations, during that 5-year period, or (ii) was acquired during that period only through transactions where gain or loss wasn't taxed — possibly combined with acquisitions made before the 5-year period began. For rule (D), all receiving corporations that are part of the same affiliated group count as a single corporation. (3) Special rules for affiliated groups. (A) When checking whether a corporation meets the test in (2)(A), every member of its "separate affiliated group" counts as one corporation. (B) A "separate affiliated group" means the affiliated group that would exist under the usual rules if that corporation were the parent, without applying the normal restriction that limits which subsidiaries count. (C) If a corporation joined a separate affiliated group through a transaction where gain or loss was taxed, any trade or business it was running when it joined is treated, for the test in (2), as having been acquired in a taxable transaction. (D) The Secretary must write regulations to properly apply these affiliated-group rules, including adjusting how subsection (a)(3)(B) works alongside them. (c) Tax to the corporation itself on the distribution. (1) In general, the distributing corporation owes no tax on a distribution covered by this section, as long as it isn't part of a formal reorganization plan — subject to the exception in paragraph (2). (2) Distribution of appreciated property. (A) If the distributing corporation hands out property other than "qualified property," and that property is worth more than its tax basis, the distributing corporation must recognize gain, taxed as if it had sold the property to the recipient at its fair market value. (B) "Qualified property" here means stock or securities in the controlled corporation. (C) If property distributed carries a debt, or the shareholder takes on a debt of the distributing corporation as part of the deal, the property's fair market value under rule (A) is treated as at least the amount of that debt. (3) Two other rules about taxing corporate distributions — sections 311 and 336(a) — don't apply to a distribution covered by paragraph (1). (d) Taxing gain on certain "disqualified" distributions. (1) If a distribution is "disqualified," the stock or securities in the controlled corporation are not treated as tax-free "qualified property" under subsection (c)(2) or under the related rule in section 361(c)(2) — so the distributing corporation must recognize gain on them. (2) A distribution is "disqualified" if, right after it, (A) someone holds "disqualified stock" in the distributing corporation making up 50% or more of it, or (B) someone holds disqualified stock in the controlled corporation (or, if more than one is distributed, in any of them) making up 50% or more. (3) "Disqualified stock" means (A) stock in the distributing corporation that was bought, rather than received tax-free, within the 5 years before the distribution, and (B) stock in a controlled corporation that was either (i) bought within that same 5-year window, or (ii) received in the distribution because the holder owned stock described in (A) or bonds in the distributing corporation bought within that window. (4) "50% or greater interest" means stock worth at least 50% of the combined voting power of all stock classes, or at least 50% of the total value of all stock classes. (5) "Purchase" generally means acquiring property where (i) the buyer's tax basis isn't figured from the previous owner's basis or from inheritance rules, and (ii) the property wasn't acquired through a tax-free exchange under sections 351, 354, 355, or 356. It also includes certain otherwise-tax-free section 351 exchanges, to the extent paid for with cash, marketable stock or securities, or debt owed by the person transferring the property. If someone buys property from another person who themselves had bought it, the purchase date carries over to when that earlier purchase happened. (6) If someone's risk of loss on stock or securities is substantially reduced during some period — through an option, a short sale, a special stock class, or a similar device or transaction — the running of the applicable 5-year lookback period pauses during that time. (7) Aggregation. Related people, as defined by cross-reference elsewhere in the tax code, are treated as a single person for this subsection; so are two or more people acting together under a plan or arrangement to acquire stock. (8) A special attribution rule treats someone who owns 10% or more of an entity as holding that entity's stock and securities proportionally, and treats a purchase of the entity interest as a purchase of that underlying stock or securities, dated to whichever purchase happened later. (9) The Secretary must issue regulations to prevent this subsection's purposes from being avoided through related persons, intermediaries, pass-through entities, options, or other arrangements, and to refine the definition of "purchase." (e) Taxing gain on distributions tied to certain acquisitions. (1) If a distribution falls under this subsection, the controlled corporation's stock or securities again aren't treated as tax-free "qualified property" under subsection (c)(2) or section 361(c)(2). (2) This subsection covers a distribution that (A) otherwise qualifies under this section and (ii) is part of a plan, or series of related transactions, under which one or more people end up acquiring, directly or indirectly, 50% or more of the distributing corporation or of any controlled corporation. (B) If such an acquisition happens during a 4-year window running from 2 years before to 2 years after the distribution, it's presumed to be part of such a plan unless the taxpayer proves otherwise. (C) But a plan is disregarded if, right after it's completed, the distributing corporation and all controlled corporations remain part of a single affiliated group. (D) This subsection doesn't apply to any distribution already covered by subsection (d). (3) Special acquisition rules. (A) Certain acquisitions don't count toward the 50% test, including: the distributing corporation buying stock in its own controlled corporation; someone acquiring controlled-corporation stock simply because they already held stock or bonds in the distributing corporation; a similar rule for stock in a successor corporation; and acquisitions where each existing shareholder's ownership percentage doesn't actually decrease (unless the stock they held before was itself part of the suspect plan). (B) If a successor corporation acquires the distributing or controlled corporation's assets through certain tax-free reorganizations, the shareholders of that successor, right before the acquisition, are treated as having acquired stock in the corporation whose assets were taken. (4) Definitions and special rules. "50% or greater interest" has the same meaning as in subsection (d)(4); this subsection doesn't apply to distributions made in a bankruptcy or similar case; the aggregation rule from subsection (d)(7)(A) applies, along with the stock-attribution rules, modified to drop a value threshold that would otherwise limit them; references to "controlled" or "distributing" corporation include their predecessors and successors; and if this subsection applies to a distribution, the government gets an extra 3 years after being notified of the distribution to assess related taxes, overriding the normal deadline. (5) The Secretary must issue regulations covering cases with more than one controlled corporation, treating two or more distributions as a single one where necessary to prevent abuse, and applying rules similar to subsection (d)(6)'s risk-reduction pause where appropriate. (f) Exception for distributions within an affiliated group. Except as provided by regulations, this section (and the related part of section 356) doesn't apply to a stock distribution from one member of an affiliated group to another member, if that distribution is part of the same kind of acquisition plan described in subsection (e)(2)(A)(ii). (g) Exception denied for distributions involving "disqualified investment corporations." (1) This section doesn't apply to a distribution that's part of a transaction if (A) either the distributing or controlled corporation is, right after the transaction, a "disqualified investment corporation," and (B) someone ends up holding, right after the transaction, a 50%-or-greater interest in that disqualified investment corporation that they didn't hold before the transaction. (2) A corporation is a "disqualified investment corporation" if the fair market value of its investment assets makes up two-thirds or more of all its assets' value (three-quarters or more, for distributions during the first year after this rule took effect). "Investment assets" generally means cash, stock or securities in a corporation, partnership interests, debt instruments, options and similar financial contracts, and foreign currency — but excludes assets actively used in a genuine lending or finance business, a licensed banking business, or a licensed insurance business, as long as most of that business's income comes from unrelated customers; excludes securities a securities dealer marks to market; excludes stock in, and certain related assets issued by, a corporation the company controls 20% or more of (the company is instead treated as owning its proportional share of that subsidiary's assets); and excludes certain partnership interests whose business already counts toward the active-business test in subsection (b) (again, with the company treated as owning its share of the partnership's assets). (3) "50% or greater interest" has the same meaning as in subsection (d)(4), applying the normal stock-attribution rules. (4) "Transaction" includes a series of transactions. (5) The Secretary must issue regulations to prevent this subsection's purposes from being avoided — including through related persons, intermediaries, pass-through entities, or similar arrangements, and by treating unrelated assets bought using investment assets before the distribution as investment assets — and may exclude, in appropriate cases, a distribution that doesn't function like a stock redemption that would be treated as a sale under section 302, and may adjust the attribution rules used for this subsection. (h) Restriction on distributions involving real estate investment trusts (REITs). (1) This section doesn't apply to a distribution if either the distributing or controlled corporation is a REIT. (2) Exceptions. (A) This restriction doesn't apply if, right after the distribution, both the distributing and controlled corporations are REITs. (B) It also doesn't apply if the distributing corporation has been a REIT for the full 3 years before the distribution, the controlled corporation has been the distributing corporation's "taxable REIT subsidiary" for that same 3-year period, and the distributing corporation controlled it — as defined in section 368(c), counting stock owned directly or indirectly through other corporations or partnerships — throughout that period. A controlled corporation also meets these conditions if its stock was distributed by a taxable REIT subsidiary in a transaction covered by this section, and its assets consist entirely of stock or assets held by one or more taxable REIT subsidiaries of the distributing corporation that themselves meet these conditions. For a partnership, "control" means owning at least 80% of the profits interest and at least 80% of the capital interests.