Tax-free spin-off transactions under Section 355 of the tax code have been a persistent challenge for the IRS, marked by frequently shifting guidance and a cycle of proposed and revised regulations. The Office of Management and Budget’s spring 2024 regulatory agenda, released earlier this month, lists four proposals for Treasury Department guidance concerning these transactions.
This regulatory activity follows the recent US Supreme Court decision that overturned Chevron deference, which permitted executive branch agencies to interpret ambiguous statutory laws without facing constant judicial challenges. Without Chevron deference, the Treasury and IRS may find themselves more frequently litigated over their interpretations of Section 355, complicating the regulatory landscape.
Historically, regulations published under Section 355 have evolved to reflect congressional intent, particularly regarding the prohibition of transactions that serve as mere distributions of corporate earnings to shareholders. As these rules become more liberal in their interpretations, they also become more susceptible to judicial scrutiny in a post-Chevron environment. This shift incentivizes taxpayers dealing with high-stakes audits and litigation to challenge the constitutionality of IRS regulations if needed to advance their cases.
Two of the four regulatory items on the agenda seem to be reiterations. One relates to the proposed 2007 regulations on the active trade or business requirement under Section 355(b). The other aims to clarify the application of the device prohibition and the active business requirement of Section 355(a)(1)(B) and (C) found in regulations issued in 2016. These regulations introduced changes to the device prohibition, which restricts transactions primarily used to distribute corporate earnings and focuses on nonbusiness rather than investment assets.
Additional proposals include new form requirements for transactions under Treas. Reg. Section 1.355-5, and restrictions outlined in Rev. Proc. 2024-24 on private letter ruling requests under Section 355 and Section 361, addressing debt-for-equity exchanges, delayed distributions, and retained controlled stock. The proposals also follow Notice 2024-38, which seeks feedback on developing future guidance for Section 355 transactions.
Despite the potential for more litigation, the Treasury’s proposed guidance offers a chance to provide clarity, particularly regarding the interplay with new regulatory frameworks such as the corporation alternative minimum tax and stock buyback excise tax rules, which interact with Section 355. To date, there has been no guidance on how these new rules intersect with Section 355 regulations.