The IRS and Treasury Department have issued proposed regulations (REG-112261-24) that provide comprehensive guidance on nonrecognition treatment in corporate separations, incorporations, and reorganizations under IRC Sections 355, 357, 361, and 368. These rules would impose new substantive requirements for spin-offs and divisive reorganizations while also affecting certain acquisitive reorganizations and IRC Section 351 exchanges. A separate set of proposed reporting regulations (REG-116085-23) would introduce multi-year reporting obligations for spin-offs and related transactions, requiring taxpayers to file a new Form 7216 over multiple years. These regulations, if finalized, will significantly increase documentation and compliance requirements for affected transactions.

Notable Provisions

Expanded Guidance on IRC Section 355 Transactions

The proposed regulations aim to provide clarity and consistency for transactions involving spin-offs and corporate separations. The key areas addressed include:

• Establishing mandatory plan requirements for spin-offs and reorganizations.
• Rules governing the retention and disposition of controlled corporation stock.
• Restrictions on the assumption of liabilities in tax-free exchanges.
• Limitations on boot distributions and their treatment under nonrecognition provisions.
• Rules governing the use of consideration to satisfy creditors in corporate separations.

These provisions are intended to ensure compliance with statutory nonrecognition provisions while addressing potential tax avoidance concerns.

Mandatory Plans for Corporate Separations and Reorganizations

A formal plan of distribution (for spin-offs) or plan of reorganization (for other reorganizations) must now be adopted before the first step of the transaction and completed within a reasonable timeframe, presumed to be within 24 months. The plan must:

• Identify all parties involved in the transaction.
• Clearly describe the distributions or asset transfers taking place.
• Define the intended federal income tax treatment of each transaction.
• Provide a business purpose for each component of the transaction.

Failure to formally file such a plan does not automatically disqualify a transaction from nonrecognition treatment, but it could lead to increased IRS scrutiny and challenges.

New Restrictions on Retained Stock and Delayed Disposition

A distributing corporation retaining stock in a controlled entity after a spin-off must demonstrate that the retention was not primarily for tax avoidance. The proposed regulations introduce a presumption that any retained stock that does not meet a specified safe harbor or facts-and-circumstances test may be deemed as having a tax avoidance purpose. The safe harbor generally requires:

• A specific business purpose for retention.
• A plan to dispose of retained stock within five years.
• That the controlled corporation’s stock is widely held during the retention period.
• That there are no overlapping key officers, directors, or employees between the distributing and controlled corporations.

This rule is more restrictive than previous IRS ruling policies and requires taxpayers to carefully document the rationale behind any retained stock position.

Assumption of Liabilities in Reorganizations

The proposed regulations clarify when assumed liabilities in an IRC Section 351 or 361 exchange may be treated as taxable boot. Under the new rules, a presumption of tax avoidance applies if:

• The assumed liabilities were not incurred in the ordinary course of business of the transferor.
• The liabilities are not properly associated with the transferred business assets.
• The assumption is not necessary to ensure the proper transfer of a business.

For divisive reorganizations, the assumption of liabilities is subject to additional requirements. Only “eligible distributing corporation liabilities” qualify for nonrecognition treatment, and these are generally limited to historical liabilities incurred before the earliest of:

1. The public announcement of the reorganization.
2. The formal agreement to proceed with the transaction.
3. The board of directors’ approval of the reorganization.

While refinanced debt and trade payables may qualify in certain circumstances; these rules impose stricter limitations than past IRS ruling policies.

Stricter Standards for Boot Distributions and Debt-for-Debt Exchanges

The proposed regulations place new restrictions on boot distributions, which refer to cash or other property received by the distributing corporation in a tax-free exchange. To qualify for nonrecognition, the IRS now requires:

• Boot to be held in a segregated account and distributed within 12 months.
• That boot distributions not be used for stock repurchases or ordinary dividends, unless explicitly provided for in the plan.

Debt-for-debt and debt-for-equity exchanges are also subject to new qualifying requirements. These exchanges must meet the qualifying debt elimination transaction test, which mandates that:

• The repaid debt must be historical and existed before the reorganization was publicly announced or agreed upon.
• Trade payables and refinanced debt may qualify under limited conditions.
• Any intermediary involved in a debt exchange must hold the relevant debt for at least 30 days before the distribution.

These changes impose substantial compliance burdens on companies undertaking debt exchanges as part of a spin-off or reorganization.

Introduction of Multi-Year Reporting Requirements (Form 7216)

A major administrative change introduced in the proposed regulations is the requirement for extended reporting on Form 7216, which applies to all covered filers involved in IRC Section 355 transactions.

• The form must be filed annually for up to seven years (beginning with the year of the first distribution and continuing for five years after control is transferred).
• The form requires detailed disclosures on the following:
  • Compliance with IRC Section 355 requirements.
  • Ongoing corporate relationships between distributing and controlled corporations.
  • Implications for international tax and consolidated group transactions.
  • Impact on the corporate alternative minimum tax (CAMT) and excise tax obligations.

Given the extensive nature of this reporting requirement, companies engaged in spin-offs will face a significant increase in long-term tax compliance obligations.

Why This Matters

These proposed regulations represent a major shift in how the IRS oversees spin-offs, divisive reorganizations, and other corporate separations. Key implications include:

• Greater Documentation Burden: Taxpayers must formally adopt and file detailed plans for spin-offs and reorganizations to avoid potential IRS challenges.
• Stronger Anti-Tax Avoidance Measures: The IRS is increasing scrutiny over retained stock, liability assumptions, and boot distributions, requiring companies to justify each transaction element carefully.
• Heightened Compliance Costs: The introduction of multi-year reporting on Form 7216 creates long-term tax filing obligations, increasing administrative complexity.
• Potential Unintended Consequences for Reorganizations: Although the primary focus is on spin-offs, some provisions extend to acquisitive reorganizations and IRC Section 351 exchanges, which may lead to unexpected tax consequences.

Next Steps

Taxpayers planning spin-offs or corporate reorganizations should assess the impact of these proposed regulations on their transaction structures. Recommended actions include:

• Reviewing existing spin-off plans to ensure compliance with the new plan documentation requirements.
• Evaluating retained stock positions and documenting a defensible business purpose to avoid adverse tax consequences.
• Preparing for the increased reporting burden, particularly the multi-year Form 7216 filing requirement.
• Considering IRS comment submission before finalization to address potential concerns or ambiguities in the proposed rules.

Given the complexity and scope of these proposed changes, businesses should consult tax professionals and legal advisors early in the planning process to mitigate risks and ensure compliance.

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