No, I am not referring to some fleeting summer romance. After all, “. . . summer friends will melt away like summer snows.” (George R.R. Martin, A Feast for Crows).

Rather, I am referring to the abundant guidance that the IRS has issued or proposed this summer regarding the requirements that must be satisfied in order for a corporate break-up to receive favorable tax treatment. (See example).

Among the concerns addressed by the IRS are those relating to distributions involving relatively small active businesses or substantial amounts of investment assets. These transactions may (i) present evidence of a prohibited “device,” (ii) may lack an adequate business purpose, or (iii) may fail to distribute a qualifying active business. (See October 13, 2015 blog post).

Statutory Requirements

Generally, if a corporation distributes property with respect to its stock to a shareholder, the amount of the distribution is equal to the fair market value (“FMV”) of the property. This amount is treated first as the receipt by the shareholder of a dividend to the extent of the corporation’s earnings and profits (“E&P”), then as the recovery of the shareholder’s basis in the stock, and finally as gain from the sale or exchange of the stock.

The corporation recognizes gain to the extent the FMV of the property distributed exceeds the corporation’s adjusted basis in the property.

However, the Code provides that, under certain circumstances, a corporation (Distributing) may distribute stock in a corporation that it controls (Controlled) to its shareholders without causing either Distributing or its shareholders to recognize gain on the distribution.

Numerous requirements must be satisfied in order for a distribution to be tax-free to Distributing and its shareholders.

For example, the transaction must not be used principally as a device for the distribution of the E&P of Distributing or Controlled, and Distributing and Controlled must each be engaged, immediately after the distribution, in the active conduct of a trade or business.

A qualifying business is one that has been actively conducted throughout the five-year period ending on the date of the distribution and that was not acquired within this period in a transaction in which gain or loss was recognized.

Distributions of Controlled stock generally take three different forms: (1) a pro rata distribution to Distributing’s shareholders (a spin-off), (2) a distribution in redemption of Distributing stock (a split-off), or (3) a liquidating distribution by Distributing which may be pro rata or non-pro rata (a split-up).

A Device?

In determining whether a transaction was used principally as a device for the distribution of the E&P of Distributing or of Controlled, consideration is given to all of the facts and circumstances of the transaction and, in particular, to the nature, kind and amount of the assets of both corporations immediately after the transaction, and to the ratio for each corporation of the value of assets not used in a qualifying business to the value of its qualifying business.

Thus, the fact that at the time of the transaction substantially all of the assets of each of the corporations involved are used in a qualifying business is considered evidence that the transaction was not used principally as a device, and a difference in the asset ratios for Distributing and Controlled is ordinarily not evidence of device if the distribution is not pro rata among the shareholders of Distributing, and such difference is attributable to a need to equalize the value of the stock distributed and the value of the stock exchanged by the distributees.

In addition, certain distributions are ordinarily not considered a device, including a distribution that, with respect to each distributee, would be a redemption of stock to which sale-or-exchange treatment applies, and distributions in which the corporations have no E&P.

The existence of assets that are not used in a qualifying five-year business is evidence of device. Such assets include liquid investment assets that are not related to the reasonable needs of the qualifying business.

The current regulations, however, are not specific as to the quality or quantity of assets relevant in the “nature and use of assets” device factor or the appropriate weighing of the device and non-device factors.

Active Business

The IRS previously noted there is no requirement that a specific percentage of a corporation’s assets be devoted to a qualifying business, provided its active business assets represent a “substantial portion” of the value of the corporation immediately after the distribution. Thus, the fact that Distributing’s or Controlled’s qualifying business is small in relation to all the total assets of Distributing or Controlled raises an issue as to whether a relatively small active business satisfies the active business requirement.

Proposed Regulations

The IRS recently proposed regulations to address concerns over distributions involving relatively small active businesses, but substantial amounts of investment assets, because these may present evidence of device, or may lack an adequate business purpose or a qualifying active business.

Specifically, the proposed regulations provide guidance regarding the device prohibition, and they also provide a minimum threshold for the assets of one or more active businesses of Distributing and of Controlled.

Device Regulations

The potential for device generally exists either if Distributing or Controlled owns a large percentage of “investment” assets not used in business operations compared to total assets, or if Distributing’s and Controlled’s percentages of these assets differs substantially.

Instead of focusing on investment assets, the proposed regulations compare a corporation’s assets used in an active business (“Business Assets”) to those not so used (“Nonbusiness Assets”).  Business Assets are the gross assets used in an active business – without regard to whether they satisfy the five-year-active-business requirement – including reasonable amounts of cash and cash equivalents held for working capital and assets required to be held to provide for exigencies related to a business or for regulatory purposes with respect to a business.

In addition, under the proposed regulations, if the ratio of  a corporation’s Nonbusiness Assets to its total assets (“Nonbusiness Asset Percentage”) is at least 20 percent, the ownership of the Nonbusiness Assets is evidence of device. Additionally, a difference in this ratio between Distributing and Controlled ordinarily would not be evidence of device if such difference is less than 10 percentage points or, in the case of a non-pro rata distribution, if the difference is attributable to a need to equalize the value of the Controlled stock and securities distributed and the consideration exchanged therefor by the distributees. Such circumstances would ordinarily be treated as not constituting evidence of device.

Corporate Business Purpose

The presence of a strong, bona fide business purpose is a non-device factor.

Under the proposed revision, a corporate business purpose that relates to a separation of Nonbusiness Assets from one or more Businesses, or from Business Assets, would not be evidence of non-device, unless the business purpose involves an exigency that requires an investment or other use of the Nonbusiness Assets in a Business. Absent such an exigency, such a separation would be viewed as evidence of a device.

Per Se Device Test

The IRS also proposes to add a per se device test. If designated percentages of Distributing’s and/or Controlled’s total assets are Nonbusiness Assets, the transaction would be considered a device, notwithstanding the presence of any other non-device factors. However, this per se device rule would not apply if the distribution is one in which the corporate distributee would be entitled to a dividends received deduction or if the distribution would qualify as a sale or exchange if it were a redemption.

The per se device test has two prongs, both of which must be met for the distribution to be treated as a per se device.

The first prong is met if Distributing or Controlled has a Nonbusiness Asset Percentage of 66 2/3 percent or more.

The second prong of the test compares the Nonbusiness Asset Percentage of Distributing with that of Controlled. This prong of the per se device test provides for three “bands” in making this comparison. Each of these bands represents a case in which the Nonbusiness Asset Percentages of Distributing and Controlled are significantly different. For example, in the first band, if one corporation’s Nonbusiness Asset Percentage is 66 2/3 percent or more, but less than 80 percent, the distribution would fall within the band if the other corporation’s Nonbusiness Asset Percentage is less than 30 percent.

If both prongs of this test are met, that is, if the Nonbusiness Asset Percentage for either Distributing or Controlled is 66 2/3 percent or more and the Nonbusiness Asset Percentages of Distributing and Controlled fall within one of the three bands, the distribution would be a per se device.

Minimum Size for Active Business

The Code does not literally provide a minimum absolute or relative size requirement for an active business to qualify. Nevertheless, the IRS has determined that the Code requires that distributions have substance, and that a distribution involving only a relatively de minimis active business should not receive favorable tax treatment because such a distribution is not a separation of businesses.

To ensure that these requirements are satisfied, the IRS proposes to add a new regulation to require that the percentage determined by dividing the FMV of each of Distributing’s and Controlled’s corporation’s five-year-active Business Assets by the FMV of its total assets must be at least five percent. These five-year-active-Business Assets would include reasonable amounts of cash and cash equivalents held for working capital and assets required to be held to provide for exigencies related to a five-year-active Business or for regulatory purposes with respect to such a business.

Timing of Asset Identification, Characterization, and Valuation

For purposes of the above rules, the assets held by Distributing and by Controlled immediately after the distribution must be identified, and their character and FMV must be determined.

The FMV of assets would be determined, at the election of the parties on a consistent basis, either (a) immediately before the distribution, (b) on any date within the 60-day period before the distribution, or (c) on the date of an agreement with respect to the distribution that was binding on Distributing on such date and at all times thereafter. The parties would be required to make consistent determinations between themselves, and use the same date, for purposes of applying the device rules and the five-percent minimum Five-Year-Active-Business Asset Percentage requirement.


Generally speaking, the proposed regulations should be welcomed by taxpayers. Although some may disagree with the thresholds established, and with the resulting increased reliance on valuations, the IRS is correct in its approach: the favorable tax treatment afforded by the Code for certain corporate separations is intended to apply only to genuine separations of businesses and business assets. The congressional purpose for adopting the active business requirement was to separate businesses, not to separate inactive assets from a business. Accordingly, when a corporation that owns only nonbusiness assets and a relatively de minimis active business is separated from a corporation with another active business, the substance of the transaction is not a qualifying separation of businesses.