United States

IRS ruling addresses spin-off active trade or business requirement

Sufficient active business functions were performed by employees


Private Letter Ruling 201734004 (the Ruling) addresses the active trade or business (ATB) requirement for tax-free spin-offs. The IRS considered whether the business activities performed by employees of the spun-off business were sufficient to satisfy the ATB requirement. The Ruling provides a reminder that only the activities of employees, and not those of independent contractors, can satisfy the test.

ATB requirement – employees performing ATB functions

In a spin-off, a corporation (Distributing) distributes stock of a subsidiary (Controlled) to its shareholders. To qualify a spin-off for tax-free treatment, various requirements must be met; the ATB requirement is one. Distributing and Controlled must each actively conduct a trade or business immediately after the spin-off (the Post-Spin ATB Requirement).[1] In addition, each ATB also has the following corollary requirements. The ATB of each company must have been conducted for at least five years before the spinoff (the Pre-Spin ATB Requirement),[2] and cannot have been acquired within the five-year period in a taxable transaction.[3]

A corporation is engaged in an ATB if it is carrying on for-profit activities and the corporation itself performs active and substantial management and operational functions (ATB Functions).[4] Employees generally must perform the ATB Functions; having independent contractors perform the ATB Functions does not suffice.[5] The employees performing the ATB may be employees of the company in question (Distributing or Controlled) or employees of a subsidiary of that company.[6]

Ruling concluded the ATB requirement would be met

In providing the Ruling, the IRS considered whether the relevant employees performed sufficient ATB Functions. The IRS concluded that spin-off addressed in the Ruling could satisfy the ATB requirement. A number of the employees of the business to be spun off by Distributing (Business B) were previously transferred from Distributing to a related company (Acquiring) that was neither Distributing nor a subsidiary of Distributing (the Employee Transfer). ATB Functions performed by these Business B employees while employees of Acquiring, like activities performed by independent contractors in general, would not help satisfy the ATB requirement. The Employee Transfer therefore gave rise to some doubt as to whether Distributing’s employees’ activities sufficed to meet the Pre-Spin ATB Requirement.

By contrast, meeting the Post-Spin ATB Requirement was not in significant doubt because the Business B employees will be employed by Acquiring, the corporation that will conduct Business B after the spin-off. Transferring the Business B assets and employees to Acquiring will be implemented via the spin-off and a merger. First, in the spin-off, Distributing will contribute Business B assets to a new subsidiary, Controlled, after which Distributing will distribute all of Controlled’s stock to Distributing’s parent company (Parent). Second, after the spin-off, Controlled will merge into Acquiring, another subsidiary of Parent.

The IRS resolved the doubt regarding the Employee Transfer, holding in the Ruling that the Employee Transfer would not prevent the spin-off from satisfying the ATB requirement.


To qualify a spin-off for tax-free treatment, employees must perform active and substantial management and operational functions. These functions may include, for example, management, engineering, product development, product design, and marketing. The ATB requirement mandates conducting two ATBs during the preceding five years. Further, Distributing and Controlled must each conduct an ATB after the spin-off. For example, Controlled (or a subsidiary of Controlled), as operator of the spun-off line of business, generally must be the employer of the employees performing active and substantial functions of that business.

Companies should be mindful that to qualify a spin-off for tax-free treatment, essential managerial and operational employees will need to accompany each business line. Companies considering a tax-free spin-off should consult with tax advisors experienced in this area.

[1] §§ 355(a)(1)(C), (b)(1), and (b)(2)(A).
[2] § 355(b)(2)(B),  
[3] §§ 355(b)(2)(C) and (D)
[4] Reg. §§ 1.355-3(b)(2)(ii) and (iii).
[5] Reg. § 1.355-3(b)(2)(iii).
[6] See § 355(b)(3).   


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