IRS Permits Elective Basis Step-Up in Taxable Spin-Offs & Other Taxable Dispositions
The IRS recently finalized regulations under Internal Revenue Code Section 336(e) that will permit taxpayers to elect to treat taxable spin-offs as asset sales for tax purposes with the result that the spun-off corporation will generally obtain a stepped-up basis in its assets. This election can be used proactively to reduce the net tax cost of a taxable spin-off by generating compensatory additional deductions offsetting the tax on the spin-off. It can also be used protectively to mitigate net tax cost in the event a hoped-for tax-free spin-off is determined to be taxable. These planning issues are discussed in our prior memo regarding the IRS's 2008 proposed version of the regulations.
The final regulations address a quirk in the application of the proposed regulations to spin-offs that could have made the election impractical. Specifically, the new regulations permit losses to be recognized up to gains, while the proposed regulations disallowed recognition of losses altogether in the case of a spin-off. Thus, a spun-off corporation with more gains than losses in its assets can readily avail itself of the election, whereas under the proposed regulations, the inability to recognize losses to offset gains could have rendered the election unduly expensive.
Taxpayers should consider making the election protectively in any case of a spin-off that is intended to be tax-free. If the spin-off is in fact tax-free, the election has no effect.
Taxable sales, as distinguished from spin-offs, of corporate subsidiaries and taxable sales of S corporations are also potentially eligible for the new election. While taxable sales of corporate subsidiaries and S corporations have long been eligible for a similar election under Internal Revenue Code Section 338(h)(10), the new rules are, in some cases, simpler to satisfy, especially as they relate to partnership buyers or sellers. Thus, the new election may significantly simplify acquisitions by private equity funds.