Spinoffs
Now that you understand shareholder rights including dividends, you can see how corporations sometimes distribute entire business units to shareholders through a special type of distribution called a spinoff.
What Is a Spinoff?
- A spinoff occurs when a corporation distributes shares of a subsidiary to its existing shareholders as a dividend
- Shareholders receive shares in the new company at no cost - there is no cash outlay
- After the spinoff, the shareholder owns stock in two separate companies instead of one
- The original company's stock price typically adjusts downward to reflect the value of the spun-off entity
Why companies spin off divisions:
- Unlock hidden value in a subsidiary
- Allow each business to focus on its core operations
- Improve market valuation by eliminating conglomerate discount
Cost Basis Allocation
This is the most testable aspect of spinoffs. When a shareholder receives spinoff shares, their original cost basis in the parent company is split between the two companies.
The rule: Cost basis is allocated based on relative fair market values immediately after the distribution.
Example:
- You own 100 shares of Parent Corp with a cost basis of $10,000
- Parent spins off Subsidiary Corp
- After the spinoff: Parent trades at $70/share (FMV = $7,000), Subsidiary trades at $30/share (FMV = $3,000)
- Relative FMV: Parent = 70%, Subsidiary = 30%
| Company | FMV | % of Total | Allocated Basis |
|---|---|---|---|
| Parent Corp | $7,000 | 70% | $7,000 |
| Subsidiary Corp | $3,000 | 30% | $3,000 |
| Total | $10,000 | 100% | $10,000 |
Your total basis stays the same ($10,000) - it's just divided between two holdings.
Exam Tip: Gotchas
In a spinoff, the shareholder's original cost basis is SPLIT between the two companies based on relative fair market values. A shareholder does NOT get a "free" zero-cost-basis stock. The basis from the parent is reallocated proportionally.
Tax Treatment Under IRC Section 355
- Tax-free spinoffs qualify under IRC Section 355 - shareholders recognize no gain or loss at the time of distribution
- The holding period of the spinoff shares includes (tacks onto) the holding period of the original parent shares
- This means if you held the parent stock for 2 years before the spinoff, the subsidiary shares also have a 2-year holding period from day one
Requirements for tax-free treatment:
- The parent must distribute at least 80% of the subsidiary's stock
- Both the parent and subsidiary must be engaged in an active trade or business for at least 5 years prior
- The spinoff cannot be used primarily as a device for distributing earnings
Exam Tip: Gotchas
- The holding period of the parent TACKS ON to the spinoff shares. If you held the parent for 2 years, the subsidiary shares are also long-term from day one.
- No gain or loss is recognized at the time of a qualifying spinoff (IRC Section 355). Tax consequences are deferred until the shares are eventually sold.