IRS to Respond to Questions on Corporate Spin-Offs

Published on: 13:21PM Sep 01, 2016

~~Many farm corporations were started by "mom and dad" many years ago and have been passed down to sons or daughters to operate.  In most cases, this continues to work well, but in other cases, disagreements may arise and the simplest method to correct this is to "split" the corporation into two or more parts and have the parties go on their merry ways.

However, if this is not done correctly from a tax standpoint, it can easily result in millions of taxes being owed with no cash available to pay the tax.  For example, assume mom and dad created ABC farm corporation in 1960 and contributed land with a cost basis of $50,000 into the corporation.  This becomes their cost basis in the stock.  During their lifetime, they gift the stock to their two sons.  After several years, it becomes apparent that the sons cannot operate together.  The value of the land is now $10 million and the other assets have a value of $4 million and very little tax cost.  They decide the split up the corporation into two and spin-off one of the corporations to a brother.  If this is done incorrectly, the tax effect could be as follows (1) a "deemed" sale of half the land and other assets for $7 million resulting in tax of about $3 million at the corporate level and (2) the brother could be hit with a gain of about $7 million resulting in another $1.5 million of tax.  This is not what most farmers want to happen.

The IRS had originally announced earlier that they would not give any opinions on whether these types of spin-offs/split-ups would meet the requirements. 

To be tax-free, there must be a corporate business purpose and not a device for getting earnings and profits out of the corporation.  Two brothers fighting as investors is not a corporate purpose.  However, if the business cannot operate since two brothers can't get along, that would normally qualify as a corporate purpose.  There are many other requirements that are beyond the scope of this post.

The IRS just announced in Revenue Procedure 2016-45 that they will now start providing rulings on these situations.  These rulings can easily cost the farm family $50,000 or more, but if you are facing a possible tax bill exceeding $4 million as shown in our example, it may be the best $50,000 you ever spent.