Other properties received in a stock spinoff.

The IRS recently issued a ruling on the tax treatment of property other than stock - e.g., cash, notes, securities, receivables and other assets ("other property") - received by a shareholder in a spinoff that would otherwise be nontaxable (Rev. Rul. 93-62).

A spinoff generally involves a corporation's distribution of 80% or more of the stock of a controlled subsidiary to a shareholder of the distributing corporation. If certain Code requirements are met, the distribution is nontaxable, except to the extent that other property is also distributed. A spinoff may involve either a pro rata or a non-pro rata distribution of stock. A pro rata distribution of stock, accompanied by a pro rata distribution of other property, will have the effect of a dividend.

Rev. Rul. 93-62 discussed a non-pro rata distribution of stock, accompanied by a non-pro rata distribution of cash. Sec. 302(b)(2) provides that exchange treatment (rather than dividend treatment) applies for substantially disproportionate redemptions of stock - i. e., (1) the shareholder's voting stock interest and common stock interest after redemption are each less than 80% of those interests immediately before redemption, and (2) the shareholder owns less than 50% of the voting power of all classes of stock after the redemption.

Example: Distributing corporation D has 1,000 shares of a single class of stock outstanding, with a fair market value (FMV) of $1 per share. A, one of five unrelated individual shareholders, owns 400 shares of D stock. D owns all of the outstanding stock of controlled corporation C, which has a $200 FMV, and distributes all of the C stock plus $200 cash to A in exchange for all of her D stock. The exchange would be completely non-taxable except for the receipt of the cash.

The ruling provided that an analysis of the overall spinoff transaction required viewing the cash as in redemption of a portion of the distributing corporation's stock.

Therefore, in the example, A's interest in D immediately before the exchange is compared with the interest she would have retained if she had hypothetically surrendered only the D shares equal in value to the cash received. Before the exchange, A owned 400 shares, or 40%, of the outstanding D stock. If A surrendered only the 200 shares for which she received cash, she would still hold 200 shares, or 25% of the 800 remaining D outstanding shares after the exchange. A's 25% stock interest after the redemption is 62.5% of her 40% pre-exchange stock interest in D. Accordingly, the deemed redemption would be treated as an exchange and would be entitled to capital gains treatment as a substantially disproportionate redemption.

In any spinoff involving receipt of property other than stock, careful planning is required to achieve the desired tax treatment - usually, corporate shareholders want dividend treatment and individual shareholders desire capital gains treatment.