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a subsidiary corporation, wholly owned by the currently existing company. The assets, liabilities, and
all other attributes of the molding operation would then be transferred to this new subsidiary in
exchange for its stock. At that point in the first scenario (known as a spin-off), the parent corporation
would declare a dividend of all such stock to its current stockholders. Thus, Morris, Lisa, and Brad
would own the former subsidiary in the same proportions in which they own the parent. Morris, as the
majority owner of the new corporation, could then give further shares to Brad, enter into a buy-sell
agreement with him, or sell him some shares. In any case, upon Morris‟s death, Brad would succeed to
unquestioned leadership in this corporation. Lisa would stay as a minority stockholder, or, if she
wished, sell her shares to Morris while he was alive. Lisa would gain control of the former parent
corporation upon Morris‟s death.
In the second scenario (known as a split-off), after the formation of the subsidiary, Brad would sell
his shares of Plant Supply to that parent corporation in exchange for stock affording him control of the
subsidiary. Lisa would remain the only minority stockholder of the parent corporation (Brad‟s interest
having been removed) and would succeed to full ownership upon Morris‟s death through one of the
mechanisms discussed earlier.
Unfortunately, when Morris brought his ideas to his professional advisers, he was faced with
serious tax objections. The IRS would likely take the position that the distribution of the subsidiary‟s
stock to Plant Supply‟s stockholders in the first scenario was a taxable dividend to the extent of Plant
Supply‟s earnings and profits at the time of the distribution. This would be less of a concern if his
corporation were operating as an S corporation, although even then, he would have to be concerned
about undistributed earnings and profits dating from before the S election. And in the second scenario,
Brad‟s sale of his Plant Supply stock to the parent in exchange for stock in the subsidiary would be
treated as a taxable sale or exchange of his stock.
Fortunately, however, recognizing that not all transactions of this type are entered into to disguise
the declaration of a dividend, the Internal Revenue Code does allow spin-offs and split-offs to take
place tax-free, under the limited circumstances described in Section 355. These circumstances track
the scenarios concocted by Morris, but are limited to circumstances in which both the parent and the
subsidiary will be conducting an active trade or business after the transaction. Moreover, each trade or
business must have been conducted for a period exceeding five years prior to the distribution and
cannot have been acquired in a taxable transaction during such time. Since Morris‟s corporation
acquired the molding business only two years previously and such transaction was not tax-free, the
benefits of Section 355 are not available now. Short of another solution, it would appear that Morris
will have to live with the bickering of Brad and Lisa for another three years.
Sale of the Corporation
Fortunately for Morris, another solution is not long in coming. Within months of the failure of his
proposal to split up the company, Morris is approached by the president of a company in a related
field who is interested in purchasing Plant Supply. Such a transaction is very intriguing to Morris. He
has worked very hard for many years and would not be averse to an early retirement. A purchase such
as this would relieve him of all his concerns over adequate liquidity for his estate and strategies for
funding his retirement. He could take care of both Lisa and Victor with the cash he would receive, and