The IRS and Treasury Department have released proposed regulations (REG-112261-24) under IRC Sections 355, 357, 361 and 368 on the nonrecognition of gain or loss on corporate separations, incorporations and reorganizations. The proposed regulations primarily relate to IRC Section 355 distributions that are not reorganizations and IRC Section 368(a)(1)(D) reorganizations to which IRC Section 355 applies (Divisive Reorganizations) (collectively, IRC Section 355 Transactions), and would provide substantive rules on topics previously described in Notice 2024-38 and applied by the IRS in Revenue Procedure 2024-24 (see Tax Alert 2024-0949). However, certain aspects of the proposed regulations would also extend to acquisitive reorganizations and IRC Section 351 exchanges.

Accompanying proposed regulations (REG-116085-23, reporting proposed regulations) under IRC Section 355 would require multi-year reporting for corporate separations and related transactions. Taxpayers would be required to provide relevant information on a new Form 7216, Multi-Year Transaction Reporting Related to Section 355 Transactions.

Overview

In Revenue Procedure 2024-24, the IRS updated procedures for taxpayers requesting a private letter ruling (PLR) on an IRC Section 355 Transaction. Notice 2024-38 describes Treasury and the IRS's views and concerns on the matters addressed in Revenue Procedure 2024-24.

The proposed regulations would provide substantive guidance on all IRC Section 355 Transactions, not just those for which a PLR is sought, as well as acquisitive reorganizations and IRC Section 351 exchanges. The proposed regulations address many of the areas under study noted in Notice 2024-38, including:

• Plan of reorganization and plan of distribution
• The retention of and delayed dispositions of controlled corporation (Controlled) stock or securities
• The assumption of distributing corporation (Distributing) liabilities by Controlled
• Distributions and transfers of Controlled stock, Controlled securities or other debt obligations, and money or other property (IRC Section 361 Consideration) to shareholders and creditors of Distributing

While the proposed regulations are not yet accompanied by an update to Revenue Procedure 2024-24, the IRS announced in IR-2025-11 that it intends to apply the guidance in the proposed regulations in issuing PLRs on certain corporate separations and update Revenue Procedure 2024-24 to reflect the proposed regulations. The timing of this update is currently unknown.

Proposed regulations on IRC Section 355 Transactions

Plan of reorganization and plan of distribution

Prop. Treas. Reg. Sections 1.355-4 and 1.368-4 would introduce parallel rules describing how a taxpayer can establish its plan of distribution (applicable to IRC Section 355 distributions that are not part of a Divisive Reorganization) or plan of reorganization (applicable to all reorganizations, whether Divisive Reorganizations or acquisitive reorganizations).

Under the proposed regulations, a plan of distribution or plan of reorganization would be (1) a single, comprehensive document that satisfies all the requirements in Prop. Treas. Reg. Section 1.355-4(c) or 1.368-4(d) and is filed with the IRS, (2) the plan that results from the Commissioner correcting a taxpayer's plan; or (3) the plan identified by the Commissioner if a taxpayer fails to file a plan.

To qualify as a plan of distribution, a plan would need to (1) identify the distributing corporation and each controlled corporation; (2) identify all distributions; (3) describe the intended federal income tax treatment of each distribution; and (4) describe the corporate business purpose for each distribution.

To qualify as a plan of reorganization, a plan would need to:

• Identify all the parties to the reorganization
• Identify all the transactions included in the plan
• Identify all liabilities to be assumed and the associated creditors
• Identify all debt of the target corporation to be satisfied with IRC Section 361 consideration and the associated creditors
• Describe the intended federal income tax treatment of each transaction
• Describe the business purpose for each transaction
• Establish that the readjustments involved in the relevant transactions are undertaken to facilitate the continuance of the business of a party to the reorganization

The proposed regulations would require the plan of distribution or plan of reorganization to be adopted before the first step in the plan and completed as "expeditiously as practicable." The latter requirement would be presumed satisfied if a plan is completed within 24 months.

For a step to be "properly included" in a plan of distribution or plan of reorganization, the proposed regulations would require (1) evidence of a definite intent to carry out the transaction through a written commitment in one or more official records, before the first step; (2) the step to bear a "proximate relationship" to the distribution or reorganization (through the satisfaction of a "necessary or integral test," for a distribution and a "but for, or integral to" test for a reorganization); and (3) the step, on its own or as part of a series of transactions, to be consistent with, and directly related to, one or more business purposes for the distribution or reorganization. The existence of contingencies or conditions would not be conclusive in determining whether these requirements were satisfied. Further, the proposed regulations would explicitly provide that mere temporal proximity does not cause a distribution or transaction to be part of a plan.

Importantly, as discussed in greater detail below, the filing and determination of a plan could affect qualification as a reorganization and the application of nonrecognition provisions of the Code such as IRC Sections 355, 357 and 361. The proposed regulations, however, explicitly provide that a taxpayer's failure to comply with any particular requirement or procedure in Prop. Treas. Reg. Sections 1.355-4 or 1.368-4 (including the failure to file a plan of reorganization or plan of distribution with the IRS) does not, on its own, prevent a transaction or series of transactions from being considered part of a plan, qualifying as a reorganization, or qualifying for nonrecognition treatment. It is not completely clear how to reconcile these possibly conflicting aspects of the proposed regulations. In addition, if all steps in a plan are not completed in the manner described in the plan, the relevant definitional and operative provisions of the Code would not apply unless the Commissioner determines that a plan exists. A plan may be amended in limited circumstances, however, if certain requirements are satisfied.

Retentions and delayed dispositions of Controlled stock

Under IRC Section 355(a)(1)(D)(ii), Distributing may distribute less than all of the Controlled stock or securities that it owns, provided that it distributes Controlled stock representing IRC Section 368(c) control of Controlled (IRC Section 368(c) Control) and establishes to the satisfaction of the Secretary that the retention of any remaining Controlled stock or securities by Distributing was not pursuant to a plan having as one of its principal purposes the avoidance of federal income tax. If so, Distributing may then dispose of the remaining Controlled stock or securities by distributing such stock or securities to its shareholders or security holders on a delayed basis or, in the case of a Divisive Reorganization, using Controlled stock or securities to repay Distributing debt in a "debt-for-equity" or "debt-for-debt" exchange. Alternatively, Distributing may hold the retained stock or securities for an extended period and later dispose of such stock or securities in a taxable disposition.

Prop. Treas. Reg. Section 1.355-2(e) would require the distribution of IRC Section 368(c) Control of Controlled within a single tax year of Distributing or during two tax years of Distributing, provided that all distributions making up the distribution of IRC Section 368(c) Control are made pursuant to a binding commitment that is described in a plan of distribution or plan of reorganization, as applicable. In addition, the retention of any stock or securities not distributed as part of the first distribution of Controlled stock would be presumed to have a tax avoidance purpose, and accordingly, would have to satisfy the requirements for a qualifying retention in Prop. Treas. Reg. Section 1.355-10(c) under either a safe harbor or a facts-and-circumstances test.

Unlike the standards in Revenue Procedure 2024-24, the requirements for a qualifying retention would apply regardless of the manner of the later disposition of Controlled stock. In an expansion of the plain language of IRC Section 355(a)(1)(D)(ii), a retention would also include a situation in which Distributing continues to hold stock or securities of another member of Controlled's separate affiliated group (SAG) (as defined in IRC Section 355(b)(3)(B)).

Under the qualifying retention safe harbor in Prop. Treas. Reg. Section 1.355-10(c)(3), the plan of distribution or plan of reorganization, as applicable, would have to describe each agreement and transaction that establishes that each of the following six requirements is satisfied:

1. A specific business purpose exists for the retention
2. The Controlled corporation stock is widely held during the period of retention
3. Subject to certain exceptions, there are no overlapping officers, directors or key employees
4. Any continuing arrangements reflect arm's-length terms or are terminated (or renegotiated at arm's-length terms) within two years
5. The plan of distribution or plan of reorganization reflects a definite intent in the official records to dispose of the retained Controlled stock or securities within five years
6. The disposition of the retained Controlled stock or securities would not result in less federal income tax to Distributing (i.e., at the time of first distribution, there is no built-in loss in the retained Controlled stock or securities)

As set forth in the plan-of-distribution or plan-of-reorganization rules, the timing of a delayed distribution of Controlled stock or a debt-for-equity or debt-for-debt exchange that is pursuant to the applicable plan would be subject to the "expeditiously as practicable" standard. In addition, the mechanics for a debt-for-equity or debt-for-debt exchange would be subject to additional new rules applicable for transfers to creditors, described below.

In contrast to the ruling policy established by Revenue Procedure 2024-24, examples in the proposed plan-of-reorganization rules illustrate that a definitive plan for alternative transactions regarding disposition of the same retained stock or securities is permissible, provided that a definite intent regarding a specified ordering of the alternatives is described in the plan of reorganization or plan of distribution. The proposed requirements for a qualifying retention would be generally consistent with historic IRS ruling policies and revenue rulings predating Revenue Procedure 2024-24.

Assumptions of liabilities under IRC Section 357

IRC Section 357(b) provides that the total amount of liabilities assumed in an IRC Section 351 or 361 exchange is treated as money or other property (boot) if the principal purpose for assuming any liability in the exchange is to avoid federal income tax on the exchange or is otherwise not a bona fide business purpose.

Prop. Treas. Reg. Section 1.357-3 would create a presumption that the principal purpose rule in IRC Section 357(b) is violated if a liability assumed were not incurred in the ordinary course of a business of a transferor. The presumption would apply to all reorganizations and IRC Section 351 exchanges, not just Divisive Reorganizations.

For Divisive Reorganizations, the principal purpose rule in IRC Section 357(b) would be presumed to be violated by Distributing if:

• The Distributing liabilities assumed in the reorganization were not "eligible distributing corporation liabilities" that are described in a plan of reorganization and incurred in the ordinary course of Distributing's business

or

• The assumption was not necessary to ensure the transfer of all liabilities properly associated with the business assets transferred to Controlled and in an amount that properly relates to Controlled's business operations

For Distributing liabilities that constitute debt to be treated as "eligible distributing corporation liabilities," such debt generally would have to be historical Distributing debt (i.e., incurred before the earliest of the date the Divisive Reorganization is (1) publicly announced, (2) agreed to by Distributing in a written agreement, or (3) approved by Distributing's board of directors (the Earliest Applicable Date)).

In a helpful departure from Revenue Procedure 2024-24, trade payables, debt incurred to refinance historical debt (refinanced debt), and debt under certain revolving credit agreements would be treated as "eligible distributing corporation liabilities," even if the debt was not historical Distributing debt. In addition, "eligible distributing corporation liabilities" would include related-party liabilities and the amount of "eligible distributing corporation liabilities" eligible for assumption under IRC Section 357 would not be limited to Distributing's historical average debt.

When applying IRC Section 357(c), the proposed regulations would largely follow current law. The proposed regulations would not, however, exclude a liability described in IRC Section 357(c)(3) for purposes of applying IRC Section 357(c) unless it was incurred in the ordinary course of business or associated with the transferred assets.

IRC Section 357(d) treats recourse liabilities as assumed if the transferee has agreed to, and is expected to, satisfy the liabilities, whether or not the transferor has been relieved of the liabilities. In a narrowing of this Code language, Prop. Treas. Reg. Section 1.357-2(e) would treat a liability assumption as boot in an IRC Section 351 or 361 exchange if the transferee were to make a payment on the assumed liability and the transferor (or, in the case of a Divisive Reorganization, a member of Distributing's SAG) has legal or practical dominion or control over any part of the payment (e.g., the payment on the assumed liability is made through the transferor), unless certain exceptions are satisfied.

Boot distributions under IRC Section 361(b)

IRC Section 361(b) provides nonrecognition treatment for the receipt of boot in an IRC Section 361 exchange if the recipient "purges" the boot through a distribution to shareholders in pursuance of the plan of reorganization or a transfer to its creditors in connection with the reorganization.

Prop. Treas. Reg. Section 1.361-3(c) would impose limitations on a qualifying boot purge in a Divisive Reorganization, requiring Distributing to deposit the boot in a segregated account (a departure from historic IRS ruling policy) and purge the boot within 12 months of the IRC Section 361 exchange. The 12-month timing requirement would transform what has historically been an IRS ruling policy into a substantive bright-line rule, notwithstanding that IRC Section 361 does not impose any time-based limitations. If Distributing were to receive a payment from Controlled after the date that IRC Section 368(c) Control of Controlled is distributed (the control distribution date), Distributing would be required to purge the boot within the later of 90 days of receipt or 12 months after the IRC Section 361 exchange, among other requirements.

In another departure from historic IRS ruling policy, the "but for, or integral to" test in the proposed plan of reorganization rules would treat a distribution of cash to pay ordinary-course dividends or to fund a repurchase of Distributing stock under an existing stock repurchase program as not properly included in the plan of reorganization. Thus, boot transferred in this manner would not be treated as sufficiently purged and would be ineligible for nonrecognition treatment under IRC Section 361(b).

Boot purges to creditors would be subject to additional limitations on Distributing debt eligible for repayment, as described next.

Transfers of IRC Section 361 consideration to creditors

IRC Section 361(c) provides nonrecognition treatment to a party to a reorganization on the distribution of property to shareholders in pursuance of the plan of reorganization or a transfer of qualified property to creditors in connection with the reorganization.

Prop. Treas. Reg. Section 1.361-5 would impose new Divisive Reorganization requirements for nonrecognition treatment to Distributing on the receipt of boot that is transferred to creditors (i.e., under IRC Section 361(b)(3)) or a transfer of qualified property (e.g., Controlled stock) to its creditors (i.e., under IRC Section 361(c)(3)). The requirements specify that (1) the creditor must be a qualifying creditor; (2) the Distributing debt that is satisfied must be "eligible distributing corporation debt" that is identified in the plan of reorganization, and (3) the transfer must be part of a qualifying debt elimination transaction. A qualifying creditor could be a related party, provided that boot is ultimately used to repay an unrelated creditor within 12 months of receipt, or qualified property is ultimately transferred to an unrelated creditor pursuant to the plan of reorganization.

The Distributing debt that is eligible to be satisfied with consideration received in the IRC Section 361 exchange (i.e., IRC Section 361 consideration) would generally be limited to historical debt incurred before the Earliest Applicable Date and capped at the lesser of (1) the aggregate amount of eligible distributing corporation debt as of that date or (2) of the amount of Distributing's historical average debt (generally based on Distributing's outstanding debt as of the close of the eight fiscal quarters immediately preceding the Earliest Applicable Date), less Distributing debt assumed by Controlled. Helpfully, unlike Revenue Procedure 2024-24, the proposed regulations would provide an exception for qualifying trade payables as of the date of the IRC Section 361 exchange and refinanced debt (up to the lesser of the amount of the refinanced debt or the historical debt as of the Earliest Applicable Date). It appears, however, that refinanced debt could only be repaid with qualified property (e.g., in a debt-for-equity or debt-for-debt exchange) and not with boot, which could significantly affect a company's liability management.

Consistent with Revenue Procedure 2024-24, eligible distributing corporation debt could include debt borrowed under a revolving credit agreement. The proposed regulations, however, would limit the amount of revolver debt that could be repaid with IRC Section 361 consideration to the lesser of (1) the balance at the time of the Earliest Applicable Date or (2) the lowest balance from the Earliest Applicable Date to the control distribution date.

Finally, the amount of IRC Section 361 consideration treated as transferred to a creditor in a qualifying debt elimination transaction would be reduced by the amount of "transitorily eliminated" debt, which would generally be the amount of reborrowing incurred by Distributing or a related party after the Earliest Applicable Date that was expected or committed to before the Earliest Applicable Date. Exceptions would be made for ordinary-course borrowings and borrowings resulting from unexpected events that are unrelated to, and demonstrably independent of, the Divisive Reorganization or any related transaction.

Debt-for-debt and debt-for-equity exchanges in a qualifying debt elimination transaction

Historic IRS ruling policy has contemplated two models for executing debt-for-debt and debt-for-equity exchanges. Under the "direct issuance model," Distributing issues new debt directly to an intermediary, such as an investment bank, uses Controlled stock or securities to repay the new debt, and uses the proceeds of the new debt to repay its historical debt within a specified period. Under the "intermediated exchange" model, the intermediary purchases Distributing's debt from historical Distributing creditors, and Distributing subsequently transfers Controlled stock or securities to the intermediary in exchange for the Distributing debt held by the intermediary. Revenue Procedure 2024-24 generally prohibited direct issuances.

Under the proposed rules for a qualifying debt elimination transaction, a debt-for-debt or debt-for-equity exchange could be executed under either the direct issuance model or the intermediated exchange model, provided that certain requirements were satisfied. A direct issuance transaction could satisfy the requirement for a qualifying debt elimination transaction under a facts-and-circumstances test (based on the presence of qualification or non-qualification factors) or a safe harbor. In a helpful development, the proposed plan of reorganization rules would give taxpayers 24 months (or potentially more) to complete a debt-for-debt and debt-for-equity exchange. However, under both the intermediated exchange model or the safe harbor for the direct issuance model, the intermediary would have to hold the historical Distributing debt or the new debt, as applicable, for at least 30 days before the control distribution date. The holding period of that debt would be a factor under the facts-and-circumstances test for a direct issuance transaction. As a practical matter, as drafted, the holding period would often require the debt to be held for significantly longer than 30 days where market considerations (e.g., lock-up periods and black-out dates) limit a company's ability to execute a debt-for-equity exchange contemporaneously with an initial distribution. However, informal comments made by the government indicate that the reference to the control date may have been a drafting error, and the rule was intended to instead require the intermediary to hold the historical Distributing debt or the new debt, as applicable, for a total of 30 days.

Multi-year reporting requirement

In addition to the requirement discussed above to file a plan of distribution or plan of reorganization with the IRS, Prop. Treas. Reg. Section 1.355-5 would require taxpayers to file a new Form 7216, Multi-Year Transaction Reporting Related to Section 355 Transactions.

The proposed regulations would require all covered filers with respect to an IRC Section 355 Transaction to file a Form 7216 with the IRS each year in the period beginning with the tax year in which the first distribution occurs through the fifth tax year after the tax year in which the control distribution occurs, regardless of when the Section 355 Transaction is completed. Thus, a Form 7216 could be required for as many as seven years. In addition, the questions on the Form 7216 would be extensive and not limited to areas covered by the proposed regulations. Instead, taxpayers would be required to answer questions about each requirement under IRC Section 355, as well as continuing relationships, international issues, the corporate alternative minimum tax, excise tax, transaction costs and intercompany transactions (for spins occurring within a consolidated group). Questions on the non-device and active trade or business requirements under IRC Section 355 would incorporate concepts from a prior proposed regulation package from 2016 that has yet to be finalized.

Applicability dates

The proposed regulations would be effective when finalized. A transition rule would apply, however, for transactions that are generally underway before the proposed regulations are finalized but occur after finalization (e.g., transactions that are publicly announced, the subject of a PLR submitted to the IRS, or agreed to or approved before finalization of the proposed regulations). The transition rule would apply to the various substantive rules in the proposed regulations, as well as the requirement for taxpayers to file a plan of distribution or plan of reorganization with the IRS. However, the other aspects of the reporting requirements under Prop. Treas. Reg. Section 1.355-5 (i.e., the requirement for covered filers to file a Form 7216 in multiple years) would apply to tax years ending after the date the regulations are finalized for IRC Section 355 Transactions occurring after that date.

Implications

As a general matter, the proposed regulations would relax some of the standards for IRC Section 355 Transactions previously introduced in Revenue Procedure 2024-24, which may provide taxpayers seeking a PLR with increased flexibility. Certain aspects of the proposed regulations, however, would tighten existing ruling standards or substantive law and could affect companies' ability to efficiently undertake IRC Section 355 Transactions.

While the proposed rules appear to be drafted primarily with public spin-off transactions in mind, they would impose intricate and significant documentation and reporting requirements that taxpayers would need to navigate closely to ensure nonrecognition treatment for all reorganizations. For example, the definition of "official records" for purposes of the plan of reorganization rules does not appear to include step plans or similar documentation, which often set forth the scope of typical internal restructuring transactions. The new procedural requirements under the proposed regulations could make it more challenging for acquisitive reorganizations that otherwise satisfy all relevant substantive requirements under the Code to qualify for nonrecognition treatment.