DEFINITION of 'Taxable Spinoff'

A taxable spinoff is a divestiture of a subsidiary or division by a publicly traded company, which will be subject to capital gains taxation. To qualify as a taxable transaction, the parent corporation must divest through direct sale of the division or the assets it contains. The profits made from the sale will be taxed as capital gains.

BREAKING DOWN 'Taxable Spinoff'

A spinoff occurs when a parent corporation separates part of its business to create a new business subsidiary and distributes shares of the new entity to its current shareholders. The subsidiary will become completely independent from the parent corporation, operating entirely on its own. If a parent corporation distributes stock of the subsidiary to its shareholders, the distribution is generally taxable to the shareholder as a dividend payout. In this case, ordinary income tax equal to the fair market value of the stock received is imposed on investors. In addition, the parent corporation is taxed on the built-in gain (the amount the asset has appreciated) in the stock of the subsidiary. The tax in this case is a capital gains tax equal to the fair market value of the distributed shares less the parent company’s inside basis in the stock. When cash is received in lieu of fractional shares in the spinoff, the fractional shares are generally taxable to shareholders.

A taxable spinoff will bring in liquid assets to the company, usually in the form of cash. The downside of this transaction comes from the decrease in income from the capital gains tax. If a parent company wishes to avoid a taxation, they may consider a tax-free spinoff. Section 355 of the Internal Revenue Code (IRC) provides an exemption to taxing transactions from spinoffs, allowing a corporation to spin off or distribute shares of a subsidiary in a transaction that is tax free to both shareholders and the parent company.

There are typically two ways that a company can undertake a tax-free spinoff of a business unit. First, a company can choose to simply distribute the new shares (or at least 80%) of the division to existing shareholders on a pro rata basis. The second way a company can avoid any capital gains from divestiture is by giving current shareholders the option to exchange shares of the parent company for an equal stock position in the spun off company or to maintain their existing stock position in the parent company. This means the shareholders are free to choose whichever company they believe offers the best potential return on investment (ROI) going forward.

RELATED TERMS
  1. Spinoff

    A spinoff is the creation of an independent company through the ...
  2. Subsidiary

    A subsidiary is an independent company that is more than 50% ...
  3. Tracking Stock

    A tracking stock is a common stock issued by a parent company ...
  4. Taxable Event

    A taxable event refers to any event or transaction that results ...
  5. Letter Of Moral Intent

    A letter of moral intent is written to a bank from a parent company ...
  6. IRS Publication 525 - Taxable And ...

    Publication 525 is a document published by the IRS detailing ...
Related Articles
  1. Investing

    What is a Spinoff?

    Businesses wishing to streamline their operations often sell less productive or unrelated subsidiary businesses as spinoffs.
  2. Investing

    Parents and Spinoffs: When to Buy and When to Sell

    Spinoffs can create great investment opportunities, but there's a time to stick around and then there's a time to jump ship.
  3. Investing

    Cashing In on Corporate Restructuring

    Companies use M&As and spinoffs to boost profits. Learn how you can do the same.
  4. Retirement

    Not All Retirement Accounts Should Be Tax-Deferred

    It may be better to leave your assets exposed to the tax man when you're saving to retire.
  5. Managing Wealth

    How To Parent Your Aging Parents

    For sandwich generation, planning ahead is key to good elder care.
  6. Investing

    ETFs Can be Tax Efficient: Here’s How

    Learn about the primary reasons ETFs are highly tax-efficient, including how their unique structure allows them to reduce the tax burden of all shareholders.
  7. Financial Advisor

    Income tax on mutual funds: The basics

    Learn about the basics of income tax on mutual funds, including what types of income may be subject to the capital gains tax rate.
  8. Taxes

    5 Tax-Efficient Portfolio Tips for High Income Earners

    High income earners can use these tips to make their portfolio more tax-efficient.
  9. Retirement

    Tips for Helping an Aging Parent

    Many Millennials and Gen Xers find themselves unexpectedly caring for their aging parents.
RELATED FAQS
  1. How is taxation treated during a company spinoff?

    Learn how the potential tax implications of a spinoff can affect both parent and subsidiary companies and how taxes may be ... Read Answer >>
  2. How do spinoffs impact investors in the both the parent and subsidiary companies?

    Learn about how spinoffs affect investors in both the parent company and the subsidiary and what strategies investors use ... Read Answer >>
  3. How do spinoffs differ from initial public offerings (IPOs)?

    Learn about the differences between a spinoff and an initial public offering, and understand why spinoffs may be attractive ... Read Answer >>
  4. What is the difference between a subsidiary and a sister company?

    Discover the differences between subsidiary companies and sister companies, and understand how both are related to parent ... Read Answer >>
Trading Center