Daily Tax Update - April 18, 2005

Today, the IRS and Treasury Department issued final regulations providing guidance as to what constitutes a "plan (or series of related transactions)" (collectively "plan") for purposes of section 355(e). Section 355(e) provides generally that a corporation will recognize gain on the distribution of controlled corporation stock if such stock is distributed as part of a plan pursuant to which one or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing or controlled corporation. The final regulations largely adopt the temporary regulations issued on April 26, 2002 (the "2002 temporary regulations") with certain modifications in response to comments received by the IRS and Treasury.

  • The most significant changes made by the final regulations were to provide additional guidance in the case of pre-distribution acquisitions. The 2002 temporary regulations contained a safe harbor for an acquisition and a distribution that occurred more than two years after the acquisition if there was no agreement, understanding, arrangement, or substantial negotiations concerning the distribution at the time of the acquisition or within six months thereafter. The 2002 temporary regulations also included as a factor tending to show a plan the absence of discussions by the distributing or controlled corporation with the acquirer regarding the distribution during the two-year period before the acquisition. The absence of such discussions, however, would not tend to show the absence of a plan if the acquisition occurred after the date of the public announcement of the distribution. The final regulations provide additional helpful guidance for pre-distribution acquisitions.
    • The IRS and Treasury believe that if an acquirer had no knowledge of the intent to effect a distribution and had no intention or ability to cause a distribution, a pre-distribution acquisition and a distribution should not be considered part of a plan. Thus, the final regulations amend the safe harbor to provide that a pre-distribution acquisition (not involving a public offering) and a distribution will not be part of a plan if the acquisition occurs before the first disclosure event regarding the distribution. This safe harbor is not available for acquisitions by a person that was a controlling or 10-percent shareholder of the acquired corporation at any time after the acquisition and before the distribution. The safe harbor is also unavailable if the aggregate acquisitions represent 20 percent or more of the stock of the acquired corporation
    • The IRS and Treasury also believe that acquisitions before a pro rata spin-off are not likely to be part of a plan where the distribution has been publicly announced. Thus, the final regulations add a new safe harbor for acquisitions (not involving a public offering) of stock before a pro rata distribution if the acquisition occurs after the public announcement of the distribution and there were no discussions by the distributing or controlled corporation with the acquirer on or before such announcement. This safe harbor is also not available for acquisitions by controlling or 10-percent shareholders or for aggregate acquisitions representing 20-percent or more.
    • The final regulations also modify the non-plan factor for the absence of discussions to remove the public announcement restriction.
  • The final regulations also provide additional guidance for public offerings. The final regulations clarify the definition of public offering and provide additional guidance regarding when an acquisition is "similar" to a potential acquisition involving a public offering. In addition, the final regulations add a new safe harbor for pre-distribution public offerings. Such offerings will not be considered part of a plan if the acquisition occurs before the first disclosure event or public announcement regarding the distribution. The final regulations also provide that acquisitions pursuant to publicly offered options will be governed by the rules relating to public offerings.
  • The final regulations modify the safe harbor for acquisitions in connection with the performance of services in a transaction to which section 83 or 421(a) applies to include services performed for the distributing, controlled, or related corporation or a corporation that, by reason of a reorganization, precedes or succeeds such a corporation.
  • The 2002 temporary regulations exempt compensatory options from the special rule that treats an option as an agreement, understanding, or arrangement to acquire stock on the earliest of the date the option was written, transferred, or modified, if on that date the option was more likely than not to be exercised. The final regulations remove this exemption, because the IRS and Treasury have become aware of arrangements using compensatory options that have been structured to prevent an acquisition from being treated as part of a plan.
  • The final regulations are effective for distributions occurring after the regulations are published in the Federal Register. The 2002 temporary regulations continue to apply to distributions after April 26, 2002 and before the effective date of the final regulations; however, taxpayers may apply the final regulations in whole, but not in part, to such distributions.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com or Lisa M. Zarlenga - lzarlenga@steptoe.com.

Today, the Treasury Department and the IRS issued Revenue Procedure 2005-23 that addresses the application of a recent Supreme Court decision relating to pension benefits, Central Laborers' Pension Fund v. Heinz, 541 U.S. 739 (June 7, 2004).  According to the Treasury Department, "This case held that ERISA generally prohibits an amendment that imposes additional conditions on the right to receive early retirement benefits for benefits accrued before the amendment.  However, there may be a number of retirement plans that have adopted such an amendment and the retroactive application of the Supreme Court's opinion would put these plans' tax-qualified status in jeopardy as a result of violating the parallel tax-qualification requirement.  Recognizing this, the Supreme Court recommended that the IRS use its authority under Internal Revenue Code section 7805(b)(8) to provide relief to plans in order for them to avoid disqualification.  The revenue procedure issued today generally provides relief from the risk of disqualification for a suspension of benefits amendment that is not permissible under the Supreme Court decision, assuming that the plan takes corrective action for early and normal retirement benefits retroactive to the June 7, 2004 date of the case."


  • S. 812 sponsored by Sen. Arlen Specter (R-PA) would impose a flat tax only on individual taxable earned income and business taxable income.
  • S. 815 sponsored by Sen. Craig Thomas (R-WY) would allow a 15-year applicable recovery period for depreciation of certain electric transmission property.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving.  Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them.  Read  more information on Steptoe's tax practice