IRS Partially Withdraws Section 355 Spin-Off Device and Active Business Rules

The Internal Revenue Service has partially withdrawn its proposed regulations on the device prohibition and the active trade or business requirement that govern tax-free spin-offs and other distributions of controlled corporation stock under section 355 of the Internal Revenue Code. The action, taken by the Department of the Treasury and the IRS, is published as a partial withdrawal of notice of proposed rulemaking in the Federal Register of Wednesday, 21 October 2026, and takes effect that same day. The document carries the docket number REG–134016–15, RIN 1545–BN47 and FR Doc. 2026–21568.

The rules at stake are the two gateways that decide whether a distribution of stock, or stock and securities, of a controlled corporation can escape recognition of gain or loss for the distributing corporation and its shareholders. Section 355(a)(1)(B) and § 1.355–2(b)(4) and (d) bar transactions used principally as a device for distributing the earnings and profits of either corporation, while section 355(a)(1)(C) and (b) and §§ 1.355–2(h) and 1.355–3 require both corporations to be engaged in the active conduct of a trade or business immediately after the distribution.

What the agency withdrew

The IRS withdrew three specific provisions from the package it first proposed on 15 July 2016 (81 FR 46004):

• Proposed § 1.355–2(d)(5), the “per se” device rule, under which a distribution would have been treated as a device whenever a corporation’s “Nonbusiness Asset Percentage” exceeded designated thresholds, both individually and relative to the other corporation, regardless of other nondevice factors such as corporate business purpose.
• Proposed § 1.355–2(d)(2)(iv)(E) and (d)(5)(iv), the first set of anti-abuse rules, aimed at transactions or series of transactions — a change in the form of ownership of an asset, the issuance, assumption or repayment of indebtedness, or the issuance or redemption of stock — that would not have been given effect if undertaken with a principal purpose of manipulating the Nonbusiness Asset Percentage.
• Proposed § 1.355–9(d), the minimum active trade or business anti-abuse rule, tied to a “Five-Year-Active-Business Asset Percentage” that each corporation would have been required to keep at or above five percent.

The anti-abuse rules generally would not have applied to non-transitory acquisitions or dispositions of assets, or to non-transitory transfers of assets between the distributing and controlled corporations.

Criticism from stakeholders

According to the notice, the Treasury Department and the IRS received feedback from stakeholders that “generally was critical” of the proposed per se device rule and of the two anti-abuse rules. In response, the agencies are withdrawing the three provisions and say they continue to study the issues addressed in the 2016 proposed regulations.

The withdrawal is not a clean slate. The notice states that it does not affect the potential application of other rules or judicial doctrines, such as the substance-over-form or step-transaction doctrines, which remain available to the government in testing a distribution.

Procedure and contacts

The underlying docket, IRS–2016–0030, remains the channel for electronic submissions through the Federal eRulemaking Portal, with paper submissions addressed to CC:PA:01:PR (REG–134016–15), Room 5503, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. The notice was issued under the authority of 26 U.S.C. 7805 and lists income taxes and reporting and recordkeeping requirements as the subjects affected in 26 CFR Part 1.

Aglaia Ovtchinnikova, of the Office of Associate Chief Counsel (Corporate), is the principal author of the document; she and Justin Du Mouchel are the contacts listed for further information. The notice is signed by Frank J. Bisignano, Chief Executive Officer.

Why it matters

For companies weighing a tax-free separation, the withdrawal removes the bright-line arithmetic test that would have made a spin-off a device almost automatically once nonbusiness assets crossed set percentages, restoring the older facts-and-circumstances analysis of business purpose and nondevice factors. Shareholders and security holders of distributing and controlled corporations regain room to plan around the active trade or business requirement without the five-percent asset floor, though the substance-over-form and step-transaction doctrines keep the residual risk in place.

Source: Federal Register, Vol. 91, No. 202, 21 October 2026, Proposed Rules, p. 66540 (official reference: FR Doc. 2026–21568; REG–134016–15).