There’s no need for Uncle Sam to take a cut when a company splits

Space Exploration Technologies Corp. (SpaceX) is beta testing a new satellite-provided broadband internet service through its Starlink brand.

At times, reports have come out that SpaceX planned to spin off Starlink. Other reports quoted the SpaceX founder Elon Musk saying he had no plan to spin off Starlink.

The bandied spinoff idea can be intriguing to follow not only for SpaceX, but also for other corporations. What does it mean to spin off a part of a corporation and what are the different mechanisms for accomplishing a corporate break-up?

Why would a corporation choose to engage in a corporate breakup?

In broad terms, there are three main mechanisms to facilitate a corporate breakup: the spinoff, the split-off and the split-up.

Each achieves a different outcome for the corporation that this column will not explore.

But, in simplified terms, the breakup options all accomplish the goal of taking a whole corporation and separating it into distinct businesses.

The businesses may, but need not, operate independent of each other. Or, the businesses may operate independent, but under a common owner (such as a holding company).

The breakup of a corporation is an example of a corporate “reorganization” contemplated under the Internal Revenue Code section 368. And, though the U.S. tax code provides broad authority to tax corporate distributions of any kind, the various breakup options can be structured to avoid triggering that same income tax.

This tax treatment can be beneficial for those that engage in qualified corporate divisions.

Corporations and their governing bodies have countless reasons to engage in corporate breakups.

The corporation may want to take advantage of (or avoid) various tax and regulatory jurisdictions.

The corporation may want to separate two or more materially different business enterprises that the corporate governance deems better managed by two distinct set of governors.

The Hewlett Packard Company notably broke up into Hewlett Packard Enterprise Company and HP Inc. in 2015 and each is still run as a separate company with separate business lines.

Perhaps the corporation decides to sell a portion of a corporation.

In this scenario, a corporate breakup would allow the seller to still engage in a stock sale transaction but the stock being sold can be specific to the portion of the business being sold.

Perhaps the corporation has decided to list a portion of the corporation on a stock exchange to create additional funding while retaining the remaining portion under private ownership to preserve ownership and avoid the regulatory oversight by the Securities and Exchange Commission or other entities that oversee publicly-traded corporations.

A corporate breakup need not only occur on Wall Street; similar considerations might prompt a corporate breakup on Main Street as well.

A common Main Street scenario that might prompt the use of a corporate division under IRC 368 is corporate governance.

Imagine two owners that run Company ABC. Company ABC is a landscaping and lawn maintenance company.

The two owners combined their services and know-how to create a one-stop shop for homeowners and business owners looking to solve for their landscaping and lawn maintenance needs.

One owner is primarily involved in landscaping. One is primarily involved in lawn maintenance. After a while, as sometimes happens, the owners become disenchanted with each other.

The lawn maintenance owner touts his consistent recurring revenue and low-risk operations. The landscaping owner touts his big projects that provide the bulk of the revenue for the company. Each believes they would be better off without the other.

The company can engage in a tax-free split-up.

The company can value its assets and revenue streams. It can create one or two new companies. And, it can transfer assets to the new companies (lawn care equipment and customer lists to one company and landscaping equipment and office machines to the other).

Then, the stock of the old company is exchanged – each owner trades his 50% of Company ABC in exchange for 100% of one of the new companies. Each owner is then free to run his or her business as desired.

Importantly, neither owner need pay any income tax incident to the division of assets. They will just need to pay some money to the attorney and accountant assisting in the tax-free corporate division.

Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.

 

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