A corporate spinoff is generally tax-free to you when it happens: if the transaction qualifies under Section 355 of the tax code, you owe no tax the day the new shares appear in your account. What changes is the arithmetic behind your holdings. Your original cost basis in the parent stock gets split between the parent shares you still own and the new company’s shares you just received, and your holding period carries over to the new stock. Tax comes later, when you sell. The one small exception up front is any cash you receive in place of a fractional share, which is generally taxable in the year of the distribution.
That’s the headline. The details matter because a mistake in the basis allocation, or a misunderstanding of the holding period, tends to surface years later on a 1099-B with a gain you weren’t expecting.
How Your Cost Basis Gets Split
You don’t get a fresh cost basis in the spinoff shares. Instead, your existing basis in the parent stock is divided between the two companies based on their relative fair market values right after the distribution. The tax code requires this allocation to cover both the retained parent shares and the newly received shares.1Office of the Law Revision Counsel. 26 USC 358 – Basis to Distributees
A concrete example. Say you bought parent stock at $100 per share. After the spinoff, the parent trades at $82 and the new company trades at $18, a roughly 82/18 split by value. Your $100 basis becomes $82 in the parent and $18 in the new company. If you later sell the new stock for $25, your taxable gain is $7 per share, not $25.
The parent company is required to file IRS Form 8937 reporting how the spinoff affects the basis of its securities, and to provide shareholders with a copy of Form 8937 or a written statement containing the same information, including the allocation percentages.2Internal Revenue Service. Instructions for Form 8937 – Report of Organizational Actions Affecting Basis of Securities Your brokerage should apply those percentages automatically, but errors are common and you won’t discover them until you sell. Compare what shows in your account against the Form 8937 the parent posts (typically on its investor relations page) before you trade the new stock.
Your Holding Period Carries Over
In a tax-free spinoff, the clock on the new shares does not restart. The holding period from your original parent stock tacks onto the spinoff shares.3Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
The practical effect: if you’ve held the parent for more than a year, the spinoff shares are long-term capital gain property from day one. Selling the new stock the week it lands still gets long-term rates. Without this rule, every spinoff would push shareholders into short-term rates on the distributed stock, which for most investors is a meaningfully worse outcome.
When a Spinoff Qualifies as Tax-Free
Most major spinoffs are structured to qualify under Section 355, and companies spend heavily on tax counsel to make sure they do.4Office of the Law Revision Counsel. 26 USC 355 – Distribution of Stock and Securities of a Controlled Corporation From a shareholder’s standpoint, you don’t have to verify these conditions yourself, but knowing what tax-free treatment depends on tells you what you’re relying on.
Active Business for Five Years
Both the parent and the new company must each be actively running a trade or business that has been in continuous operation for at least five years before the distribution, and the business cannot have been acquired in a taxable transaction during that window.4Office of the Law Revision Counsel. 26 USC 355 – Distribution of Stock and Securities of a Controlled Corporation The rule stops a company from buying a business, immediately spinning it off, and claiming tax-free treatment on what is essentially an asset reshuffling.
Distribution of Control
The parent must distribute stock representing at least 80% of the new company’s total voting power and 80% of every other class of stock.5Internal Revenue Service. Revenue Ruling 2015-10 – Section 368 Definitions Relating to Corporate Reorganizations If the parent keeps a residual stake, it has to show the retention isn’t part of a tax-avoidance plan.4Office of the Law Revision Counsel. 26 USC 355 – Distribution of Stock and Securities of a Controlled Corporation
The Device Test
The spinoff can’t be used mainly as a way to extract corporate earnings at capital gains rates rather than as dividends. The IRS weighs factors such as whether either company is sitting on large amounts of cash or investment assets unrelated to its business, and whether shareholders have pre-arranged plans to sell shortly after the distribution.4Office of the Law Revision Counsel. 26 USC 355 – Distribution of Stock and Securities of a Controlled Corporation A post-spinoff sale isn’t automatically fatal, but a sale that was negotiated before the distribution counts heavily against it.
Business Purpose and Continuity of Interest
The company must have a real, non-tax reason for separating: sharper management focus, regulatory compliance, better access to capital markets, or a similar strategic goal. The IRS also applies a continuity of interest doctrine, generally treated as satisfied when pre-distribution shareholders own at least 50% of the stock of each resulting company after the split.6Internal Revenue Service. Revenue Ruling 2003-79 – Distribution of Stock and Securities of a Controlled Corporation
What Happens if the Spinoff Is Taxable
If a spinoff fails Section 355, the distribution is treated as a property distribution under the normal corporate rules rather than a tax-free reorganization. The tax treatment then follows a three-step waterfall. First, the fair market value of the shares you receive is taxed as a dividend to the extent of the parent’s accumulated earnings and profits. Second, anything above that reduces your cost basis in the parent stock. Third, anything left after your basis hits zero is capital gain.7Office of the Law Revision Counsel. 26 USC 301 – Distributions of Property
The impact: instead of deferring all tax until sale, you’d owe tax at dividend rates on most of the distribution in the year you receive it. On a large spinoff, that’s a substantial unexpected bill. Most major spinoffs avoid this outcome because the company obtains either an IRS private letter ruling or a formal legal opinion confirming tax-free treatment before proceeding. The IRS reopened access to private letter rulings for spinoffs starting in 2024 and refined the process with Rev. Proc. 2025-30, which lays out updated procedures for requesting rulings on Section 355 transactions.8Internal Revenue Service. Rev Proc 2025-30 – Procedures for Private Letter Rulings on Section 355 Transactions
Cash Received Instead of Fractional Shares
Distribution ratios rarely divide cleanly. If the ratio is one new share for every four parent shares and you own 10 parent shares, you’re entitled to 2.5 shares of the new company. Brokerages generally can’t hold the half share, so the transfer agent aggregates fractional shares across all shareholders, sells them on the open market, and sends you the cash proceeds.
That cash is taxable even when the spinoff itself qualifies as tax-free. The IRS treats it as if you received the fractional share and immediately sold it, so it’s generally reported as a small capital gain (long-term if your parent-stock holding period was over a year). Your brokerage should list it on your 1099-B. The amount is usually small enough to overlook, which is exactly why people miss it at tax time.
A Boundary Worth Knowing: The Anti-Morris Trust Rule
Even a spinoff that legitimately qualifies as tax-free can trigger a corporate-level tax bill if either company is acquired soon after. Under Section 355(e), if one or more buyers acquire 50% or more of either the parent or the new company as part of a plan connected to the spinoff, the parent must recognize gain on the built-in appreciation of the distributed stock. The law presumes any acquisition within two years before or after the distribution is part of such a plan, subject to rebuttal.9eCFR. 26 CFR 1.355-7 – Recognition of Gain on Certain Distributions of Stock or Securities in Connection With an Acquisition
This tax lands on the corporation, not on you as a shareholder. It doesn’t change your personal tax treatment of the original distribution. It does often shape the timing of any later merger involving either company, which can affect share prices.
What to Check When the Shares Land
When spinoff shares appear in your account, a few minutes of checking prevents most of the problems that show up later.
- Verify the cost basis split. Pull up the parent’s Form 8937 and compare the allocation percentages against what your brokerage applied to your account. If the numbers don’t match, contact your broker before you sell. The IRS won’t accept a broker error as a defense on an incorrect gain.2Internal Revenue Service. Instructions for Form 8937 – Report of Organizational Actions Affecting Basis of Securities
- Confirm your holding period. If you held the parent for more than a year, the new shares are already long-term. Selling within days of distribution doesn’t reset it.3Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
- Note any cash-in-lieu payment. It’s small but taxable, and it needs to appear on your return.
- Look at both stocks separately before selling. The whole point of a spinoff is that each company can be valued on its own. Automatically dumping the smaller one because it’s unfamiliar is a common mistake.