Tax Law

IRS Issues Final "Hot Stock" Regulations

The IRS recently issued final regulations regarding the distribution of stock of a controlled corporation acquired in a transaction under IRC Section 355(a)(3)(B)TD 9548, 76 FR 65110.  The final regulations adopt the substantive rules of the temporary regulations without change.  TD 9435, 73 FR 75946.  The temporary regulations were set to expire on December 15, 2011. 

Under certain circumstances, a corporation may distribute stock and securities in a corporation it controls to its shareholders and security holders without causing either the distributing corporation or its shareholders and security holders to recognize income, gain, or loss.  IRC § 355(a).  Generally, the distributing corporation and the controlled corporation must each be engaged, immediately after the distribution, in the active conduct of a trade or business (the "ATB requirement").  IRC §§ 355(a)(1)(C), (b)(1).  The trade or business must have been actively conducted throughout the five-year period ending on the date of the distribution.  IRC § 355(b)(2)(B).  Furthermore, the trade or business must not have been acquired in a transaction in which gain or loss was recognized in whole or in part within the pre-distribution period. IRC § 355(b)(2)(C).  However, the ATB requirement may be met by reference to the affiliated group of the distributing or controlled corporation that is treated as one corporation.  IRC § 355(b)(3).

The "hot stock" rule provides that stock of the controlled corporation acquired by the distributing corporation in any transaction which occurs within five years of the distribution of the stock, and is a taxable transaction is not treated as stock of the controlled corporation, but as other property (i.e., boot).  IRC § 355(a)(3)(B)

The final regulations harmonize the application of the hot stock rule with the ATB requirement.  In general, the regulations provide that the hot stock rule does not apply to any acquisition of stock of the controlled corporation where the controlled corporation is a member of the distributing corporation's separate affiliated group at any time after the acquisition but prior to the distribution of the controlled corporation.  Transfers of controlled stock owned by members of the distributing corporation's separate affiliated group immediately before and immediately after the transfer are disregarded and are not treated as acquisitions for purposes of the hot stock rule.  Lastly, the hot stock rule does not apply to taxable acquisitions of the stock of the controlled corporation from affiliates, as described in Treasury Regulation Section 1.355-3(b)(4)(iii); Treasury Regulation Section 1.355-2(g)

Practitioners were generally pleased that the regulations remove the hot stock rules when the stock being acquired is part of the distributing corporation's separate affiliated group, and expressed surprise that the hot stock regulations were finalized while the regulations for the ATB requirement are still under development. Amy S. Elliott, Treasury Finalizes 'Hot Stock' Regs Without Changes, 2011 TNT 203-1 (Oct. 20, 2011). The IRS continues to study the interrelationship between the hot stock rule and the ATB requirement, and may issue additional guidance under the hot stock rule in connection with future ATB guidance if necessary to further harmonize the two provisions.  TD 9548, 76 FR 65110.  Thus, only time will tell whether more changes are to come for the hot stock rule; but for now, the result appears good for taxpayers.

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