Key Facts

- On October 21, 2026, the U.S. Department of the Treasury published a guidance document that partially withdraws portions of a previously issued notice of proposed rulemaking (NPRM) concerning the device prohibition and the active trade‑or‑business requirement under Internal Revenue Code Section 355 [1].

- The withdrawn language would have applied specifically to distributions of controlled corporation stock—or a combination of stock and other securities—by a distributing corporation that reports no income, gain, or loss from the distribution [1].

- The guidance identifies corporations, their shareholders, and other security holders as the classes of parties that could be affected by the proposed provisions [1].

- The Treasury’s action removes the proposed regulatory language that dealt with the device prohibition and the active‑trade‑or‑business test for the narrow class of transactions described above [1].

- The document is issued as guidance, not as a final rule, and therefore does not have the force of law [1].

Treasury Reverses Part of Section 355 Proposal

The October 21, 2026 Federal Register notice makes clear that the Treasury is withdrawing only the sections of the earlier NPRM that addressed two concepts: (1) a definition of a “device” that would have been prohibited in certain tax‑free reorganizations, and (2) a requirement that the distributing corporation be engaged in an active trade or business at the time of the distribution [1]. The guidance does not state that the Treasury is withdrawing the entire NPRM; it limits the withdrawal to those two topics. The record does not provide detail on whether any other portions of the original proposal remain in effect [1].

Section 355 of the Internal Revenue Code provides the statutory framework for certain tax‑free corporate reorganizations, including stock‑for‑stock exchanges and related distributions. While the guidance references Section 355 as the statutory basis for the proposed regulations, it does not elaborate on the broader background of “devices” or the policy reasons for restricting them [1]. Accordingly, the record does not contain a narrative explaining how the device prohibition would have fit within the overall purpose of Section 355.

Because the guidance is issued as a statement of the Treasury’s current position rather than as a final regulation, it does not create binding obligations. The Treasury notes that the withdrawn language is no longer being proposed, but the guidance does not expressly claim that the pre‑proposal regulatory environment is being restored for the affected transactions [1]. In other words, the withdrawal simply removes the proposed language; the guidance does not describe the resulting legal status beyond stating that the proposal is no longer under consideration for those specific provisions.

How the Withdrawal Reshapes Section 355 Application

The portion of the NPRM that was withdrawn required a distributing corporation to satisfy an “active trade or business” test in order to qualify for tax‑free treatment when distributing controlled corporation stock without generating any income, gain, or loss. By withdrawing that language, the Treasury eliminates the proposed requirement that corporations demonstrate ongoing business activity for the narrowly defined set of transactions [1]. Practitioners should therefore continue to rely on the existing statutory and regulatory framework that currently governs Section 355 transactions, without having to incorporate the withdrawn active‑trade test into their analysis.

Similarly, the withdrawn device prohibition sought to define certain arrangements as prohibited “devices” designed to circumvent the tax consequences of Section 355. The guidance now indicates that the Treasury will not enforce the proposed definition for the specific class of transactions described in the NPRM [1]. The record does not provide a replacement definition or any alternative enforcement mechanism, meaning that, for the withdrawn scope, the Treasury is not proposing a new prohibitive rule.

The guidance explicitly limits the withdrawal to distributions of controlled corporation stock (or stock together with other securities) by a corporation that reports no taxable result from the distribution. It does not extend to other types of Section 355 reorganizations—such as stock‑for‑stock exchanges that generate gain, or liquidations that produce taxable income—nor does it affect transactions that fall outside the narrow definition of “controlled corporation stock” used in the proposal [1]. As a result, the practical impact of the withdrawal is confined to a relatively small subset of possible Section 355 transactions.

Practical Changes for Corporations and Shareholders

For corporate taxpayers that were preparing to rely on the proposed active‑trade‑or‑business test or device prohibition, the withdrawal means that those specific compliance steps are no longer required for the targeted transactions. Counsel and tax advisors can therefore continue to apply the pre‑withdrawal analysis, which does not include the proposed definitions or tests, when evaluating whether a distribution of controlled corporation stock without income, gain, or loss qualifies for tax‑free treatment [1].

Shareholders and other security holders who might have been subject to the proposed device prohibition are likewise not required to assess whether their holdings fall within the withdrawn definition of a prohibited device for the described transactions [1]. The guidance does not impose any new filing, reporting, or documentation obligations on shareholders, and it does not require amendment of existing shareholder agreements or other contractual arrangements.

Because the withdrawal does not introduce any new regulatory language, there is no new effective date to track. The Treasury’s guidance simply states that the proposed language is being withdrawn; it does not set a future date for any alternative rulemaking or for the re‑introduction of similar provisions. Accordingly, entities should continue to monitor Treasury communications for any subsequent proposals that might address the device prohibition or active‑trade‑or‑business concepts in a different form.

In practice, the withdrawal may reduce the immediate compliance burden for a limited group of taxpayers who had been preparing for the proposed changes. However, the broader landscape of Section 355 remains unchanged, and all other existing requirements—including those related to the continuity of interest, the business purpose test, and other statutory limitations—continue to apply as before [1].

What to Watch

- The Treasury guidance does not establish an effective date for any new rule because it is a withdrawal of proposed language, not the issuance of a final regulation [1].

- No new filing, reporting, or documentation requirements are introduced by the withdrawal; corporations and shareholders should continue to follow the existing Section 355 guidance and regulations [1].

- Future Treasury rulemaking could revisit the device prohibition or active‑trade‑or‑business test, either in a revised proposal or as part of a different regulatory initiative. Stakeholders should therefore keep an eye on subsequent Federal Register notices that reference Section 355 [1].

- The withdrawal is limited to distributions of controlled corporation stock (or stock and securities) by a distributing corporation that reports no income, gain, or loss. Other Section 355 transactions—such as those that generate taxable results or involve different asset classes—remain subject to the current statutory and regulatory framework [1].

- Because the guidance does not comment on the status of any other portions of the original NPRM, parties should review the original notice of proposed rulemaking if they need to understand which, if any, additional provisions remain under consideration.