Chapter 7
Corporations:
Reorganizations
Corporations, Partnerships,
Estates & Trusts
Copyright ©2008 South-Western/Thomson Learning
Reorganizations—In General
• Refers to any corporate restructuring that
may be tax-free under §368
– To qualify, must meet certain general
requirements:
• Must be a plan of reorganization
• Must meet continuity of interest and continuity of
business enterprise tests
• Must have a sound business purpose
• Tax-free status can be denied under step transaction
doctrine
Corporations, Partnerships, Estates & Trusts
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Summary of Different Types
of Reorganizations
• The term reorganization includes:
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Statutory merger or consolidation
Stock for stock exchange
Stock for assets exchange
Divisive exchange
Recapitalization
Change in identity, form, or place of organization
Transfers in bankruptcy or receivership
Corporations, Partnerships, Estates & Trusts
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Tax Free Reorganization
Consequences, in General (slide 1 of 3)
• Consequences to Acquiring Corporation
– No gain or loss recognized unless it transfers
property to the Target corporation as part of the
transaction
• Then gain, but not loss, may be recognized
– Basis of property received retains basis it had in
hands of Target corp plus any gain recognized
by the target
Corporations, Partnerships, Estates & Trusts
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Tax Free Reorganization
Consequences, in General (slide 2 of 3)
• Consequences to Target Corporation
– No gain or loss unless it retains “other
property” received in the exchange or it
distributes its own property to shareholders
• Other property is defined as anything received other
than stock or securities
– Treated as boot
• Gain, but not loss, may be recognized
Corporations, Partnerships, Estates & Trusts
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Tax Free Reorganization
Consequences, in General (slide 3 of 3)
• Consequences to Target or Acquiring Co.
Shareholders
– No gain or loss unless shareholders receive
cash or other property in addition to stock
• Cash or other property is considered boot
– Gain recognized by the stockholder is the lesser of the
boot received or the realized gain
– Basis of shares received is same as basis of
those surrendered, decreased by boot received,
increased by gain and dividend income, if any,
recognized in the transaction
Corporations, Partnerships, Estates & Trusts
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Type A Reorganization
• Includes mergers and consolidations
– Merger is union of two or more corporations
• One corporation retains it existence and absorbs the
others
– Consolidation occurs when a new corporation is
created to take the place of two or more
corporations
Corporations, Partnerships, Estates & Trusts
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Type A Reorganization (slide 1 of 2)
Corporations, Partnerships, Estates & Trusts
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Type A Reorganization (slide 2 of 2)
Corporations, Partnerships, Estates & Trusts
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Type A Reorganization Issues
(slide 1 of 2)
• Advantages:
– Type A reorganization is flexible
– Consideration need not be voting stock
– Money or other property can be transferred
without disqualifying the transaction, as long as
“continuity of interest” is met (at least 50% of
consideration used in reorganization must be
stock)
Corporations, Partnerships, Estates & Trusts
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Type A Reorganization Issues
(slide 2 of 2)
• Disadvantages:
– Money or other property transferred is “boot”
so some gain may be required to be recognized
– Shareholders of either entity may dissent; in
most states their shares must be redeemed
– Acquiring entity must assume all liabilities of
Target
Corporations, Partnerships, Estates & Trusts
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Type B Reorganization
(Stock-for-Stock Reorganization)
Corporations, Partnerships, Estates & Trusts
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Type B Reorganization
Requirements (slide 1 of 4)
• Corporation acquires stock of Target solely
in exchange for its own voting stock (stock
for stock)
– Acquiring corporation must acquire
“control” of Target
• Control is ownership of at least 80% of all classes of
stock of target
• Acquirer may add shares owned previously with
shares acquired in reorganization
Corporations, Partnerships, Estates & Trusts
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Type B Reorganization
Requirements (slide 2 of 4)
• Acquiring corporation may acquire shares
from either:
(1) Shareholders of Target, or
(2) Directly from Target
• Exception to the “solely for voting stock”
requirement when shareholders must
receive fractional shares
– May receive cash rather than fractional shares
in the acquiring corporation
Corporations, Partnerships, Estates & Trusts
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Type B Reorganization
Requirements (slide 3 of 4)
• Example: Assume Target has 100 shares
outstanding:
– Acquirer may obtain 80 shares from current
Target shareholders in exchange for Acquirer’s
voting stock
– Target may also issue 400 new shares to
Acquirer in exchange for Acquirer’s voting
stock (500 shares would be outstanding)
Corporations, Partnerships, Estates & Trusts
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Type B Reorganization
Requirements (slide 4 of 4)
• Consideration paid by Acquirer can only
include Acquirer’s voting stock or
transaction does not qualify
Corporations, Partnerships, Estates & Trusts
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Type C Reorganization
(Stock-for-Assets Reorganization)
Corporations, Partnerships, Estates & Trusts
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Type C Reorganization
Requirements (slide 1 of 3)
• A ‘‘Type C’’ reorganization is essentially an
exchange of voting stock for assets
followed by liquidation of the target
corporation
– Called a “Stock-for-Assets” reorganization
– Transfer is generally between the entities, not
the shareholders
Corporations, Partnerships, Estates & Trusts
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Type C Reorganization
Requirements (slide 2 of 3)
• Consideration paid by Acquirer normally
consists only of voting stock
– However, if at least 80% of FMV of Target is
acquired with voting stock, cash or other
property can be used for remainder
– Limitation: liabilities assumed by Acquirer are
considered “other property” if any additional
“other property” is used
Corporations, Partnerships, Estates & Trusts
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Type C Reorganization
Requirements (slide 3 of 3)
• “Substantially all” of Target’s assets must
be transferred to Acquirer
• There is no statutory definition of
‘‘substantially all’’
– To receive a favorable ruling from the IRS, the
target must transfer at least 90% of net asset
value or 70% of the gross asset value to the
acquiring corporation
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
(slide 1 of 4)
• Generally a mechanism for corporate
division
– Called a “divisive reorganization” but can be
used to carry out a corporate combination
– In a Type D acquisitive reorganization
• Entity transferring assets is considered the acquiring
corporation
• Corporation receiving the property is the target
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
(slide 2 of 4)
• In an acquisitive Type D reorganization
– Substantially all of acquiring corp’s property
must be transferred to target corporation
– The acquiring corp must be in control (at least
50%) of the target
– Target stock received by the acquiring corp and
any remaining assets of acquiring corp must be
distributed to its shareholders
– Acquiring corporation must liquidate
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
(slide 3 of 4)
• In a divisive Type D reorganization
– A corporation is divided
– One or more new corps are formed to receive
assets of original corp
– Original corp must receive stock representing
control (80%) of new corps
– Stock of new corps is then distributed to
shareholders of original corp
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
(slide 4 of 4)
• Three types of divisive “Type D”
reorganizations
– Spin-Off and Split-Off
• A new corporation is formed to receive some of the
assets of the original corporation in exchange for the
new corporation's stock
– Split-Up
• Two or more corporations are formed to receive
substantially all of the assets of the original
corporation
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
Spin-Off (slide 1 of 2)
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Type D Reorganization
Spin-Off (slide 2 of 2)
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Type D Reorganization
Split-Off (slide 1 of 2)
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization
Split-Off (slide 2 of 2)
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Type D Reorganization Split-Up
(slide 1 of 2)
Corporations, Partnerships, Estates & Trusts
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Type D Reorganization Split-Up
(slide 2 of 2)
Corporations, Partnerships, Estates & Trusts
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Type E Reorganization
(slide 1 of 2)
• Type E reorganization is a recapitalization
– Involves a major change in character and
amount of outstanding stock, securities, or paidin-capital
• The following exchanges qualify:
– Bonds for stock
– Stock for stock
– Bonds for bonds
Corporations, Partnerships, Estates & Trusts
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Type E Reorganization
(slide 2 of 2)
• Corporation can exchange its common stock
for preferred stock or its preferred stock for
common stock tax-free
– The exchange of bonds for other bonds is taxfree when the debt received has a principal
amount that is not more than the surrendered
debt’s principal amount
Corporations, Partnerships, Estates & Trusts
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Type F Reorganization
• A mere change in identity, form, or place of
organization, however effected
– Restricted to a single operating corporation
– Tax characteristics of predecessor corp carry
over to successor corp
– Does not jeopardize status of §1244 stock or
terminate a valid S corp election
Corporations, Partnerships, Estates & Trusts
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Type G Reorganization
• All or part of assets of debtor corp are
transferred to an acquiring corp in
bankruptcy
– Debtor corp’s creditors must receive voting
stock of the acquiring corp in exchange for debt
representing 80% or more of total FMV of debt
of debtor corp
Corporations, Partnerships, Estates & Trusts
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Judicial Doctrines (slide 1 of 2)
• Besides meeting specific requirements of
reorganization, several judicially created doctrines
must be met
– Reorganization must exhibit a sound business purpose
• Not a well defined test
– Continuity of interest test
• IRS deems this test met if shareholders of Target receive stock
in Acquirer equal to at least 50% of their prior stock ownership
in Target stock
Corporations, Partnerships, Estates & Trusts
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Judicial Doctrines (slide 2 of 2)
– Continuity of business enterprise test
• Requires the acquiring corp to either:
– Continue the Target’s historic business, or
– Use a significant portion of Target’s assets in business
– Step transaction doctrine
• Ensures that a series of transactions are not used to obtain tax
benefits that would be unavailable if the transaction were
accomplished in a single step
• IRS generally views any transactions occurring within one year
of reorganization as part of the restructuring
Corporations, Partnerships, Estates & Trusts
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Carryover of Corporate
Tax Attributes (slide 1 of 4)
• Assumption of liabilities
– Acquiring corp either assumes liabilities of
Target or takes property subject to liabilities
• Allowance of Carryovers
– In Type A, C, acquisitive D, and G
reorganizations, the Target’s tax attributes are
acquired
– In Type B reorganizations, Target retains its
assets and tax attributes
Corporations, Partnerships, Estates & Trusts
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Carryover of Corporate
Tax Attributes (slide 2 of 4)
• NOL Carryovers
– Amount of NOL that can be used in year
ownership change occurs is limited to a
percentage representing the remaining days in
the tax year over the total number of days in the
year
Corporations, Partnerships, Estates & Trusts
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Carryover of Corporate
Tax Attributes (slide 3 of 4)
• NOL Carryovers (cont’d)
– NOL can be further limited in first and succeeding
years when there is a more than 50-percentage-point
ownership change
• An ownership change takes place on the day (change date) that
either an equity structure shift or an owner shift occurs
– An equity structure shift occurs when a tax-free reorganization causes an
owner shift
– An owner shift is any change in the common stock ownership of
shareholders owning at least 5%
– NOL can be used to the extent of the value of the loss corp’s stock
on the date of the ownership change multiplied by the long-term
tax-exempt rate
Corporations, Partnerships, Estates & Trusts
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Carryover of Corporate
Tax Attributes (slide 4 of 4)
• Earnings and Profits
– Positive E & P of acquired corp carries over
– E & P of a deficit corp are deemed received by
acquiring corp as of change date
• Deficit may only be used to offset E & P
accumulated by successor corporation after the
change date
Corporations, Partnerships, Estates & Trusts
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Comparison of Reorganization
Types (slide 1 of 5)
Type
Advantages
A. Merger/
Consolidation
Consideration
need not be
voting stock
Disadvantages
State law may
give dissenters
rights or require
s/holder mtgs.
Up to 50% of
All liabilities of
consideration can Target are
be in cash
assumed by
Acquirer
Corporations, Partnerships, Estates & Trusts
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Comparison of Reorganization
Types (slide 2 of 5)
Type
Advantages
Disadvantages
B. Stock-for- Stock can be acq’d
Stock
from shareholders
Only voting stock of
Acquirer can be
used
Procedures are not
complex
Must have 80%
control of Target
-May have minority
after reorg.
Corporations, Partnerships, Estates & Trusts
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Comparison of Reorganization
Types (slide 3 of 5)
Type
Advantages
C. Stock-for- Less complex as to
Assets
state law than “A”
Cash or property are
OK consideration if
20% or less of FMV
of property
transferred
Corporations, Partnerships, Estates & Trusts
Disadvantages
“Substantially all”
assets of Target
must be transferred
Liabilities count as
“other property” for
20% test if any other
consideration used.
Target must
distribute assets
rec’d to s/holders
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Comparison of Reorganization
Types (slide 4 of 5)
Type
Advantages
D. Division
(generally)
Permits corporate division without
tax consequences if no boot is
involved
E. Recapitalization Allows for major change in makeup
of shareholders’ equity without gain
recognition requirement
Corporations, Partnerships, Estates & Trusts
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Comparison of Reorganization
Types (slide 5 of 5)
Type
Advantages
F. Change in form, Survivor is treated as same entity
identity, or place
as predecessor; tax attributes of
of organization
predecessor can be carried back
or forward
G. Court approved Creditors can exchange notes for
reorganization
stock tax-free and state merger
laws need not be followed
Corporations, Partnerships, Estates & Trusts
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