Chapter 9 - Acquisitive Corporate Reorganizations

Concept of a “corporate reorganization” - the exchange of an equity interest in the old corporation for shares in the new corporation; 

cf., §1001.

Effects of tax-free corporate reorganizations:

1) Corporate parties to the transaction - no gain or loss on transfers of properties.

2) Exchanging shareholders - no gain or loss.

3) Tax attributes transferred to the acquirer.


(cf., Divisive Reorgs), p.415

One corporation acquires the stock or assets of another corporation in exchange for stock of the acquiring corporation:

1) "A" reorganization - statutory merger

2) "B" reorganization -  stock/stock exchange

3) "C" stock for assets exchange, and

4)  certain “triangular” variants (e.g., using acquisition subsidiaries).

Judicial Limitations -  
Tax “Common Law”         p.415

1)  “Business purpose” doctrine.

2)  Continuity of interest (COI) (or ownership) requirement.

3)  Continuity of business enterprise  

      (COBE) requirement.

Note: a “step” or “integrated” transaction rule or an “old and cold” rule also often applies.


Concepts of Tax-free Corporate Reorganizations

1) Limit on the character of the consideration received - a proprietary interest in the acquirer.  Must be stock in the acquirer (cf., nonqualified preferred).

2) Substantially all the transferor's properties must be acquired,  i.e., the operating “business” must be acquired.

3) A business purpose (i.e., non-tax objective) for the transaction must exist. 

Tax Code Provisions re Tax-free Reorgs          p.416

§354 - no gain or loss is to be recognized upon an exchange of shares by shareholders who are parties to a reorganization.  Cf., §351.

§361 - no gain or loss to the acquired corporation.  Also, §1032 for the stock issue.

§§356/357 - treatment of boot received and liabilities assumed in the transaction.

§358/362(b) - substitute tax basis rules.

§381 - carryover of tax attributes.

How Assure Tax-free Reorganization Treatment?


1)   IRS Private Letter Ruling – but, limited availability, unless a “significant issue.”

                - See Rev. Proc. 2010-3.

                - See Rev. Proc. 77-37 re guidelines for issuing corporate reorganization tax rulings.  

      Is this Rev. Proc. substantive law?

2)  Law firm tax opinion letter.

Statutory Merger or Consolidation             p.417

Code §368(a)(1)(A).

1)  Merger:  Shareholders of the target corporation receive shares of the acquiring corporation as a result of a “statutory merger” of target into purchaser, i.e., under local law merger statute.

2)  Consolidation:  mergers of two existing corporations into a third (often new) corporation.

Divisive Mergers             p.418
(i.e., not “acquisitive”)

Rev. Rul. 2000-5 – for tax-free corporate  reorganization treatment the merger must be acquisitive, rather than divisive (i.e., subject to the §355 rules).

Mere compliance with the local corporate law merger statute (i.e., calling the transaction a “merger”) does not constitute a merger transaction as a tax-free corporate reorganization. 


Mergers involving Disregarded Entities  p.419

Example:  Mergers between a corporation and a disregarded entity.

A.  Merger of a target corporation into a disregarded entity (e.g., LLC) is treated as a “merger” into another corporation.

B.  Merger of an LLC into a corporation does not qualify (since only divisional assets are transferred, presumably not all of the assets of the transferor corp., owner of the LLC).

Continuity of Proprietary Interest – Quantity Test

Southwest Natural Gas Co.                     p.420

Merger of Peoples Gas into Southwest.

Less than 1% of the consideration received was paid in acquirer’s common stock.  The remaining portion was paid in bonds or cash.

Held:  No “continuity of interest” results.

The stock received was not a substantial part of the value of  the property transferred.

Rev. Rul. 66-224              p.422
50% of Consideration as Stock

Four 25 percent shareholders - A & B received cash for their 25% interests;

C & D received stock for their 25% interests.

Held:  COI requirement was satisfied.

Alternative:  COI requirement is satisfied if each shareholder received 1/2 cash and 1/2 stock (total 50% in the form of stock as the consideration for the acquisition).


What Stock % is Required?
P. 423

1)  Nelson case (Sup. Ct – 1935) – 38% nonvoting preferred stock OK.

2   To obtain an IRS PLR – Rev. Proc. 77-37 requires a 50% stock value issuance.

3)  Reg. §1.368-1T(e)(2)(v), Example 1.

What is large firm practice re a merger opinion?

What is “stock”?   Cf., “nonqualified preferred stock” (as “boot”?).


Other COI Issues:
p. 424

1)  Remote Continuity – can assets be dropped down into subsidiaries by Acquirer and not violate COI requirement?

2)  When to measure COI text compliance?

- Day before the binding contract if fixed number of shares.

- Alternative if variable consideration, i.e., shares  are increased if Acquirer’s share value declines.

J.E. Seagram Corp. case           Reorg. Treatment            p.425

Competing tender offers for Conoco between Seagram and DuPont.  Neither gets 50%.

DuPont then acquires the remaining Conoco shares for DuPont stock (including Seagram shares –  purchased previously for cash).

Seagram claims a loss - but IRS is successful in asserting that this was a reorganization (i.e., continuity of interest did exist).

Pre-deal trading not negating the tax-free status.

Continuity by Historic Target Shareholders

Kass v. Commissioner            p. 428, note 1

Squeeze-out upstream merger after a cash stock acquisition in a tender offer and a prior 80% plus purchase of Target’s stock.

5.82 percent of the outstanding stock was not tendered but then subjected to a squeeze-out. This enabled acquisition of the entire business.

Held:  Not a merger - even though the shareholder received exclusively shares of Acquirer.


Continuity of Interest (COI) Regulations

Reg. § 1.368-1(e)(1)(i).

Disposition of stock prior to a reorganization to unrelated persons will be disregarded and will not affect continuity of interest into the acquirer by exchanging party.

Requirement:  exchange Target stock for Purchaser stock to have at least 50 percent of the entire consideration received being equity.

Post-Acquisition Continuity
p. 430

How long must the target shareholders hold their stock in the acquiring corporation after their acquisition?

What is the impact of a pre-arranged stock sale commitment by majority shareholders?

The COI regulations focus on exchanges between target shareholders and the purchaser corp. 

Sales of stock by the former target shareholders generally are disregarded (unless made to P).

Rev. Rul. 99-58          p. 431
Open Market Repurchase

Reorganization acquisition (50/50 stock & cash) followed by open market reacquisitions of  the Purchaser’s stock (redemptions? § 302(b)(2)).

The purpose of the reacquisition was to prevent stock ownership dilution for Purchaser. 

No understanding that the P share ownership by T shareholders would be transitory.   

No impact on the COI status.


Continuity of Business Enterprise (COBE)      p.433

Bentsen v. Phinney    Corporation was engaged in land development business and transferred property to a life insurance company.

Shareholders received stock of insurance co.

Type of business carried on by the survivor entity was the insurance business (acquirer).

No IRS private letter ruling re tax-free status.

Held: COBE requirement was satisfied - need not engage in the same business – only some business activity.  Appropriate result in tax refund suit?

Rev. Rul. 81-25                p.436
Transferor Business Important

COBE requirement – per IRS:

Look to the business assets of the transferor corporation (not the transferee corporation) to determine whether the continuity of business enterprise (COBE) test is satisfied in the acquisition transaction.

Reg. § 1.368-1(d)(1980).

Must look to the transferor's historic business; no relevance to business of the Acquirer. 

Continuity of Business Enterprise Regulations

COBE regulations - Reg.  §1.368-1(d).

COBE requires that the issuing corporation either continue the Target's historic business or use a significant portion of the Target's historic business assets.

COBE requirement is not violated if P transfers acquired T assets or stock to (1)  controlled subsidiaries or (2) a controlled partnership.

Reg.  §1.368-1(d)(4).

Problem 1(a)                    p.438
All Cash Merger

"All cash" merger - valid under state law.

Lacks continuity of interest (but does satisfy the §368(a)(1)(A) mechanical rules).

No continuing proprietary interest exists (see Southwest Natural Gas).

Therefore, the transaction is taxable to:

(i) Target (i.e., a cash asset sale), and (ii) its shareholders (a §331 taxable liquidation).

Who has the liability for the corporate tax?

Problem 1(b)                    p.438
Non-Voting Preferred Stock

T shareholders receive P non-voting preferred stock in exchange for their T stock.

The “continuity of interest” rule is satisfied.

This stock is a “proprietary interest”; 

the nature of the equity interest is not considered in an “A” reorganization.

But, cf., what result if “nonqualified preferred stock” is received?

Problem 1(c)                    p.438
Commitment to Sell Stock

Shareholders holding 75% of Target have a binding commitment to sell one week after the merger transaction is completed. 

The only consideration received is stock and, therefore, a tax-free merger has occurred.

But, what is the adverse impact (if any) of the post-acquisition stock disposition?  None (on other 25%).   See Reg. §1.368-1(e)(7), Example 1(i). 

Problem 1(d)                    p.438
Target Assets Sold

P sells T’s assets (after the merger and as part of the plan) to an unrelated party and uses proceeds to expand another P business.

The COBE requirements are not satisfied.

Reg. §1.368-1(d)(1).

A significant line of T’s business must be continued after the merger, and T’s business is not continued here. 

Problem 1(e)                    p.438
Stock & Notes Received

Nonvoting preferred stock ($120,000) and notes ($180,000) are received in the merger.

40% of the consideration received by T shareholders is P stock.

Is the continuity of interest rule satisfied? (see Regs. - 40% test;  50% test under Rev. Proc. 77-37).

Nonrecognition to the shareholders - except to the extent that they receive  "boot” - again assuming no nonqualified preferred stock.

Problem 1(f)                     p.439
P Stock Value Declines

As in (e) –stock (120,000) and notes (180,000) but stock declines to 60,000 prior to closing. At closing stock of 60,000 and notes of 180,000 equals 25% for stock. Invalidate tax-free merger treatment (for the 60,000 stock)?

Reg. §1.368-1T(e)(2)(i) says value deal measured on the last day before the binding contract – here 40% & acceptable for continuity of interest test.

Problem 1(g)                    p.439
More Non-Stock Consideration

Nonvoting preferred worth $100,000 is received and bonds worth $200,000 are received. Less than 50% of the consideration received in the merger consists of  P stock.

Does 331/3% stock consideration represent an adequate continuity of proprietary interest?  Kass - 5.82% not sufficient to satisfy test.

Will the boot cause taxable gain for all? Yes.

Problem 1(h)                    p.439
Convertible Debt   (not Stock)

Facts:  Bonds issued in the exchange transaction are convertible into P nonvoting preferred stock.

The convertibility feature of debt is to be disregarded for purposes of applying the “continuity of interest” rule (unless the bonds are recharacterized as equity?).

Similarly, warrants will not be treated as stock for this purpose.

Problem 1(i)                     p.439
Larger $ Stock Consideration

75% of shareholders owning 1/3 of the stock receive the notes worth $100,000 and 25% of the shareholders owning 2/3rds of the stock receive P stock worth $200,000.

The “continuity of interest” rule is satisfied.

Continuity measurement is by reference to the pro-rata values of the consideration received and not to the shareholder numbers.

See Rev. Rul. 66-224 (p.422).


Problem 1(j)                     p.439
“Old & Cold” Cash Purchase?

70% of T stock was acquired by P for cash five years ago.  T merges into P and the 30 percent minority shareholders of T receive 20 percent stock and 80 percent cash.

Is this a “creeping A” acquisition?

70 percent of the T stock is “old and cold”.

If  P's holdings are counted - 70% continuity, plus a small percentage for the minority (6%) and a qualifying “A” reorg. does occur.

Problem 1(k)                    p.439
Step Transaction & Cash?

A acquired 80 percent of T stock six months ago in a tender offer for $240,000 cash.  T merges into A and the remaining shareholders receive $60,000 of P stock in exchange for their T stock.

The 80% stock interest (for cash) is not "old and cold”.

Only a 20% “continuity of interest” results and, therefore, gain or loss recognition occurs to the minority shareholders.


The “B” Reorganization -
Stock-for-stock Exchange  

Code §368(a)(1)(B).

Stock-for stock exchange (completed at the Target shareholder level):

Step 1.  A stock exchange occurs between the Target shareholders and the Purchaser Corporation (for P Shares).

Step 2.  The acquired Target Corporation becomes a subsidiary of the Purchaser as a result of the stock acquisition transaction.

Chapman case                p.439
ITT/Hartford    “No boot in a B”

Motion for Summary Judgment:

ITT as the Purchaser of Hartford acquires 8% for cash and then an 80% exchange of “stock for stock” occurs.

Held:  Cannot exclude the prior acquisition for cash - if linkage exists. The 8% is not essentially irrelevant.  The entire payment must not contain any non-stock consideration.

On remand: are the two transactions linked?


Rev. Rul. 67-274              p.449
“C”, not a “B” Reorganization

1)  Y corporation acquired X corporation shares from X corporation shareholders.

2)  Y corporation then liquidated X corporation into Y Corp. &  Y then conducted the X business.

Held:  A step transaction - not a "B" reorganization, but a "C" reorganization -i.e., a “stock for assets” exchange.

Why differentiate between the “B” and “C”?

Rev. Rul. 55-440              p.450 Preferred Previously Called

X corporation acquired Y corp. common stock in exchange solely for X corp. common.

Y corp. voting preferred was outstanding and the voting control test would not be satisfied.

But, preferred previously called for redemption.

Held:  Rights of the preferred terminated upon the redemption call and shareholder rights transformed into a claim for payment. Therefore, the preferred was not outstanding at the time of exchange.

“B” Reorganization Limitations on Eligibility

No "boot" in a B reorganization.

Voting preferred is possible.

What if preferred only votes in the event of dividend arrearages?

Is a fractional share cash-out OK?   Yes.  Why?

Payment of target’s expenses by acquirer (yes, but not expenses of the shareholders).

How to deal with the problem of dissenters?

“B” Reorganizations- Contingent Stock    p.453-4

Contingent stock arrangements are acceptable (for B reorg. treatment) if:

1) Only additional stock can be issued.

2) Five year limit is applicable.

3) Valid business reason, e.g., valuation.

4) Maximum 50% of the deal limit applies.

5) Contingent rights are not transferable.

6) No control by seller of triggering event.

Cf., escrow arrangement – outstanding stock

Problem 1(a)                    p.455
Voting Preferred Received

Target shareholders receive voting preferred with value of $1,000 per share (ten times the value of common stock) & 1:1 voting rights.

Treated as solely “voting stock”?   yes

Need not be common stock;  can receive voting preferred stock in the B reorganization.

What if substantially diluted voting rights compared to common stock?

Problem 1(b)                    p.455
“Solely” Requirement Not Met

Transfer of 85% voting stock and 15% warrants to Target shareholders.

Warrants are not voting stock.

The “solely" for voting stock requirement is violated and the transaction is not a "B" reorganization.  

No "boot" is permitted in a "B" reorganization.



Problem 1(c)                    p.455
Fractional Share Cash-out

Voting shares are received with an additional

payment for the fractional share cash-out.

Assuming "not separately bargained for" consideration, the “solely for voting stock” requirement is deemed satisfied.

The fractional share cash received is treated as received from a separate §302 redemption distribution (not under §356).

Problem 1(d)                    p.455
P pays T’s Expenses

P pays Target's legal and related transaction fees in addition to issuing P voting common stock.

If related to the reorganization:   the solely for voting stock requirement is not violated.  

Why?  Payment must be made directly to the creditors, rather than to Target (per Rev.  Rul. 73-54, p. 452).


Problem 1(e)                    p.455
B Reorg Status Not Available

P pays attorney's fees incurred by T's majority shareholders for legal and tax advice relating to the exchange transaction.

This payment would constitute "boot", i.e., consideration which is other than solely "voting stock“ to the shareholders.

The amount is paid to the shareholders (as shareholders), not on behalf of the Target corporation.


Problem 2(a)                    p.455
Minority Shareholder

Dee Minimis is unwilling to participate in transaction.   Disregard Dee (a 5% minority shareholder) in the acquisition transaction since Dee does not want to participate?

Yes, but then Dee is a minority shareholder

in Target & fiduciary obligations are imposed on the majority towards the minority (under state corporate/business law). 


Problem 2(b)                    p.455
5% Shareholder Redeemed

1) T redeems Dee prior to exchange with P.

The prior redemption does not violate the “solely for voting stock”  requirement.

2) Loan situation - is the P loan bona fide?

  a) if so, the arrangement should be OK;

  b) if not, the loan proceeds constitute additional consideration, disqualifying the attempted “B” reorganization.


Problem 2(c)                    p.455
Post-Acquisition Purchase

P redeems Dee's P shares one month after the exchange - pursuant to an oral understanding with Dee.

IRS would argue step transaction treatment and that this transaction with Dee constitutes a violation of the “solely for voting stock” B reorganization requirement.


Problem 2(d)                    p.455
Third Party Share Purchase

Majority shareholders of T buy Dee's stock and then enter into an exchange with P.

This qualifies as a “solely for voting stock” exchange.

Assuming: The cash did not come from P but from the shareholders’ own funds.

And, no indirect funding from P to the purchasing shareholders.


Problem 3(a)                    p.455
Creeping “B”?  “Old & Cold”?

(1) P acquired 30% of T for cash 5 years ago.

(2) Now P acquires the remaining 70% of T stock for P voting common stock in a single transaction (going above 80% ownership). 

Step transaction doctrine is not applied here.

The statute does permit “creeping control,” i.e., the entire 80% voting stock interest need not be acquired in one transaction.


Problem 3(b)                    p.455
Step Transaction?

P acquired 85% of T in a cash tender offer one year ago.  P acquires the remaining 15% from T shareholders in exchange for P voting common shares.

A valid "B" reorganization exists for the 15%  T shareholders if that acquisition is unrelated to the acquisition of the 85 percent for cash.


Problem 3(c)                    p.456
Multiple Acquisitions

Prior 30% ownership.  Staggered acquisition of the remaining 70% occurs: 40% (for stock) in year one and 30% (for stock) in year two.

1)  The final 30% acquisition (70 to 100%) should be a "B" reorganization transaction.

2)  An issue exists whether the earlier 40%  transaction is integrally related to the later 30% stock transaction (or is it a separate, ineligible transaction?).  Reg. §1.368-2(c).

Problem 3(d)                    p.456
Intermediate Cash Purchase

Facts:  An additional 40% is acquired (for cash) and later the remaining 30% (from 70% to 100% ownership) is acquired for stock.

Issue:  Are (i) the cash acquisition and (ii) the subsequent acquisition for stock (a) related or (b) unrelated transactions?   If unrelated, the 30% acquisition qualifies for “B” reorg. treatment.  But, not the 40% for cash transaction. If related - what impact on 30%?


Problem 3(e)                    p.456
Purchase & Sale of T Stock

P bought 10% of T stock for cash 1 year ago.

Then P sold the 10% interest to Friendly.

P then in a single transaction acquired 100% of the T stock solely for P stock.

Issue: 1) Are the cash and the subsequent acquisition separate and unrelated?          

If yes, then 100% is a qualifying "B” reorg.

2) If not, then questions about the transfer and the reacquisition from Friendly Bank.

The “C” Reorganization -The “Practical Merger”

Criteria for a valid "C" reorganization:  

1) Voting stock of the acquirer is received.

2) A transfer of “substantially all” properties.

3) Liquidation of Target with the distribution to the shareholders of the Acquirer’s stock.

4) Assumption of some liabilities is permitted.

5) Limited "boot" exception - but a 20% limitation rule (including liabilities assumed).

The “Substantially All” Requirement               p.457

IRS ruling position:  70% of gross & 90% of net assets (for ruling purposes) are to be acquired.

Emphasis on “operating assets” (even if the percentage tests are not met).

Cannot be a divisive transaction;  e.g., consider Rev. Rul. 88-48 (p.457) permitting the sale of 50% of the historic assets if the cash proceeds are also transferred by Target corporation to Purchaser.

Liquidation of the Target Corporation                     p.457

§368(a)(2)(G) requires the Target to distribute all its assets (including the shares of purchaser) in liquidation.

Possible waiver of the liquidation requirement can be obtained from the Service.  Then treated as if (1) the distribution to Target shareholders had occurred, and

    (2) the assets were then contributed to the capital of a new corporation.

Creeping Acquisitions          p.458

Prior purchase of stock of the Target - is this purchase transaction “old and cold”?

Purchaser’s prior holding of stock not invalidating the “solely for voting stock” requirement.  See the prior Bausch &  Lomb history.

Under the boot relation rule the non-qualifying consideration cannot exceed 20% of the value of all of the Target’s properties.

Reg. § 1.368-2(d)(4)(i) & (ii).

Problem 1(a)                    p.459
70% Operating Assets

T has $70,000 of operating assets and $30,000 of cash and securities & A issues voting stock worth $70,000.   T liquidates (stock & cash).

Tax issue concerns whether "substantially all" the properties have been transferred?

The “70 percent of gross and 90 percent of net” test  (Rev. Proc. 77-37) has not been satisfied.

But, only non-operating properties are retained and all assets transferred to shareholders in liquidation.

Problem 1(b)                    p.459
Operating Assets Retained

A acquires (1) $40,000 (of a total of $70,000) of the operating assets and (2) $30,000 of the investment assets of Target in exchange for A voting stock. 

T then liquidates, distributing $70,000 of A stock and $30,000 of T’s operating assets.

Here, operating assets have been retained by Target shareholders in the exchange and a failure occurs to satisfy the "C" reorganization “substantially all” requirement.


Problem 1(c)                    p.459
Assumption of Liabilities

T has $100,000 of operating assets and $30,000 of liabilities.

A issues $70,000 of voting stock in exchange for the T assets & liabilities.

“Substantially all” the T assets are acquired.

The assumption of liabilities is permitted in this situation without losing tax-free “C” reorganization treatment.  See §368(a)(1)(C) re liability assumption.

What if $90,000 of liabilities?

Problem 1(d)                    p.459
Cash & Liability Assumption

A issues $60,000 of its voting stock and $10,000 cash in exchange for all of T's assets and the assumption of the $30,000 of liabilities.

T liquidates, distributing A stock and cash. 

See the "boot relaxation rule"- §368(a)(2)(B). 

Assumed liabilities are treated as additional cash.

60% of assets are acquired for stock and 40% for cash.    The boot relaxation rule is not satisfied and no “C” reorganization occurs.

Problem 2(a)                    p.459
“B” or “C” Reorg?

T owns (1) $70,000 of operating assets and (2) $30,000 cash and investment securities. 

T redeems 30% of the stock for the cash and investment securities.

Acquiring issues $70,000 worth of voting stock to the remaining T shareholders in exchange for T stock and T then liquidates. 

If no step transaction:   a valid "B” reorg?

If a step transaction:  a "C" reorganization? Yes?

Problem 2(b)                    p.459
Step Transaction?

T redeems 30% shareholders by distributing operating assets rather than cash and investment securities.

1) If the redemption is separate:  a "C" reorganization occurs (since then all assets are acquired in the transaction).

2) If the redemption is not separatenot a valid "C" reorganization, since substantially all the assets are not transferred to P.

Problem 2(c)                    p.459
“C” Reorg Status?

A has held 30 percent of T stock (old & cold).

A exchanges voting stock of A for the remaining 70 percent of T stock & liquidates. 

Under (now obsolete) Bausch & Lomb case A would be treated as obtaining 30% of T's assets for T stock,  not A stock and not a "C" reorganization.  See Rev. Rul. 67-274 re testing as a “C” reorganization.

The “solely for voting stock” requirement is not satisfied. But, cf. Reg. §1.368-2(d)(4), Ex. 1


Triangular Reorganizations

Alternative structures:     (see supp. charts)

1. “A” Reorg. (§368(a)(1)(A)) & then an asset drop down to a subsidiary.   §368(a)(2)(C).

2. Forward Triangular Merger. §368(a)(2)(D).

3. Parenthetical "B" Reorg.   §368(a)(1)(B).

4. Parenthetical "C" Reorg.   §368(a)(1)(C).

5. Reverse Triangular Merger.  §368(a)(2)(E).


Objectives of Triangular Reorganizations

To satisfy business (i.e., non-tax) objectives.

E.g., Parent avoids hidden liabilities in the transferred assets (through the isolation of the liabilities of Target into a separate sub).

E.g., to facilitate the acquisition of non-transferable assets (through maintaining the Target corporation’s separate existence).

E.g., to avoid shareholder votes.

Structures of Triangular Reorganizations      p.460-2

See the separate charts concerning the structuring of these triangular reorganization transactions.


(Charts available on W. Streng  UH Law Center/faculty website:  corporate tax slides).

Multi-Step Transactions

Objectives in multi-step transactions:

1)  Achieve business plan –including regulatory and financial accounting issues

2)  Tax result based on overall transaction basis

3)  Relevance of Section 338/cash asset purchase transaction treatment.

Overall objective:  (1) get assets acquired; (2) then restructure to rationalize operations.

Multi-Step Transactions
Rev. Rul. 2001-26       p.463

§368(a)(2)(E) reverse triangular merger issue:

Transaction: (1) tender offer of P stock for 51% of T’s stock,  followed by (2) merger of P’s sub into T and remaining T shareholders receive P voting stock and cash combination (83%+ consideration is stock).

(Alternative:  Sub initiates the tender offer).

Held:  When segments are integrated at least 80% of the T stock was acquired for P stock & tax-free reorg. status is available (under §368(a)(2)(E)).

Multi-Step Transactions
Rev. Rul. 2001-46       p.466

(1) Purchaser’s wholly owned transaction sub merges into Target and then (2) Target merges into acquiring corporation. 

Holding:  Step transaction treatment and  therefore a statutory merger into Purchaser and §368(a)(1)(A) reorg. treatment.

Situation one: if not a step-transaction, would be a qualified stock purchase for §338 purposes and asset basis step-up would be applicable.   continued

Multi-Step Transactions
Rev. Rul. 2001-46, cont.

Situation two:  In an acquisition merger (1) the Target shareholders receive solely acquiring corporation stock, and then (2) an upstream merger of the acquired corporation into the parent occurs.

This transaction qualifies as a §368(a)(2)(E) reorg.  However, the transaction is still treated as a single statutory merger qualifying under §368(a)(1)(A).

Multi-Step Transactions
Rev. Rul. 2008-25       Supp.

1) P forms merger sub which merges into T.

Consideration paid to T shareholder is 10x cash and 90X P voting stock.

2) T then liquidates into P (not a merger) & then P conducts the T business.

If separate: § 368(a)(2)(E) and then §332 .

If integrated: Not an (a)(2)(E) reorg since T does not hold substantially all properties. 

Holding: not reorg & purchase of stock under 338.

Triangular Reorganizations
 Problems                    p.471


See the separate charts concerning the elements of the transactions identified in these problems.

Acquisitive Reorganization
Treatment of the Parties

Consider the income tax treatment from a tax-free corporate reorganization for the following parties:

1) The shareholders of the Target Corporation

2) The Acquiring Corporation & any Acquisition Subsidiary

3)  The Target Corporation

Shareholder Consequences in a Reorganization    p.473    

§354 - no gain or loss to be recognized on the share exchange.

§358 - carryover/substituted stock basis.

§1223(1) - tacked holding period.

What if "boot"?    §356(a)

  including "excess securities" treated as boot. 

   §356(a)(1) & §356(d)

Tax basis for any “boot” received - FMV.

Tax "characterization” of boot? §356(a)(2).

Commissioner v. Clark
p. 474 (n. 10)   Code §356(a)(2)

Code §368(a)(2)(D) reorganization.

Received 300,000 P shares and $3.25 mil. cash.  Could have received 425,000 P shares.   

What is the Code §356(a)(2) applicability?

1)  deemed pre-reorganization redemption of Target acquired shares  (Shimberg case);    or,

2)  deemed post-reorganization redemption of acquiring corp. (P) shares  (Wright case)?


Characterization of Boot as Dividend or Capital Gain

Boot dividend is limited to the gain amount. §356(a)(2) - (dividend within gain)

Tax rate of 15% on both dividend and capital gain reduces tax significance, but:

1)  Prefer dividends received deduction (DRD) – for a corporate shareholder?

2)  Boot gain is received as installment notes –

     not if dividend characterization applies.

Basis and Holding Period for Target Shareholders       p.475

§358 – basis in the property received is derived from the basis of the property transferred.

Boot takes a fair market value basis.

What about multiple “tax lots”? – tracing or pro rata allocation?  Allocation to each block of stock is required.  Average basis method not available – Cf., basis reporting by brokers - §6045(g) regulations (effective in 2011).

Problem (a)                 p.477
Merger  “A” Reorganization

Each shareholder receives 4,000 ($40,000) of voting common stock and nonvoting (not nonqualified) preferred stock worth $10,000.

1) Nontaxable - solely “stock for stock”  §354(a)

2)  Substituted basis.   §358(a)(1) - $20,000 total;

      common-16,000;  preferred - 4,000

3) Tacked holding period.   §1223(1).

4) Preferred stock - §306 stock. §306(c)(1)(B).


Problem (b)                 p.477 Note & Not Stock Received

Shareholder receives voting common stock plus a 20 year $10,000 interest bearing note (rather than the preferred stock).

Necessitates a Clark case analysis re  §302(b)(2) redemption status.

Treatment as if (1) each shareholder received 1,000 shares and (2) subsequently transformed those shares into the $10,000 note.                                                      continued

Problem (b)          continued
Note & Stock Received

1)  Each shareholder before redemption: 

5,000 shares = $50,000 (1,000 shares are boot).

550,000 shares equals .909 shareholder %.

2)  After redemption:

4,000      (actual shares retained by each)

540,000  equals  .741 percent.

3) 80% times  .909% equals .727% and

§302(b)(2) is not satisfied.  But, is §302(b)(1) (“not essentially equivalent”) applicable?


Problem (c)                 p.477 High Tax Basis Limits Gain

Each shareholder has $45,000 basis in her T stock. Only a $5,000 amount of realized gain.

The recognized gain is limited to $5,000.

Tax character of gain – see the Clark case analysis.

Notes have a $10,000 FMV basis.  §358(a)(2).

Stock has an exchanged basis.  §358(a)(1).

-$45,000 less $10,000 equals $35,000, plus

- the $5,000 gain recognized equals a $40,000 basis.

Problem (d)                 p.477
Notes Paid for Redemption

Two shareholders receive notes - $100,000. 

The remaining shareholders receive voting common stock worth $400,000.

1)  Shareholders receiving solely voting stock:

Non-recognition under §354(a)(1).

$20,000 substituted basis under §358(a)(1).

2) Shareholders receiving solely securities.

Not boot, since no non-recognition property is                                                                                     received. Treated as §302 redemptions to each.


Problem (e)                 p.478
Boot & T has limited E&P

T had $50,000 E&P, not $100,000 E&P.

Assume boot is received as a dividend. §356(a)(2).

What is the amount of  the §356(a)(2) dividend:

   1) only $50,000 of T's E&P?  or,

   2) also the E&P of the acquiring corporation?          

Cf.,  the §304(b)(2) result.   Assuming only T’s E&P to be relevant: $5,000 dividend and $5,000 gain from stock sale or exchange.

Target Corporation     p.478 Consequences - Issues

Income tax realization events:

1) Reorganization exchange of its property for stock (and boot) (e.g., “A”, “C” or forward triangular reorganization).

2) Distribution in corporate liquidation of stock received (or boot)  (or sale of stock prior to the corporate liquidation).

Tax recognition on these events occurring?


Reorganization Exchange
Target Level Treatment

§361(a) - no gain or loss recognized on the transfer of assets in the reorganization transaction.

§357(a) - assumption of the target's liabilities is not treated as boot.

These rules apply to (1) "A“ &  "C" reorganizations, and (2) forward triangular mergers;  but, not for "B" reorganizations, or reverse triangular mergers, since stock, not assets, acquired in those transactions.

Shareholder Distribution
- Tax Effects to the Target

No gain or loss is recognized to Target when it distributes qualified property - §361(c).

"Qualified property" requirement under §361(c) - stock of the other party in the reorganization.

Distribution of other than “qualified property” - e.g., boot - gain recognition on the distribution is required.  §§361(c)(1) & (2) (but prior step-up when transferred by P)?

Acquiring Corporation Consequences - Asset Deal

§1032(a) -  issuance of its shares by the acquiring corporation is not a taxable event.

Same result if issuance of debt securities by the acquirer.  But, other assets as “boot”?

Tax basis for assets received by Acquirer:

§362(b) carryover from the transferor.

This relevant in acquisition of target's assets:

“A” or “C” &  forward triangular merger.



Acquiring Corporation Consequences - Stock Deal

What tax basis result to a Acquirer when receiving stock from the “seller” shareholders in exchange for Acquirer stock? 

If a "B" reorganization (or reverse triangular?) - take shareholders’ tax bases.

Sampling is acceptable to determine stock basis of the shareholders if multiple shareholders of the Target.

Rev. Proc. 81-70 is under review.

Acquiring Corporation -Triangular Reorganization

What if issuance by sub of parent's stock – constitute a transfer of appreciated property by the sub to the target shareholders?  No.

What tax basis to parent for the target stock received in a triangular reorganization (i.e., merger of (i) target into sub, or (ii) sub into target)?

Not basis of the stock of subsidiary (often zero). Rather - treat as (i) an asset acquisition and (ii) an asset drop down transaction into the sub.


Rev. Rul. 72-327         p.482

1)  Recipient corporate shareholder receiving dividend boot can obtain dividends received deduction (under §243(a)).

2)  FMV basis for the asset received by shareholder as dividend boot.

3)  Acquiring corporation using appreciated property for acquisition recognizes gain on use of that appreciated property (40x less 10 x equals 30x gain).  Davis case.   continued

Rev. Rul. 72-327              p.482 continued

4) Acquirer’s E&P is increased by the gain recognized.

5) Acquirer succeeds to the Target’s E&P.

6) Corporate shareholder receiving realized gain is required to recognize that gain to extent of boot and to include that boot amount in its E&P.



Problem 1(a)               p.484
“C” Reorganization 

P transfers voting stock worth $80,000 in exchange for T's assets (fmv $100,000) subject to $20,000 liabilities, and T distributes shares. P - no gain on issuance of its stock - §1032.  P takes T’s E&P.

P takes assets with $60,000 basis - §362(b).

T has no gain recognition for the $40,000 realized gain - §361(a). No gain recognition to T on the liquidation distribution - §361(c).  

Nonrecognition to T’s shareholders & exchanged basis ($20,000) under §358(a)(1).

Problem 1(b)               p.484
Cash Used for Liabilities

P transfers $80,000 of voting stock and $20,000 of cash to T used to pay liabilities.  C reorg & boot.

Stock is distributed in complete liquidation.

Target - recognizes no gain on transfer of its assets to P - §361(a) & (b)(1)(A).   “C” Reorg.

T received $20,000 boot from P but no recognition to P. §1032.  Boot is distributed.

Distribution: No T gain on distribution of P stock - all is qualified property - §361(c)(1).


Problem 1(c)               p.484
Securities as “boot.”

1) P transfers  (a)  voting stock worth $80,000 and (b) investment securities with a basis of $10,000 and a value of $20,000 for all T's assets not subject to any liabilities.  Gain of $10,000 is recognized to P.

2) T immediately distributes the consideration received.  T recognizes no gain on receipt of boot (§361(b)(1)(A)) but on the distribution of boot (if any gain, probably not here).

3) Shareholders realize $80,000 gain & recognize $20,000 boot gain.


Problem 1(d)               p.484
C Reorg & No Liquidation

1) P transfers $80,000 of its voting stock, $10,000 of its bonds and $10,000 of cash to T in exchange for its assets.  T receives permission not to liquidate and retains the cash, bonds and stock. P - no gain recognition for stock or securities.

2) T - waiver for distribution?  Treated as a constructive liquidation.  T  has no gain recognition on the deemed distribution.

3) Shareholders receive boot  (dividend?).

Problem 1(e)               p.484
Two Types of Stock

P transfers $80,000 of voting stock and $20,000 of nonvoting preferred stock to T in exchange for all of T's assets.  No debt.

T liquidates and distributes the voting and nonvoting preferred (§306) stock to its shareholders prorata & tax basis allocation.

P – no gain – under §1032.

No T gain on either its asset transfers or the distribution of P stock. §361(a), (c)(1).

No gain recognition to the shareholders. §354(a)(1).


Problem 2(a)               p.484
C Reorganization

Valid “C” reorganization?

P - no gain on the distribution of P’s stock, but $8,000 gain on the transfer of the Bell stock (& E&P increase by the $8,000).

T - no gain on transfer of its operating assets.

T’s basis for the P stock is $8,000.

Sale by T of $40,000 P stock - gain to be recognized.

Target distribution to shareholders – recognition ($22,000) for the Bell stock & the land (but not the P stock).

Problem 2(b)               p.484
C Reorganization

Transfer of stock by T to creditors as part of reorganization plan.
Code §361(c)(3) permits non-recognition of gain (i.e., $36,000 gain not recognized).

The transfer is treated as a distribution to the shareholders, entitling T to nonrecognition under §361(c)(3).

E&P does not reflect the 36,000 gain.



Problem 3(a)              p.485
Forward Triangular Merger

Code §368(a)(2)(D).

Formation of S - no gain.

P’s basis in its S stock - equal to T’s basis in assets - $100,000.

S - no gain on its issuance of its own stock.

S has no gain on its transfer of P stock.

S takes T’s assets - $100,000 carryover basis.

T’s shareholders - no gain recognition.


Problem 3(b)              p.485
Reverse Triangular Merger


Parent - non-recognition on formation of S.

P’s basis in S stock - adjusted as if T had merged into S in a forward triangular merger.

S - No gain on S issuing its own stock (§1032)  or when transferring P stock to T (§361).

T – nonrecognition (T stock for P stock).

Shareholders – nonrecognition when receiving P stock for T stock. §354(a)(1) & substituted basis.


Problem 3(c)              p.485
Forward Triangular Merger

Failed §368(a)(2)(D) – forward triangular.

Parent - non-recognition on formation of S.

S - No gain on issuing its own stock.

S gain when transferring P stock to T.

T gain recognition on transfer of its assets.

S §1012 cost basis for T’s assets.

T’s shareholders recognize 150x cap. Gain and have 200x fmv basis for P stock held.

Problem 3(d)              p.485
Reverse Triangular Merger

Failed §368(a)(2)(E).

Parent - non-recognition on formation of S.

S - No gain on issuing its own stock.

S gain when transferring P stock to T.

T transfers T stock for P stock and no gain recognition - §1032.

End of Chapter 9 information