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Course: Corporate Taxation Fall 2001
School: Wayne State University
Year: 2001
Professor: McIntyre
Course Outline provided by



VI. Liquidations

A. Complete Liquidations of Non-Subsidiary Corps.

1. Complete Liquidation

a. A distribution or series of distributions in redemption or cancellation of all of the stock of the corp. pursuant to a plan. (§346(a))

b. Corp. does not have to dissolve… only need all corp. assets to be distrib. to s/h.

c. A liquidation plan doesn’t have to be adopted to get complete liquidation treatment, but without a plan which is fully executed in 1 yr, the IRS will scrutinize the transaction… IRS may recharacterize series of distributions as div. since there is no clear determination of when liquidation occurred. §1.331-1(d)

d. If the corp. can’t pay the taxes on the G from distribution, the s/h is liab. for the taxes. (§6901)

2. Tax treatment to taxpayers

a. S/h recognizes cap G/L as if they had sold their stock in exchange for the FMV of the assets received. (§331)

(1) If the s/h assumes liab. in the liquidation, his A/B in the stock will be increased by the amount of liab., which since it is redeemed, reduces his cap G on the distribution (or may throw him into a loss).

(2) The distribution from the corp. will be net of taxes, so the s/h will get less in the distribution than the corp. has.

- If the corp. has insufficient liquid assets to cover the tax (e.g., only real prop.), the tax liability is shifted to the s/h… essentially the same as the s/h receiving a liab.

(3) Review of mortgages involved in sales:

(a) If prop. is sold and buyer takes mtg., the A/B is the FMV + the mtg. Seller recognizes proceeds + relief of mtg. – A/B

(b) If prop. is distributed and s/h takes mtg., the s/h recognizes FMV – mtg. – A/B (- unpaid corp. taxes). A/B is FMV. Corp. recognizes G = FMV – A/B… the mtg. is ignored for corp. G purposes in distribution.

b. A/B is FMV at time of distribution if the liquidation transaction is taxable (§334)

c. Holding period starts after the liquidation date. (§1223(1))

d. Installment method

(1) If installment note is liquidated to s/h, s/h can use the installment method on payments for recognizing G = % of total payment x total realized G.

(2) The sale by the corp. to produce the installment note must take place w/in 12 mos. after adoption of liquidation plan and liquidation must be completed in that 12 mo. period. (§453(h)(1)).

(3) It doesn’t apply to recognition of losses.

(4) Calculation issues:

(a) If the mtg. transferred w/ the prop. to get the note exceeds the A/B of the prop., the excess is recognized as a G immediately. The A/B is reduced to 0, and the Gross Profit % = 100%, meaning that all payments will be completely recognized as income.

(b) Any boot/cash transferred with the note is considered a payment under the note and the income is recognized based on the Gross Profit %

(c) When the note is distributed to s/h, the corp. must recognize the deferred G immediately. (§453B(a))

(d) When the note is distributed to s/h, any liab. included (including tax) are unconnected and deducted in the first year.

- may not be relevant now since accrual taxpayers can’t use accrual method (new amendment to §453)

e. If the stock is acquired by the s/h in different blocks, each block must be evaluated separately for G/L (§1.331-1(e))

f. Series of distributions in complete liquidation

(1) recover A/B first for each partial liquidation.

(2) once A/B runs out, amounts distributed are cap G

(3) any leftover A/B after all distributions are final is then taken as a loss.

3. Tax treatment to distributing corp.

a. Corp. recognizes G/L on assets distributed as if they were sold at FMV (§336(a))

(1) The FMV of the prop. can’t be less than any liab assumed by the s/h (§336(b))

(2) The distribution of depreciable prop. may result in ordinary income to the corp. rather than cap G under §1239 if it is to related parties (>50% ownership by value w/ constructive ownership under §267).

b. For distribution of installment notes, the corp. will recognize the unrecognized gain on the note §453B(a).

c. Losses are allowed - §267 doesn’t normally apply to losses involved in a complete liquidation (§267(a)(1)). No cherry picking possible like under §311 because all assets are distributed.

(1) Disallowance of losses with related parties (§336(d)(1))

(a) No loss is allowed for distributions by the corp. to §267 related persons if:

(i) the distribution isn’t pro-rata for each asset based on s/h ownership, or

(A) if one person receives loss prop. and other person receives cash for same amount as FMV it isn’t pro-rata.

(B) it doesn’t matter how the corp. got the prop. or from whom.

(ii) the prop. is disqualified prop – acquired by the corp. w/in the last 5 yrs through a §351 transaction or contribution to capital. (anti-stuffing provision)

(A) This includes prop. with substituted or transferred A/B from prop. used in §351 transaction

(B) The prop. doesn’t have to be contributed by the related party who receives it in distribution.

(b) neither of these needs built-in losses at time of acquisition by corp. to have losses disqualified.

(c) losses disappear completely since the corp. doesn’t have anything to attach it to… no suspension.

(d) if minority s/h receive loss prop. as well, these rules don’t apply to them… the corp. must allocate the loss between parties (and see §336(d)(2)).

(2) Loss is limited for transactions that use §351 or contribution of capital involving prop. with built-in losses before liquidation, where it is done principally for tax avoidance purposes. (§336(d)(2))

(a) In the distribution to the s/h or in a third party sale pursuant to a liquidation plan, the A/B in the prop. is reduced by the built-in loss in the prop. from when the corp. received the prop. through a §351 transaction or contribution of capital. Further losses beyond built-in loss are deductible.

(b) Tax avoidance is presumed if any prop. was acquired w/in 2 yrs of the date of the adoption of the plan of complete liquidation. (§336(d)(2)(B)(ii))

- The fact that the prop. is related to the corp’s trade or business does not overcome the presumption of tax avoidance purpose.

(c) The relationship b/w the corp. and the distributee/buyer is meaningless for these purposes, but if both §336(d)(1) & (2) apply because §267 related party is involved, the (d)(1) rule will trump because it is harsher since it completely disallows any loss.

(d) Meant to catch improper double losses taken from distributions to minority s/h missed under §336(d)(1).

d. E&P is meaningless because there is nothing left to distribute or preserve.

4. Whether the corp. sells the assets and distributes the cash or distributes the assets and has the s/h sell them, the tax result is the same.


B. Complete Liquidations of a Subsidiary.

1. Liquidating Sub.

a. No recognition of G/L for the sub with respect to a distribution of prop. to the parent corp. (§337(a))

b. Sub will recognize G/L on distributions to minority s/h. However, limitations:

(1) If there is a §332 transaction, no loss is recognized to the sub on distributions to minority s/h (§336(d)(3)).

(2) §336(d)(2) will also apply – built-in losses transferred in §351 transaction for tax avoidance purposes (see above)

- §336(d)(1) normally won’t apply, because only the parent will be able to get control to be a related party, and if that is the case, §337 trumps.

c. Sub must increase or decrease E&P by amount of G/L recognized. - §312(f)… If under §332, there is no G to parent, and it can’t recognize losses to any s/h, so there shouldn’t be many E&P adjustments.

d. If corp. is liquidated under §332 and the sub owed debt to the parent, transfer of prop. in satisfaction of debt is a distribution to the parent and any G/L on receipt of prop. in payment of the debt must be recognized. (§337(b))

2. The Parent

a. No G/L will be recognized by the parent in complete liquidation (§332(a))

b. Need to directly own 80% of voting and value over the entire period from the adoption of the plan to the receipt of the final piece of prop. to qualify (§332(b)(1))

(1) nonvoting, non-convertible p/s isn’t considered for test.

(2) no §318 attribution is applied

(3) purchase to put you above 80% before liquidation is OK as long as it is a real transaction. The IRS will respect the date chosen by the parent as the beginning of liquidation (Rev. Rul. 75-521)

(4) if corp. causes sub to redeem the stock of minority s/h in order to get to 80%, the IRS will treat the date of redemption as the date of the start of the liquidation (Rev. Rul. 70-7)

c. The parent takes the transferred A/B of the sub on distributed prop. (§334(b)(1))

d. Parent’s A/B in the Sub’s stock disappears after the liquidation. If the parent’s A/B in the stock is higher than the sub’s A/B in its assets, the parent is screwed and loses A/B.

e. Parent inherits the tax attributes of the sub, including E&P, NOL’s, inventory prop., and cap loss carryovers to the proportion of its ownership in sub. (§381)

3. Additional time qualifications:

a. If no formal plan of liquidation is adopted, it must be completed w/in 1 taxable yr (ending Dec. 31). (§332(b)(2))

b. If a formal plan is adopted, it must be completed w/in 3 yrs after the closing of the current tax year. (§332(b)(3)). It can be a series of distributions. If not, all distributions are retroactively taxable.

- If multiple distributions, must start status of liquidation before first distribution – stop going concern of business and prepare for wind-up. (§1.332-2(c))

4. Minority s/h - §332 doesn’t apply to minority s/h… they are treated separately under §331.

5. Reason for §332 & §337 is to prevent double taxation in subsidiary liquidations… parent can create sub under §351 and destroy it under §332 without any tax effects.


6. Sale and repurchase of part of sub may be recharacterized as liquidation and then sale of part of business if the sale doesn’t have economic substance (Associated Wholesale Grocers). Difference is that the parent’s A/B in the sub stock disappears if liquidation.


C. Taxable Corp. Acquisition and §338(g) Election

1. Qualified Stock Purchase - Transaction or series of transactions w/in 12 mo. period in which purchasing corp. buys 80% (by vote & value) of the target corp. (§338(d)(3))

a. 80% must actually be bought in 12 mo. period (“recently purchased stock”)... if it 25% is bought before and rest isn’t in 12 mos., the transaction won’t qualify.

b. Stock acquisitions involving substituted basis (i.e., §351, Reorgs, gifts), transfers at death, or related parties don’t count towards 80% acquisition. USUALLY CASH PURCHASES

2. §338(g) Election

a. Purchasing corp. must make election before the 15th day of 9th mo. after the mo. in which the acquisition date (when 80% is finally hit if in blocks) occurs.

b. Once the election is made, it is irrevocable.

c. The election doesn’t affect the seller

d. The new target can’t become part of buyer’s consolidated group (using buyer’s losses to offset gains from election) until after §338 effects occur.

e. The election must be applied consistently – if > 1 purchase w/in 1 yr before or after the 12 mo. test period, they must all either have the election or not. (§338(f))

f. §338(g) election isn’t available for tax-free reorganizations.

3. Effect of §338 (g) Election

a. The target corp. is treated as having: (§338(a))

(1) sold its assets on the acquisition date at their FMV in a single transaction, and

(a) Target corp. will have to pay taxes on gains from sale of the assets… the purchaser is ultimately liable on it.

(b) The actual amount paid for the corp. stock is irrelevant for these purposes… only affects A/B of buyer in the target’s stock. The FMV of the assets is used.

(2) become a new corp. that purchased all of the assets on the following day.

- The A/B of the assets of the target are stepped up to FMV (again, unrelated to proceeds received from sale of stock)

b. The new corp. is treated as a completely separate corp. for tax purposes, and can choose new tax year and accounting method, but loses characteristics such as NOL’s and carryovers (but they may be used to offset the G from §338 election).

- Buyer could simply pay less for the corp. instead of taking election, but the reduced amount will still be less than the A/B of the assets that can be used for depreciation.

4. §338(h)(10) Election – elected jointly by seller with §338(g) election

a. The election allows the seller to recognize G on sale of stock as if assets had been sold instead – better when the sub’s inside asset G is lower than parent’s outside stock G.

b. Only one set of G is recognized on the sale transaction and seller is liable for it instead of the buyer… only 1 level of tax instead of 2… seller will have to recognize G/L whether or not it elects §338(h)(10), but this will save buyer from paying taxes, so buyer will be willing to pay more.

c. (h)(10) election is only available to sellers if the target is a member of the seller’s affiliated group (selling parent must have a parent itself) and the sellers recognize G/L on sale of assets… must file consolidated return (§338(h)(10)(A)&(B))

d. The E&P of the sub goes to the parent.

5. Purchase of amounts < 100% - stepping up their basis. To get stepped up A/B of new target’s assets if less than 100% of the target bought or some is bought before the qualifying 12 mo. period: (§338(b))

Grossed-up basis of recently purchased (in 12 mo. period) stock =

Purchase price of new stock x (100% - % of old stock) % of new stock

+ Purchase price of old stock

+ All liabilities, including tax liab. on G from sale of assets.


(a) New stock is recently purchased stock… in 12 mos. period.

(b) Purchase price is technically referred to as A/B of the stock..

(c) Minority s/h get a good tax break since the increase in the A/B of the assets benefits them as well.

(d) Always keep tax liab. in mind when doing a §338 problem










VII. Corporate Reorganizations

A. Generally

1. “A”, “B”, and “C” reorgs are all acquisitive reorgs

2. When P acquires stock or assets of T and T gets stock as consideration from P, treat as if P stock went to T and T distributed the stock to it’s s/h.

3. No G/L to T, no G/L to s/h of T on distribution of P stock if no boot

4. All parties A/B remains the same if no boot.

5. Holding period tacks and tax attributes of T go to P (E&P, NOL, Cap. Loss Carryovers) for “A” & “C” reorg.

6. Should always be some business reason for deal, rather than purely tax avoidance or IRS can disallow tax treatment

7. If a distribution occurs before a merger, always have to consider whether it is a step-transaction that is related to the merger and therefore part of the same transaction… Was it done in contemplation of the deal? How close is the deal to occurring when distribution took place?

8. Continuity of interest and continuity of business enterprise are required for all reorgs., but “B” & ”C” have higher statutory requirements for continuity of interest than “A” common law requirements.


B. “A” Reorganization (cash for stock)

1. “A” Reorg. must be statutory merger under state law (§368(a)(1)(A)) – need formal filing.

- However, some common law mergers have been allowed when the merger failed formal requirements of state law.

2. Requires continuity of interest and continuity of business enterprise (§1.368-1(b)) – both based on facts and circumstances.

a. Continuity of interest (§1.368-1(e))

(1) How much is needed?

(a) Need at least 50% continued interest for a clear ruling from the IRS. (Rev. Proc. 77-37) However, the Supreme Court has held though that 38% is enough (Nelson) and the IRS has never brought suit for amount > 40%.

(b) % of new co. acquired is irrelevant. (Minnesota Tea Co.) Only % of target’s value that paid in stock is what matters. (e.g., small car dealer can merge w/ GM)

(2) What qualifies?

(a) Debt or securities are not considered for continuity of interest (Cortland Specialty – S/T notes, Roebling – L/T bonds… 100 yrs, Paulsen – debt that w/ vote, convertible debt) – NEED EQUITY

(b) Preferred stock is continuity of interest, whether or not it can vote (Nelson). Vote is irrelevant.

(c) The s/h don’t need to hold the stock for long to qualify… can sell immediately before or after the merger as long as it isn’t to a related party. (§1.368-1(e)(6)(Ex. 1)) Can even have a binding agreement to sell to an unrelated third party after the merger before the merger actually takes place.

(d) Related party under §318(a) – cash from related party is attributed to party to the merger – e.g., If controlling party buys target w/ cash and then merges w/ sub for it’s stock, it doesn’t work (§1.368-1(e)(6)(Ex. 2))

(3) Who is required to qualify?

(a) Only look at the target’s s/h for the test…. Debt holders will not affect the test, but may have to recognize G.

(b) Dissenters’ stock is counted in the continuing interest test as if they participated in exchange for cash.

- Usually not a big problem because co. must have super-majority to approve merger

(c) Other redemptions connected to the merger will be treated as cash and not continuity of interest. (§1.368-1(e)(6)(Ex. 4) However, open market tender offer repurchase of shares of public co. after the merger will not affect continuity of interest… not targeted (Rev. Rul. 99-58)

(d) Each s/h doesn’t have to qualify for reorg… only the transaction as a whole. Assets can be distributed unevenly to s/h (Rev. Rul. 66-224)

b. Continuity of business enterprise (§1.368-1(d)) – must continue target’s historic business or use a significant portion of target’s assets in a business. Only target’s business enterprise needs to be continued, not the acquirer (Rev. Rul. 81-25)

(1) Business Continuity (§1.368-1(d)(2))

(a) Buyer being in same line of business helps, but isn’t conclusive

(b) Historic business is most recent business before merger plan

(c) 2 or more lines of business – only 1 significant line of business needs to be continued by the buyer

(d) Can be run through a subsidiary

(2) Asset Continuity (§1.368-1(d)(3))

(a) Significance based on relative importance of assets to business and net FMV of assets.

(b) Use of sales proceeds or cash doesn’t qualify (§1.368-1(d)(5)(Ex. 4))

(c) The assets doesn’t have to be used in a way critical to the buyer’s business - using assets as back-up plans to supply problems qualifies (§1.368-1(d)(5)(Ex. 2))

(d) If the assets are distributed from the buyer to various subs, it still qualifies even if no sub by itself uses substantial assets - they are aggregated (§1.368-1(d)(5)(Ex. 6))

(3) Partnerships using prop. - must have material financial interest and/or mgmt. control of the business to qualify as business or asset continuity. (§1.368-1(d)(4)) – does P still have the assets or business through the p-ship?

(a) If significant financial interest (>33% in §368-1(d)(5)(Ex. 9)), do not need mgmt. control

(b) If complete mgmt. control, still need material financial interest (>1% in §1.368–1(d)(5)(Ex. 8))

- If some mgmt control, need more (but 15% OK in (Ex. 7))

3. Tax effect to s/h who is party to reorg.

a. No G/L if stock or securities are exchanged solely for stock or securities of the other corp. who is a party to the reorg. (§354(a)(1))

(1) Securities – don’t count towards continuity of interest qualification, but once the transaction passes, they are considered non-recognition property. What are securities?

(a) bonds over 10 yrs is security – but still will be taxable if no bonds or lesser face value received in return


(b) bond under 5 yrs isn’t security

(c) bond in between 5 and 10 yrs may be security

(d) Stock rights are considered securities – given a face/principal amount of 0 (§1.354-1(e)). Accordingly, they will not be taxed as boot since their face value won’t be higher than face value given up for §356(d).

(2) Non-qualified p/s under §351(g) isn’t stock or securities for these purposes. It is recognized as boot if it is included in the transaction.

b. Boot

(1) G up to realized G, but not losses, is recognized on boot (§356(a)(1)&(c))

(2) G may be treated as div if the transaction has effect of div. (§356(a)(2))

(a) The div. is limited to the amount of the recognized G.

(b) Only accumulated E&P is used. Amounts beyond accum. E&P are cap. G.

(c) Apply redemption rules under §302 (including §318 attribution) to see if it should be treated as a div. or cap. gain. (Clark) – Treat as is exchange purely for stock and then acquirer redeemed its stock for cash. Cash less than 20% may be div. Usually cap gain if larger boot payment and acquirer is larger than target (<50% part of test already met).

(2) If securities received have face/principal value > face value of securities surrendered (including if no securities are given up) they are considered boot to the extent of excess face value (§356(d))… Purely based on face value, not FMV or A/B. If same face amounts, no G/L even if new FMV > old FMV or A/B… maximum of boot that can be recognized is realized G. If face of new > FMV, must be allocated for G.

Formula: G = Excess face value x FMV Face value new

Ex: Face old = 200, Face new = 220, FMV = 200; G = 20 x 200/220 = 18.2

(3) Creditors receiving stock for their debt is not boot. If creditor receives S/T bonds or cash, he will be separate from the transaction and recognize the income from his debt sale as a separate taxable transaction.

(4) When securities are received, s/h may be able to use installment method on the cap G (but not dividend) from the boot (§453(f)(6)(C))

(5) If §306 stock is exchanged for boot, the prop. is treated as a §301 distribution (§356(f))

c. Assumption of Liab. (§357) – same as §351 - assumption of liab. is not normally treated as boot (§357(a)) - exceptions:

(1) Liab. in Excess of Basis: If liab. on prop. transferred > A/B of prop. transferred, the excess liab. is treated as a gain from sale (§357(c))

(a) If liab. would produce a deduction in the hands of the corp., it isn’t a liab. for these purposes (§357(c)(3)). This includes contingent liabilities, such as possible environmental suits (Rev. Rul. 95-74)…. however, payment of mtg. doesn’t produce an expense.

(b) the s/h may be able to avoid gain for excess liab., by promising to pay the corp., though a bona fide debt instrument, the excess of liab. over the basis of the assets… this will increase his A/B in the prop. transferred by the face value of the debt. (Lessinger)

- However, this rule has only been accepted by the 2nd and 9th Cir. and may not be valid law elsewhere.

(2) If the debt is taken or the assumption is done for a clear tax avoidance reason (no valid business reason), the entire assumption of liab. will be taxed, even if only a portion of the debt was assumed/taken for improper reasons. The burden is on the taxpayer to show business reason. (§357(b))

d. A/B – same as §351

(1) if no boot, the A/B of the stock/security is the same as prop. exchanged (§358)

(2) if boot

(a) A/B of stock/security = A/B in prop. – FMV of boot + G recognized – L recognized + amount treated as a dividend

(b) A/B of boot is FMV (§358(a)(2))

(c) A/B is allocated among non-recognition prop. (§358(b)(1))

- If the transferor receives non-recognition property of stock and securities or stock of different classes, basis is allocated to each based upon the FMV of each security/stock (§1.358-2(b)).

(d) Assumption of liab. is treated as boot for purposes of A/B. (§358(d)(1))

- Only liab that wouldn’t produce a deduction in the hands of the corp.

e. A s/h who doesn’t receive any qualified prop. (e.g. a dissenter cashing out), will not be subject to the provisions of §354 and §356 at all and will have a fully taxable transaction.

4. Tax Effect to the Target Corp.

a. G/L – no G/L if solely in exchange for stock or security (§361(a))

b. Boot

(1) recognize boot received as G up to realized G if it isn’t distributed. (§361(b))

(2) If it is distributed, no G/L is recognized, unless it is boot which is appreciated prop.

(3) FMV of prop received can’t be less than liab. assumed. (§361(c)(3))

5. Tax Effect to Acquiring Corp.

a. §1032 - corp. has no G/L on exchange of its own stock for prop.

b. A/B – A/B is transferred prop. A/B in hands of target + G recognized by target, but not including target s/h’s (§362(b))

c. Tax effects transfer over – asset holding period, E&P, NOL’s, cap loss carryovers


C. “B” Reorganization (stock for stock) no $ is involved

1. Stock for stock exchange (§368(a)(1)(B)) where the target (T) becomes a sub. of the acquirer (P)… usually tender offers.

2. Advantages of B reorg.

a. P will never be subject to the liabilities of the target since it does not merge with it or take its assets.

b. Do not need bd. approval or s/h approval

c. Don’t have to worry about transferring individual assets, which may be subject to debt with restrictive covenants or intellectual prop.

3. Requirements for B reorg.

a. Only voting stock can be used to pay off s/h.

(1) Qualitative - Must be able to vote for directors… ability to vote on M&A isn’t enough.

(2) Quantitative - Must be able to elect a significant amount of directors – meaningful vote… if class can vote 3 of 8 directors, that is good (Rev. Rul. 69-126)

(3) Potential voting stock (e.g., warrants, convertible debt) isn’t voting stock until it is exercised.

b. No boot can be used by P to buy stock from s/h – NO BOOT PERIOD!

(1) If any s/h receives cash, it ruins the transaction for everyone.

(2) If P pays for costs of merger (including legal fees, accounting fees, and costs of registering T s/h when they want to sell their new P stock) is OK. (Rev. Rul. 73-54 and Rev. Rul. 67-275).

- However, P can’t pay for costs of T’s s/h’s, such as their taxes.

(3) Turnbow – can’t use §356 boot rules to get around requirement, since w/o §368 satisfied, there is no merger for s/h to be a party to

c. Related to boot rules:

(1) Stock must be acquired for stock, but debt holders of T can be paid off with anything… debt, stock, cash (Rev. Rul. 98-10)

- If s/h owns debt, then there is question of valuation and whether debt was overpaid and should have been attributed to the stock.

(2) Other s/h’s of T can buy stock of T’s dissenting s/h (Rev. Rul. 68-562) – Rule is that P can’t pay cash or prop. for stock… other parties are not considered.

(3) T can redeem s/h’s before merger as long as the cash comes out of its own funds… if T borrows for it, it is ultimately paid by P. (Rev. Rul. 75-360)

- Redemptions affect continuity of interest and continuity of business enterprise. If Redemption is large, must make sure that B reorg. passes these two tests as well. (Rev. Proc. 77-37)

(4) T can declare extraordinary dividends before the reorg. as long as it uses its own funds to pay s/h (Rev. Rul. 70-172). Continuity of interest and business enterprise issues though again.

(5) P can buy treasury stock from T or advance funds to T as long as T doesn’t transfer the cash to s/h (e.g., uses it to pay off debt holders or taxes) (Rev. Rul. 72-522)

(6) Contingent consideration - pay more shares if T performs. OK as long as:

Additional consideration is voting stock; Maximum amount (cap) is stated; Must have at least 50% of cap at start; Must all be issued w/in 5 yrs; Cap must be on objective standards (e.g., earnings); and Contingent rights are not assignable. (Rev. Proc. 88-42)

d. P must have control of T after merger – 80% by vote and value of each class of shares (§368(c))

(1) Only need to get to 80% control for B reorg. – don’t actually have to acquire 80%… you must acquire 80% in transaction for C reorg.

(a) Creeping B – buy some stock with cash and then only transfer a smaller amount in the actual merger transaction later

However, can’t be clear step transaction or they will be combined and you will lose B reorg. (Chapman)

(1) How much is time is necessary? Regs give say 16 yrs is OK, but 1 yr isn’t enough (1.368-2(c). Chapman was 14 mos… disallowed since merger contemplated.

(2) Can always sell stock recently acquired with cash and then do a stock for stock transaction for the 80%.

(b) If P already has > 80% of stock, any stock for stock exchanges will be B reorgs.

(c) If P is a little short, it can always buy treasury stock from T or have T redeem it’s s/h to increase P’s ownership %, as long as the s/h do not get the cash from P.

(2) If T s/h have control of P after merger (i.e., P is really small), then it is a §351 transaction, with T stock contributed to P (can’t be §304 since no prop. is allowed to be transferred)

4. Tax effects – None really – no boot

a. G/L – no G/L to T (§361); no G/L to P (§1032); no G/L to s/h (§354)

b. A/B - is transferred basis for all… P takes T stock w/ T s/h’s A/B; T s/h’s keep old A/B in T stock for P stock.

c. Holding period of stock carries over.

d. Tax attributes (i.e., E&P, NOL’s, cap loss carryovers) do not transfer to P since T still exists.

5. Liquidation of T

a. If P liquidates T after reorg., it is a tax-free liquidation under §332. P will take T’s A/B in its assets, but lose it’s basis in T stock

Same result to P as if it merged or purchased asset – A, B, and C reorgs all have same final result if P ends up with all of the assets.


b. P can’t liquidate as part of B reorg. – must be STOCK FOR STOCK TRANSACTION … it would be a C reorg. if liquidation is part of reorg.


D. “C” Reorganization (stock for assets)

1. Transfer of majority of assets mostly for voting stock – not statutory merger. (§368(a)(1)(C))

a. Assets are transferred individually, one at a time… more of a hassle… usually only C when A not available.

b. Liabilities are also transferred in the C reorg., but liab. relief is not considered boot unless other boot is included under boot relaxation.

2. Qualifying for C Reorg.

a. Statute requires transfer “solely for voting stock”, but includes boot relaxation

Boot Relaxation (§368(a)(2)(B))

(1) >= 80% of the FMV of the T’s assets acquired by P must be exchanged for voting stock to qualify for reorg.

(a) Size of target (T) in comparison to acquirer (P) is irrelevant

(b) The test considers % of assets transferred by P that is voting stock, not how much of T’s total assets are actually received by P… that is substantially all test – only look at what P pays, including debt assumption.

(c) Essentially, must buy 80% control of T through it’s assets in merger, unlike B, where only need to own 80% after merger.

(2) Boot

(a) If there is other consideration besides voting stock and assumption of liab., the assumption of liab. is boot.

(b) Non-voting stock is considered boot for these purposes.

(c) Payment of expenses directly related to the reorg. by P will not cause boot. (Rev. Rul. 73-54)

(3) If debt is incurred in connection w/ the reorg, it’s counted as part of the reorg., coming from P, since P ultimately has to pay for it . (Rev. Rul. 73-102 and Southwest Consolidated)

- prevents T from taking debt to pay s/h cash and then have P cleanly transfer stock for encumbered assets of T, since liab. is not considered boot w/o other boot. The exclusion for debt assumes only ordinary business debts of T, not debt taken out for the merger

b. “Substantially all” requirement – must get substantially all of the assets of T

(1) Test to be substantially all. Transfer by P must be : (Rev. Proc. 77-37)

(a) 90% of FMV of net assets of T, AND

(b) 70% of FMV of gross assets of T

(2) Total Asset Base

(a) Cash removed from corp. because of dissenters counts as part of total asset base.

(b) Any assets distributed to s/h before the merger or in connection with the merger are considered part of the total asset base.

(3) Mechanical test is purely to get IRS ruling. If you miss mechanical test, still may be able to win in ct. Better off if: (Rev. Rul. 57-518)

(a) the assets that aren’t transferred from T to P in reorg. are non-operating rather than operating,

(b) the assets are used by T to pay off debt rather than distributed to s/h, and

(c) T does not retain a line of business.

c. Still need continuity of business enterprise.

d. C reorg. rules requires T to liquidate, unless IRS waives the requirement (§368(a)(2)(G)) However, it doesn’t have to dissolve.

If T has bondholders, it must pay them off before it liquidates – either transfer stock or boot to bondholders or sell enough P stock to pay off bondholders

(1) Distributions to creditors are treated as transfer to s/h if qualified prop (stock or security) (§368(c)(3))

(a) Corp. will have no G/L, neither will bondholder (security or stock for security or stock isn’t taxable (§354(a))).

(b) Bondholder transfers A/B of its bonds to its newly received stock.

(2) If T sells P stock to pay off bondholders, it is a fully taxable transaction.

(3) If bond goes to s/h, it is boot to the degree its face value > face value given up by s/h.(§356(d))

e. If P already owns > 80% of T before the asset sale, it can simply use a §332 tax deferred subsidiary liquidation.

3. The Tax Effects – Same as “A” reorg.

a. A/B – T’s A/B in its assets carry over to its P stock (§358) +boot received – G recognized (net of dividends).

b. Boot is recognized by s/h as G

(1) Non-voting stock is not considered boot for G/L purposes (unless it is 351(g) stock), only qualification purposes.

(2) Assumption of liab. is not considered boot for G/L purposes, either.

(3) Short-term notes are boot.

(4) Clark rule applies for character of G… if it qualifies as exchange redemption under §302 it is cap. G.. if not it is div. under §301 to the extent of E&P.

VIII. Triangular Mergers


A. Generally

1. The acquirer forms a subsidiary and the transaction occurs between the subsidiary and the target.

2. Advantageous in that it keeps the target out of the parent’s shell and limits the parent’s liability (e.g., from tort suits or environmental penalties).

3. The biggest problem is that the parent is not technically a party to the reorganization without special statutory help. (Groman, Bashford)

- If not a party to the reorg., the reorg. provisions do not apply to their actions or contributions


B. “C” Triangular Reorganizations

1. C with dropdown

a. Assets transferred from target (T) to parent (P) in C reorg. for stock of P and then contributed to the sub (S) in exchange for S stock. The P stock is then distributed to T s/h in liquidation.

b. Continuity of interest - without statutory help, there is no continuity of interest since the parent doesn’t have the assets (Bashford). Statutes were passed to make it work:

(1) §368(a)(1)(C) and §368(b) makes P a party to the reorg. if it controls S.

(2) §368(a)(2)(C) makes the drop-down part of the transaction and a continuity of interest if it controls S.

- However, cannot mix both P and S stock in the transaction… must use one or the other, even if you acquire 80% of one of the stocks. (§368(a)(1)(C))

c. The transfer between T and P

(1) The transfer between T and P must meet normal C reorg. rules.

(2) Tax the transaction as a normal C reorg.

d. The drop-down is treated as a §351 transaction. P must control (>= 80%) S

(1) If liab. are dropped down, P must reduce A/B in stock by liab.

(2) If no new stock is issued to P from S, P must allocate the A/B increase from the contribution among the S stock it already owns. If new S stock is received, it will separately carry the A/B of the assets contributed.

2. Direct Triangular C

a. P contributes P stock to S in exchange for S stock. The assets are then transferred from T to S in exchange for the P stock. The P stock is distributed to T s/h in liquidation.

b. No problem b/w T and its s/h

c. Problem is with transaction b/w P and S

(1) Problem:

(a) When P contributes stock to S in exchange for S stock, P’s A/B in S stock is 0 since it’s A/B in its own stock is 0… would have huge G on later sale.

(b) S’s basis in P stock is 0 and §1032 doesn’t apply since it the stock transferred to T isn’t S’s own stock… huge G on later sale.

(2) Solution:

(a) §1.358-6 – P’s A/B in S stock is treated as if P received the assets and liab. and then dropped them down – P’s A/B in S stock is A/B of T’s assets.

- If T’s liab. > A/B of assets, P keeps 0 A/B in S stock.

(b) §1.1032-2 – if stock is received as part of a reorg., it is to be treated as if P stock was S’s own stock – no G/L

- As a result, Direct C has the same exact tax effects as C with drop down.

d. Recently purchased P stock from market by S

(1) §1.1032-2 doesn’t apply to recently purchased stock by S, and therefore, §1032 doesn’t apply.

(a) S will have to recognize G on transfer of purchased stock to T.

(b) If some stock of P is purchased and some issued by P, only the stock purchased is subject to G… the stock issued is still under §1032.

(2) S’s A/B in the purchased P stock will be its cost to purchase the stock.

(3) P must reduce the A/B of its S stock by the FMV of the purchased P stock that is used in the transaction (§1.358-6(d)) (since normally it would have the A/B of T’s assets).

- However, the A/B can’t go below 0.

(4) However, no effect to anyone else in the Reorg… Reorg. goes on.

3. Triangular C when P delivers stock to T (or even it’s s/h) – treated exactly the same as if P received the assets and dropped them down to S (Rev. Rul. 70-224)


C. “A” Triangular Reorganizations (Triangular Merger)

1. P transfers P stock to S in exchange for S stock. S merges with T and T gives T s/h P stock.

- If merger shortcuts and P directly transfers P stock to A, it is still treated as if a full merger occurred.

2. Party to Reorg. - §368(a)(2)(D) – makes P a party to the reorg.

a. Without it, No “A” Reorg. when mainly P’s stock is used since P is not party (Groman and Bashford).

b. “B” and “C” reorg. section actually states that controlling P is party to reorg., unlike “A”

- If S uses enough of its own stock to qualify w/o P, then there is no party to reorg. problem and this section is irrelevant… just normal S-T merger and P stock that is transferred to T is boot.

3. Requirements of §368(a)(2)(D)

a. Must get “substantially all” of the prop. of T

(1) same “substantially all” test as C reorg. – 90% net assets, 70% gross assets

(2) Can get around this if P pays for dissenters or redeems dissenters’ P stock afterwards.

(a) The statute only looks at T’s assets, so the amounts used by P to buy T stock from s/h or redeem his P stock afterward would not be included.

(b) However, this does affect continuity of interest test (but it has a much lower threshold… 40% - Nelson)

b. No stock of S can be transferred to T’s s/h – absolutely none

(1) This includes non-voting stock

(2) S bonds can be issued by S, but they are other prop. (i.e., boot) and are taxed to the s/h to the extent that their face value is greater than face value given up by s/h.

- This brings up the question of whether the instrument is really debt or stock… big difference in result.

(3) Stock of unrelated corps (e.g,. IBM) is boot.


(4) P can assume T’s liabilities w/o it being boot.

c. Transaction would have been good merger if T into P (i.e., continuity of interest and continuity of business enterprise)

4. Tax consequences – same as A reorg. with P and dropdown into S

a. No G/L to P, S, T, or s/h is no boot

b. P’s A/B in S stock is equal to T’s A/B in assets (net of liab) – same as if dropdown.

- If S debt or other prop of S is used, the A/B of P’s S stock must be reduced by the FMV of the S securities/assets used. Stops at 0, but no G is recognized by P on amounts beyond that.

c. §1.1032-2 and §1.358-6 are used to make the transaction work cleanly (A/B of P and S stock used)

5. Can also merge w/ P and dropdown assets to S, but then asset must go through P and increase the chance of liab. problems (e.g., environmental, tort)

6. The P stock received by T’s s/h is not eligible for §351 treatment if other outside corps. also transfer their prop. in exchange for P stock… can’t be combined since P did not technically receive T’s assets or it’s stock… S did. (Rev. Rul. 88-44)














D. Reverse Triangular Mergers

1. S merges into T using P stock (“A” reorg) and T s/h get P stock. P acquires T, but T is survivor instead of S.

a. Very much like a regular “B” reorg., but it has different requirements and more flexible. “B” is easier if you can meet its requirements.

b. Usually done for non-tax reasons… e.g. to keep brand name of T, franchise problems, or special license.

2. Party to Reorg. - §368(a)(E) – makes controlling P a party to the reorg.

3. Requirements of §368(a)(E)

a. Must have qualified as good merger w/ parent – continuity of interest and continuity of business enterprise

b. Surviving corp, T, must hold substantially all of the assets of the two prior corps., both T and S (excluding P stock that was distributed). Same rule as C reorg.- 70% gross assets and 90% net assets.

(1) The test is applied separately on each corp. (§1.368-2(j)(3)(iii))

(2) If prop. is part of consideration in merger from P, it can be paid out to s/h w/o affecting substantially all test (reduces total asset pool) – However, this affects 80% control test.

- If T distributes it’s own funds, it is part of total asset pool for the test (but helps 80% test)… essentially P can pay cash w/o causing a problem for substantially all test, but T can’t

c. T’s s/h must exchange >= 80% of their stock for P voting stock.

(1) P Must actually buy 80%, not just hit 80%. Can’t creep.

- Of course, could always sell stock you currently own to unrelated party and then buy 80%

(2) Need to acquire 80% for voting stock, but rest can be done with cash.

(3) If T redeems stock from s/h before merger, it helps the 80% test (but hurts the substantially all test)

- “B” only requires control at end, but it also doesn’t allow any cash.

4. Tax Effects

a. P takes A/B in T stock as if it were forward merger.. received T’s assets and dropped them down (§1.358-6)

In B reorg, P takes A/B of T’s s/h in their stock as the A/B for P’s T stock.

(1) Special Rule – If transaction could have qualified as either B reorg or reverse triangular merger, but P went with reverse triangular merger, P can take A/B as either A/B of T s/h’s in T stock or A/B of T’s assets. (§1.358-6(c)(2)(ii)).

Also can choose if it qualifies for §351 and Reverse Triangular Merger.

(2) If P owns < 100% of T, the A/B is reduced in proportion to % of stock not owned.

(3) Also add any prop. distributed from P to S in the merger.

b. G/L under normal rules for “B”, except boot to s/h will be taxed.

E. “B” Triangular Reorgs

1. §368(a)(1)(B) actually makes a controlling P a party to the reorg.

2. Essentially the same as a normal “B”, but P’s stock is used. T becomes a sub. of S.

3. A/B of T stock to S is the A/B of T’s s/h. If P contributed anything other than P stock to S, that amount is added to P’s A/B in S stock. (§1.358-6)

4. Cannot mix both P and S stock in the transaction… must use one or the other, even if you have 80% of one of the stocks. (§368(a)(1)(B))




















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