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Course: Corporate Taxation Spring 2002
School: Wayne State University
Year: 2002
Professor: McIntyre
Course Outline provided by



VII. Corporate Reorganizations

A. Generally

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

2. When P acquires stock (B reorg) or assets (C reorg) of T and T gets stock as consideration from P, treat as if P stock went to T and T distributed the stock to its 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)) NON-STATUTORY REQUIREMENT (ic)

(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% (ic) 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?

  1. 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

    1. Convertible debt doesn’t provide continuity. (ic)

(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) (ic)

(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) NON-STATUTORY REQUIREMENT (ic)

(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 (ic) 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 its 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. Two requirements: (stk for assets and substantially all assets)

  1. Statute requires transfer “solely for voting stock” (ic), but includes boot relaxation (ic):

Boot Relaxation (§368(a)(2)(B))

(1) >= 80% (ic) 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) (ic)

(a) 90% (ic) 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 dissenter’s 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” (cash for stk) 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.




  1. Is it an acquisitive reorg? §368?

  2. Tax consequences §§354; 356

    1. Realized g/l:

      1. Fv minus adj basis of stk/assets

    2. Recognized g/l

      1. Boot & boot relaxation

  3. Tax Basis: §358

  4. Holding period §1223



Alice 75% ownership Basis 825k

Sam 15% ownership; Basis 165k

10% minority int


B” Reorg (stk for stk) §368(a)(1)(B)

  1. This is an acquisitive reorg type B (stk for stk) §368(a)(1)(B)

  2. AHS stk solely for BC stk. AHS is now a controlled subsidiary(90% owned by BC)

  3. Control test: BC now owns 90% (sufficient to meet 80% control test)§368(e)or “c”

  4. Realized gain:

    1. Alice; rec’d 1.5 basis of 825 = 675k realized §

    2. Sam; rec’d 330 and basis of 165 = 135k

    3. BC;

  5. Recognized gain

    1. Alice; no recognized gain from exchange b/c both are parties to a reorg and are exchanging stk of one corp to another pursuant to §354(a)

    2. Sam; same as above §354(a)

    3. BC; §1032

  6. Basis

    1. Alice; same basis in new stk (825k) §358(a)

    2. Sam; same (165k) §358)(a)

    3. BC; same as it was in Alice’s and Sam’s hands §362(b) (total of 825+165=990)

  7. Minority Interest:

    1. If dissenting shsrs have dissenters rts under state law that require them to be bout out then NO “B” reorg b/c can’t pay any cash in a “B” reorg.

    2. All realized gains are then recognized.

  8. Boot:

    1. If Alice and Sam rec’ “non-voting stk or any BC debentures” in exchange then violates the “solely for stk” requirement.

    2. Step transaction would also disqualify if show it was part of an integrated transaction RR 75-123.

      1. Buy out minority interest before the reorg RR 68-285

    3. All realized gains are then recognized. Alice, Sam, and BC have recognized gains.

  9. Subsequent liquidation of AHS and cash out of minority interest;

    1. Subsequent liquidation can’t be viewed as an integrated transaction with the initial acquisition. If not viewed as an integrated transaction then the liquidation is NOT taxed §332(a). BC would report no g/l on liquidation of AHS.


“A” reorg (CASH FOR STK) aka “STATUTORY MERGER” §368(a)(1)(A)

  1. Non-voting BC stk and BC debentures affect “B” reorg but not “A” reorg.

    1. “A” reorg requires continuity of propriety int, it does not require solely voting stk.

    2. BC debentures are NOT considered a proprietary interest for purposes of continuity of interest test.

    3. BC voting stk m/be at least 50% (ic) of the value of the consideration paid to qualify as an “A” reorg.

  2. Minority interest could be bought out for cash with out jeopardizing the tax-free reorg

  3. The rest is same as above.








“C” reorg (ASSETS FOR STK) §368(a)(1)(C)


  1. “Substantially all of its assets” (80%) m/be transferred.

  2. “Solely for stk of AHS”

  3. Subsequent liquidation of AHS is considered part of the reorg and IS REQUIRED under §368(a)(2)(G).

  4. Realized/Recognized g/l

    1. AHS: reports no g/l on receipt of BV voting shrs §361(a)

    2. AHS: reports no g/l upon the distribution of BC voting stk in liquidation under §361©

    3. Alice: non-recognition §354 upon receipt if BC voting shares in liquidation of AHS

    4. Sam: non-recognition §354 upon receipt if BC voting shares in liquidation of AHS

  5. Basis;

    1. Alice; same as b4 reorg §358(a)

    2. Sam; same as b4 reorg §358(a)

    3. Minority Interest shrs: will report gain upon receipt of BC stk.

    4. BC: would acquire assets with its cost basis.

  6. Boot:

    1. Assumption of Liab;

      1. Not considered boot paid under §368(a)(1)(C).

      2. “Boot relaxation” rule does consider liab as money paid for prop solely for purposes of deciding whether the acquired corp is acquiring 80% of he fmv of the prop solely for stk.

        1. BC paid 400 in boot (assumption of liab 300 + 100 in non-voting stk). This may cause BC to violate the “solely for voting stock requirement” if boot > 10% of boot relation available.

    2. BC debentures given;

      1. Alice and Sam will report gain pursuant to §356 to the extent that the principle amount of the securities rec’d exceeds the principle amount of securities surrendered.

      2. BC’s basis in the assets under §362(b) will increase by the amount of Alice’s and Sam’s gain.

    3. Non-voting stk;

      1. Under “boot relaxation” rule, the transaction would still qualify as “C” reorg as along as BC acquires 80% of fmv of AHS’s property for BC voting stk. If acquire 90% then 10% can be acquired for something other than voting stock.

  7. If violates “C” reorg:

    1. Taxable sale

    2. Recognize gains for everyone

    3. AHS is no longer required to liquidate; but if it did liquidate then the distribution in liquidation would be taxable to Alice and Sam under §331.

    4. BC would acquire the assets at cost basis.

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) (CASH FOR STOCK)

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 (ic)

(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 (ic)


(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) (ic)

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) (ic)

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. (ic)

(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 (stock for stock)

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)

  1. 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))


















Greg 50% Carol 25%

Bobby 25% Jan 25%

Peter 25% Marsha 25%

Father Mike lent 50k to corp Cindy 25%


  1. DSI creates a S. DSI acquires IDI stk for voting stk. DSI contributes IDI stk to S.

    1. B: reorg followed by “Drop Down” of IDI stk to S

    2. The initial B reorg will not be disqualified by the drop down §368(a)(2)(C). Mieks not is a “separate transaction” and doesn’t affect the reorg.

    3. Incorp of S:

      1. §351 & §1032 not taxable to DSI or S

      2. S’s basis in IDI shares is the same as DSI had which was the same as ID’s shrs had.

    4. Stk for stk btwn DSI & IDI is a B reorg .

      1. IDI shshr take under non recognition §354(a)

      2. IDI shrs have a basis in DSI stk the same as IDI stk §362(b)

  2. DSI creates S and transfers DSI stk for S stk. S acquires all IDI stk for DSI stk. What if S acquired all of IDI stk in return for DSI voting stk and S voting stk? Or DSI voting stk and S debenture?

    1. Since S is using “solely voting stk” of its parent DSI, this qualifies for control purposes. For B reorg purposes, the acquiror must use solely its own stk for solely the voting stk of a corp that controls the acquirer but not a combination. This is a disadvantage to the B reorg.

    2. S could not use both DSI and S voting stk. S’s voting stk would act as boot and NO boot is allowed in a B reorg. Also, not debentures are allowed under a B reorg.

    3. Formation of S is governed by §351 & §1032.

    4. S is entitled to non-recognition under §1.1032-2 and S would report gain only to the extent that is used DSI stk that it did not rec as part of the reorg. This is way S must be newly created.

    5. S’s basis in IDI is same as IDI shrs §362(b)

    6. IDI shrs rec non recognition under §354 and their basis is same as previous basis in IDI §358

  3. DSI acquires all IDI assets for DSI voting stk. Immediately after DSI contributes the assets to S (new sub)

    1. C” reorg followed by a drop dwn. They drop dwn doesn’t disqualify the C reorg. §368(a)(2)(C)

    2. DSI reports no g/l upon receipt of IDI assets in exchange for voting stk §1032

    3. Basis for DSI is same as IDI had §362(b)

    4. IDI reports no g/l upon receipt id DSI voting stk in exchange for its assets §361

    5. The subsequent drop down is governed by §351 & §1032 with no g/l to DSI or S. S will hold the assets with the same basis that DSI had under §358, which is the same basis that IDI had.

  4. DSI creates S by transferring DSI voting stk in return for S stk. S acquires all assets of ID in return for DSI voting stk. IDI then liquidates DSI stk to its shsrs. What if S acquired all of IDI assets in return for DSI voting stj and S voting stk? For DSI and debentures?

    1. This is a forward triangular C reorg permitted under C reorg definition, which permits the use of solely voting stk of the acquiring corp. or solely the voting stk of a corp in control of the acquiring corp.

    2. The liquidation of IDI is a required component of the transaction. §368(a)(2)(G)

    3. Initial incorp of S is governed by §351 & §1032. In the subsequent C reor, S is the acquiror but S, DSI & IDI are all parties to the reorg.

    4. S’s receipt of IDI assets in exchange for DSI voting stk is treated as a non-recog event under §1.1032-2

    5. S’s basis in the assets will be the same as IDI had. §362(b).

    6. IDI’s receipt of DSI voting stk in return for its assets not be taxable under §361(a) and its subsequent distribution to its shrs will also not be taxable §361(b). The IDI shrs who rec the DSI voting stk in liquidation will not report any gain or loss under §354 and will rec a substituted basis under §358.

    7. Combining S & DSI stk or using debentures is only permitted under “boot relaxation rules”. S must acquire 80% of IDI’s assets for DSI voting stk to qualify as a C reorg. If it fails the boot relaxation then treat as a taxable exchange to IDI shrs under §331.

  5. DSI creates S transferring DSI stk for S stk; ID then merges into S in a “statutory merger.” What if S merged into IDI Effect of paying Mike in cash?

    1. Triangular “A” reorg. §368(a)(2)(D); use of DSI’s stk doesn’t disqualify the A reorg as long as NO S stk is used. §1.1032-2(b)

    2. DSI will report no g/l §1032

    3. S will report no g/l as long as S uses DSI stk that it DID NOT rec pursuant to the reorg plan; §1.1032-2©

    4. IDI’s assets retain the same basis in S’s hand §362(b).

    5. Over the top method:

    6. Reverse triangular merger if S merged into IDI. §368(a)(2)(E); its ok if IDI holds substantially all of its properties and the merged corps properties (S’s) after the exchange. IDI’s shrs must have exchanged a sufficient amt of IDI stk for DSI stk to constitute control. S had no assets other than DSI stk. DSI’s stk is not counted for purposes of determining whether the surviving corp holds substantially all of its own properties after the reorg. The second requirement is also met since all of IDI’s assets were transferred for DSI voting stk.

      1. DSI’s basis in IDI stk in a reverse tri merger equals its basis in its S stk immediately before the transaction as if IDI had merged into S in a forward triangular merger §1.3358-6(c)(2).

      2. IDI shr’s get non-recognition under §354 upon receipt of DSI stk and use their basis in IDI stk for their new basis in DSI stk §358.

  6. Does it make a difference if DSI used an already existing S as opposed to newly created S?

    1. If pmt to Mike is part of an integrated trans then B reorg with drop dwn and direct B reorg will be disqualified from tax free reorg since not “solely for voting stk:”


    1. C reor: the pmt to Mike doesn’t disqualify the trans. Boot relation.

    2. Under the forward triangular reorg provides the greatest flexibility. As long as the > 50% of consideration takes a non-equity form A reorg will still qualify. IN a reverse triangular merger §368(a)(2)(E) requires that IDI shrs transfer 80% control in return for DSI voting stk.

  1. IF S was a preexisting Sub:

    1. Its ok in each situation but the S will report gain §358 & §1032 to the extent that it uses DSI stk that it didn’t rec as part of the reorg transaction.

    2. In addition, DSI’s old basis will be adjusted in accordance with new regulations

    3. In a reverse triangular merger, DSI must also consider the tax consequences of any old stk in the target corp that it held b4 the reorg.



























  1. “C” is owned 50% (25k bv) by A and 50% by B (25k bv). C has two divisions FL (100k bv & 500k fmv) and SG (75k bv & 300k fmv). C transfers FL to Newco, a new subsidiary. Immediately after C makes a prorate distribution of Newco to A & B. What are the tax consequences?

    1. Basic spin-off

      1. To qualify for §355 must have

        1. control of Newco immediately before the exchange

        2. both corporations are engaged in the active conduct of a trade or business immediately after the exchange

          1. Business purpose test: can’t be a devise to “distribute earnings and profits”.

            1. Need a purpose to create Newco and

            2. Need a purpose to distribute Newco’s stk

    2. Initial exchange in creating Newco is tax free §351

    3. C’s basis in Newco is same as that in FL (100k)§351

    4. Usually a distribution of stk other than of the corp is taxable to A & B ($250k each under §301 dividend distributions) but under §355 A & B report not g/l upon receipt of Newco shares §355(a).

    5. Basis to A & B is determined under §358. Property rec’d in a tax-free exchange has same basis as property exchanged. A & B have not exchanged anything for their Newco shares but §358© states that shareholder A & B are regarded as if their shares in C were surrendered and then rec’d back. A & B’s basis in Newco is their original basis of 25k each to be divided btwn C and Newco shares

      1. Allocation is based upon fv immediately after the distribution. 500//800 is allocated to Newco & 300//800 is allocated to C.

    6. Distributions are ordinarily taxable under §311. But if §355© then the gain becomes unrealized.

  2. If “C” operated FL through a preexisting “Oldco” and tehn C wanted to make a “pro rata” distribution to A & B; what are the tax consequences?

    1. A newly created S is not necessary. An “Oldco” is eligible for §355 treatment.

  3. What if A & B are each required to surrender ½ of their C shares in exchange for Newco?

    1. This is usually treated as a “redemption” and would be taxable under §302 and to the corp under §311.

    2. Assuming the transaction meets the business purpose test; A & B would be eligible for non-recognition of Newco’s receipt under §355©.

    3. Shareholder’s basis in Newco is determined under §358.

      1. §358(b)(2) provides a special rule for §355 cases under which the allocation of basis shall take into acct not only the property permitted to be rec’d w/o gain recognition, but also stk of the distributing corp which is retained. This means, the substituted basis for allocation purposes will include the full 25k basis the shrs A & B had in C and the basis will be allocated btwn Newco and C as described in (#1(e)(i))

  4. What if C transferred FL to Newco1 and SG to Newco2?

    1. “Split-up”

    2. A & B are exchanging “all” of their C shares in exchange for Newco this transaction is a “Liquidation distribution” and is normally taxed to shareholders under §331 and to the corp under §336.

    3. However, §355(a)0 provides a non-recognition to shareholders; & §355(c) provides non-recognition to corp.

    4. Shareholder’s basis in Newco is determined under §358; “substituted basis” (A gets 25k basis)

  5. What if C transferred only real estate to Newco and distributed the Newco stk prorate to A & B?

    1. This appears suspicious for non-recognition purposes. Real Estate alone is not a “trade or business”. Second, the transaction appears to be a device to distribute earnings and profit.

  6. C is owned by A (20%) & B (80%). C starts Newco and distributes Newco stk to B 80% and cash to A. What are the tax consequences?

    1. Spin off

    2. Cash rec’d by A is §301 taxable distribution

    3. Distribution to B raises §355 issues.

  7. If 90% of shareholder that rec’d Newco immediately sell their shares.

    1. Spin off §355

    2. Was this a device to distribute profits? B/c of the immediate sale of stk after receipt of Newco.

      1. If legitimate then §355 non-recognition; basis determined under §358

      2. If not legitimate then report gain on distribution §311 & shareholders have dividend income §301 for fv of distribution.








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