Evaluate Tax Implications Of Reorganizations
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CPA Tax Compliance & Planning (TCP) › Evaluate Tax Implications Of Reorganizations
In a tax-free reorganization, when a target corporation's shareholder receives acquirer stock plus cash ('boot'), the tax consequence is:
Loss is recognized to the extent boot received exceeds the shareholder's basis.
No gain is recognized since the reorganization is tax-free.
Gain is recognized to the extent of boot received (the lesser of realized gain or boot), but the gain may be characterized as capital gain or dividend income depending on whether the exchange has the effect of a dividend distribution.
The entire transaction is taxable since boot was received.
Explanation
In reorganizations, boot triggers gain recognition limited to the lesser of realized gain or boot received. The character may be ordinary income (dividend) if the exchange has the effect of a dividend. Answer C is correct. The overall transaction remains partially tax-free (A). Boot triggers recognition (B). Losses are not recognized in reorganizations even with boot (D).
A Type B reorganization requires:
The acquirer to receive at least 80% of the target's assets.
The acquirer to purchase target assets using solely its own voting stock.
The acquirer to acquire control of the target (at least 80% of total voting power and value) using solely voting stock of the acquiring corporation - no cash or other property may be used.
The target to merge into the acquirer under state law.
Explanation
Type B requires a stock-for-stock exchange using solely voting stock - the 'solely for voting stock' requirement is strict, meaning even one dollar of cash disqualifies the exchange. Answer D is correct. Asset acquisition (A) describes Type C. Merger (B) describes Type A. 80% of assets (C) is not the Type B test.
In a tax-free reorganization, the acquiring corporation's basis in the target's assets is:
The acquiring corporation's purchase price allocated among the assets using the residual method.
Zero, since the assets were received tax-free.
Carryover basis - the same basis the target had in the assets, preserving any built-in gain or loss for future recognition.
Fair market value of the assets at the time of the reorganization.
Explanation
In a tax-free reorganization, the acquiring corporation takes a carryover basis in the target's assets - the deferred gain remains embedded in the assets. Answer A is correct. FMV step-up (B) only occurs in taxable acquisitions. Residual method (C) applies to taxable asset purchases. Zero basis (D) would be incorrect.
Which of the following reorganizations is considered 'divisive' rather than 'acquisitive'?
Type B (stock-for-stock)
Type A (statutory merger)
Type C (assets-for-stock)
Type D (divisive) reorganization - a corporation transfers part of its assets to a newly formed or existing controlled corporation, then distributes the stock of the controlled corporation to its shareholders under Section 355.
Explanation
Type D can be divisive (spin-off, split-off, split-up) - the corporation transfers assets to a controlled corporation and distributes the subsidiary's stock to shareholders. Answer D is correct. Types A, B, and C are acquisitive reorganizations.
In a spin-off under Section 355, a shareholder who receives subsidiary stock:
Must hold the subsidiary stock for 5 years to maintain the tax-free treatment.
Recognizes ordinary income equal to the distributing corporation's accumulated E&P.
Recognizes gain equal to the FMV of the subsidiary stock received.
Generally recognizes no gain or loss - the shareholder takes a basis in the subsidiary stock allocated from their original basis in the distributing corporation's stock.
Explanation
In a qualifying Section 355 distribution, shareholders recognize no gain - basis is allocated between the original stock and the new subsidiary stock. Answer B is correct. FMV gain recognition (A) is the result of a taxable distribution. E&P ordinary income (C) applies only if Section 355 fails. No post-distribution holding period requirement (D).
The 'continuity of interest' requirement for tax-free reorganizations requires that:
The acquirer must be continuously engaged in business for 5 years after the reorganization.
The target corporation must continue as a separate legal entity after the reorganization.
A substantial portion (historically interpreted as at least 40%) of the consideration paid to target shareholders must consist of acquirer stock - preserving target shareholders' equity interest in the combined enterprise.
All target shareholders must receive the same type of consideration.
Explanation
Continuity of interest requires that a meaningful portion of the consideration be equity in the acquirer - target shareholders must continue as equity holders in the combined enterprise. Answer A is correct. Continuous business operation (B) is the continuity of business enterprise requirement. The target often ceases to exist (C). Shareholders can receive different consideration (D).
When a corporation undergoes a tax-free reorganization and shareholders receive only acquirer stock (no boot), the shareholder's basis in the acquirer stock is:
Zero, since the exchange was tax-free.
Fair market value of the acquirer stock received.
The original cost of the target stock when first purchased.
Carryover basis - the same as the basis in the target stock surrendered (adjusted for any boot received or gain recognized).
Explanation
In a tax-free exchange, shareholders take a carryover basis in the stock received - the deferred gain is preserved in the lower basis. Answer C is correct. FMV basis (A) would eliminate the deferred gain. Zero basis (B) is incorrect. Original cost may differ from adjusted basis if prior adjustments occurred (D).
A Type E reorganization is a:
Statutory merger under applicable state law.
Recapitalization - a reorganization within a single corporation that changes its capital structure, such as exchanging bonds for stock, preferred stock for common stock, or modifying debt terms.
Divisive transaction distributing subsidiary stock to shareholders.
Stock-for-stock acquisition of a target corporation.
Explanation
A Type E reorganization is a recapitalization - a single-corporation restructuring of its capital (e.g., swapping bonds for equity, reclassifying stock). Answer D is correct. Mergers (A) are Type A. Stock-for-stock (B) is Type B. Divisive (C) is Type D.
A Type F reorganization is a:
Conversion of a C corporation to an S corporation.
Mere change in identity, form, or place of organization of a single corporation - such as reincorporating in a different state or changing the corporation's name.
Reorganization involving a foreign subsidiary.
Foreign-to-domestic conversion of a corporation.
Explanation
A Type F reorganization is a mere change in identity, form, or place of organization - the simplest type, such as moving incorporation from one state to another. Answer B is correct. Foreign conversions (A, C) have specific rules. C-to-S conversions (D) are not reorganizations.
In a tax-free reorganization, the target corporation's tax attributes (NOL carryovers, credit carryovers, E&P) carry over to the acquiring corporation, but are subject to:
Limitations only if the acquiring corporation is a C corporation.
Complete disallowance since the target corporation no longer exists.
No limitations - tax attributes carry over without restriction.
Section 382 limitations on the use of NOL carryovers - an ownership change of more than 50 percentage points limits annual NOL usage to the value of the target's stock multiplied by the applicable federal rate.
Explanation
Section 382 limits the use of acquired NOLs after an ownership change - the annual limit is the value of the target times the AFR at acquisition. Answer A is correct. Attributes carry over but are limited (B). Limitations apply (C). Section 382 applies broadly regardless of acquirer type (D).