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Chapter 17 Corporate Reorganizations

SUMMARY OF CHAPTER
This is the capstone chapter in corporate taxation. Students must understand corporate formations (Code Sec. 351), distributions and redemptions (Code Secs. 301-304, 311, 316), and liquidations (Code Secs. 331-338) before reorganizations become meaningful. Thus, Chapters 13-15 should be reviewed as needed.

Types of Corporate Reorganizations 17,001 Statutory Definitions

There are seven basic types of corporate reorganization defined in Code Sec. 368. They are referred to by the subparagraph in which they are defined (e.g., Code Sec. 368(a)(1)(A) defines a Type A reorganization).

17,005 General Requirements

In order to receive nonrecognition treatment, the transaction(s) must have been completed pursuant to a plan of reorganization. No gain or loss will be recognized if stock or securities in a corporation that is a party to the reorganization are exchanged solely for stock or securities of the same corporation or of another corporation that is a party to the reorganization. If boot is received, a realized gain will be recognized to the extent of the boot received.

17,009 Type A Reorganizations

This type of reorganization involves the acquisition of assets and includes statutory mergers and consolidations. A merger occurs when one corporation absorbs another; a consolidation occurs when two or more corporations combine in a new corporation, the former ones dissolving. This type of reorganization is the most flexible in that boot can constitute up to 50 percent of the consideration that is used to make the acquisition. A major disadvantage is that all liabilities of the acquired corporation (including contingent and unascertained liabilities) must be assumed by the acquiring corporation.

17,015 Receipt of Boot

If a shareholder or security holder receives cash or other property (i.e., boot) in addition to the stock or securities that are permitted to be received without the recognition of gain, then a realized gain must be recognized to the extent of the lesser of (1) the realized gain or (2) the fair market value of the boot received. The distributees basis for boot property is the propertys fair market value.

17,025 Character of Recognized Gain

After the amount of recognized gain is computed, its character must be determined. If an exchange has the effect of a dividend, then a shareholders recognized gain must be treated as a dividend to the extent of the shareholders ratable share of earnings and profits. Any additional recognized gain in excess of the amount to be treated as a dividend will be treated as a capital gain.

17,053 Type B Reorganizations

The acquiring corporation must use solely voting stock to acquire control (i.e., at least 80 percent) of the acquired corporation. Solely voting stock must be used; no boot is permitted. The acquired corporation remains in existence as a subsidiary of the acquiring corporation.

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17,105 Type C Reorganizations

This type of reorganization involves the acquisition of substantially all the properties of one corporation by another in exchange solely for all or a part of the acquiring corporations voting stock. In determining whether the acquisition has been made solely for voting stock, the assumption of liabilities by the acquiring corporation is generally disregarded. However, if the acquiring corporation exchanges money or other property in addition to voting stock, then at least 80 percent of the total fair market value of all the acquired corporations property must be acquired for voting stock.

17,157 Type D Reorganizations

This type of reorganization involves a transfer by a corporation of part or all of its assets to another in exchange for stock or securities, as long as immediately after the transfer the transferor owns sufficient stock to control the transferee, and the transferees stock and securities are distributed to shareholders of the transferor in a transaction that qualifies under Code Sec. 354, 355, or 356. A Type D reorganization is often divisive and may take the form of a spin-off, split-off, or split-up.

17,165 Gain Recognized in Divisive Transactions

Rules are imposed to prevent disguised sales of a subsidiary by the parent corporation that avoid any corporate-level tax. Thus, recognition of corporate-level gain on a distribution of subsidiary stock otherwise qualifying under Code Sec. 355 is required if, immediately after the distribution, a shareholder holds a 50-percentor-greater interest in a distributed subsidiary (or the distributing corporation) that is attributable to stock that was acquired by purchase after October 9, 1990, and within the five-year period ending on the date of the distribution. In such case, the distributing corporation must recognize gain just as if had sold the distributed stock to the distributee for its fair market value.

17,217 Type E Reorganizations

A Type E reorganization is a recapitalization (i.e., a change in the debt-equity structure) of a single corporation. For example, an exchange of stock for stock or of securities for stock in the same corporation would be a Type E reorganization.

17,277 Type F Reorganizations

This includes a mere change in identity, form, or place of organization of a single corporation. For example, a change of the state of incorporation, or a name change (e.g., from International Harvester to Navistar) would be a Type F reorganization.

17,285 Type G Reorganizations

This type of reorganization takes place while a corporation is insolvent or is in bankruptcy proceedings.

Considerations for Nonrecognition Treatment 17,321 Reorganization as an Alternative to Liquidation

In a liquidation, gains and losses are generally recognized to the liquidating corporation as well as to shareholders. Alternatively, realized gains and losses are not generally recognized in a corporate reorganization because the assets remain in corporate form.

17,351 Use of Subsidiaries in Reorganizations

A corporation can frequently use a controlled subsidiary to facilitate an acquisition in a Type A, B, or C reorganization. The two primary advantages of using controlled subsidiaries in reorganizations are that shareholders of the parent corporation do not have to approve the acquisition, and the parent corporation is protected from incurring the liabilities of the acquired corporation.

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17,375 Postreorganization Transfers to Subsidiaries

Once an acquiring corporation has acquired assets or stock in a reorganization, it may subsequently transfer all or part of the assets or stock to a controlled subsidiary in a Type A, B, C, or G reorganization.

Carryover of Tax Attributes 17,457 Introduction

Code Sec. 381 provides for the carryover of tax attributes in certain types of reorganization and liquidation. However, Code Secs. 269 and 381-384 limit the use of these carryovers by the acquiring corporation.

17,465 Attribute Carryover Transactions

The tax attributes (e.g., NOL carryovers, earnings and profits) of the acquired corporation generally carry over to the acquiring corporation in an A, C, acquisitive D, F, or G reorganization, and in a Code Sec. 332 liquidation.

17,473 Limitations on Carryovers

All tax attributes generally carry over to the acquiring corporation, both favorable (e.g., net operating losses) and unfavorable (e.g., earnings and profits).

17,481 Net Operating Loss Limitation

The amount of an acquired corporations NOL carryover that can be utilized by the acquiring corporation for its first taxable year ending after the date of acquisition is limited by Code Sec. 381(b) to the amount of the acquiring corporations taxable income that is allocable to the days in the taxable year that follow the acquisition date.

17,485 Ownership ChangesAnnual Limitation

When there has been a more-than-50-percentage-point ownership change, Code Sec. 382 limits the amount of taxable income that an NOL carryover can offset. The amount, called the Code Sec. 382 limitation, is equal to the value of the loss corporations stock immediately before the ownership change multiplied by the highest long-term municipal bond rate in effect during the three-month interval ending with the month of change.

17,497 Earnings and Profits

A deficit in the acquired corporations earnings and profits can be used only to offset the acquiring corporations earnings and profits that are generated after the acquisition date.

Judicial Requirements 17,517 Introduction

In addition to satisfying one of the specific definitions of a reorganization found in Code Sec. 368, a transaction must meet certain judicial requirements in order to receive reorganization treatment.

17,525 Business Purpose

The transaction must have a valid business purpose other than tax savings.

17,533 Continuity of Proprietary Interest

The shareholders of the acquired corporation must receive stock in the acquiring corporation at least equal in value to 50 percent of the value of all the acquired corporations formerly outstanding stock.

17,541 Continuity of the Business Enterprise

The transferors historic business must be continued, or a significant portion (i.e., 1/3) of the acquired corporations historic assets must be used in a business.

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17,549 Step Transactions

CCH Federal TaxationComprehensive Topics

Transactions that are dependent on each other may be stepped together to determine whether the various reorganization requirements are met. For example, the overall result of multiple transactions may be considered to determine whether an acquisition of stock has been made for solely voting stock, or to determine whether substantially all of a corporations assets have been acquired.

17,557 Liquidation and Reincorporation

A liquidation followed by an incorporation may be treated as a Type D reorganization. As a result, assets will have a carryover basis, and tax attributes such as earnings and profits will carry over to the newly formed corporation.

17,569 Acquisitions Made to Evade or Avoid Income Tax

Certain losses and deductions may be disallowed if it is determined that the primary purpose of an acquisition is to secure the deductions and losses and, as a result, evade or avoid income tax.

ANSWER TO KEYSTONE PROBLEMCHAPTER 17

( 17,105.) 1. This is a Type C reorganization. Bark recognizes no gain or loss. Arks basis in Barks assets is a carryover basis, and Ark succeeds to Barks tax stock in Ark. The cash received will most likely be treated as a dividend if distributed pro rata to Barks shareholders. 2. Because the 20 percent boot relaxation rule is violated, this will be treated as a taxable liquidation. Bark will recognize gain or loss and investment tax credit recapture. Ark will receive a stepped-up basis, a cost basis, in Barks assets. Barks shareholders will recognize capital gain or loss under Code Sec. 331 equal to the cash and fair market value of the Ark stock received, less their basis in Bark stock. A fair market value basis in Ark stock results.

ANSWERS TO QUESTIONSCHAPTER 17
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19.

Topical List of Questions Types of Reorganization ( 17,001) Acquisitive Reorganizations (Overview) Continuity of Business Enterprise/Proprietary Interest ( 17,541) Continuity of Proprietary Interest ( 17,549) Issuance of Acquiring Corporations Stock ( 17,009) Basis for Acquired Property ( 17,009) Basis for Stock and Securities ( 17,009) Securities as Boot ( 17,015) Boot Treated as Dividend ( 17,025) Definition of Type A ( 17,009) Advantages and Disadvantages of Type A ( 17,009) Type A Use of Boot ( 17,009) Definition of Type B ( 17,053) Advantages and Disadvantages of Type B ( 17,053) Redemption of Shareholders in Type B ( 17,053) Tax Attributes in Type B ( 17,053) Definition of Type C ( 17,105) Substantially All Requirement ( 17,105) Boot Relaxation in Type C ( 17,105)
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20. 21. 22. 23. 24. 25.

Avoiding Shareholder Consent in Type A ( 17,351) Subsidiaries in Reorganizations ( 17,351) Substantially All Requirement ( 17,105) Definition of Type D ( 17,157) Definition of Spin-Off, Split-Off, Split-Up ( 17,157) Definition of Type E ( 17,217)

Answers to Questions
Types of Reorganization 1. There are seven types of reorganization as defined in Code Sec. 368(a)(1): (1) Type A: Statutory merger or consolidation (2) Type B: Acquisition of stock in exchange for voting stock (3) Type C: The acquisition of substantially all assets in exchange for voting stock (4) Type D: Acquisition of assets for stock; divisive transfer of assets in exchange for stock, followed by a distribution of stock (5) Type E: Recapitalization of one corporation (6) Type F: Mere change in form, location, or identity of one corporation (7) Type G: Reorganization of insolvent or bankrupt corporation Acquisitive Reorganizations 2. The acquisitive types of statutory reorganization include: Type Astatutory merger or consolidation; Type B acquisition of stock; Type Cacquisition of assets; and an acquisitive Type D. Continuity of Business Enterprise/Proprietary Interest 3. Continuity of business enterprise refers to whether the acquired corporations historic business assets are retained after the acquisition. Generally, a minimum of one-third of the assets must be retained and used in a business. Continuity of proprietary interest refers to whether the acquired corporations shareholders have an equity (stock) interest in the acquiring corporation after the acquisition. Generally, a minimum of 50 percent of consideration given to the acquired corporations shareholders must be stock of the acquiring corporation to satisfy this requirement. Continuity of Proprietary Interest 4. The continuity of proprietary interest requirement may be failed if the shareholders of the acquired corporation sell their stock in the acquiring corporation soon after the reorganization. This is because the IRS and the courts would measure the amount of continuing equity interest remaining after the sales of stock had taken place. Issuance of Acquiring Corporations Stock 5. Per Code Sec. 1032, a corporation never recognizes any gain or loss when it issues its stock (including treasury stock) in exchange for money or property. This nonrecognition rule applies even though the transaction fails to qualify as a reorganization. Basis for Acquired Property 6. The basis of property acquired by a corporation in a reorganization is determined under Code Sec. 362(b). Its basis is the same as it was in the hands of the transferor increased by any gain recognized to the transferor. Since the transferor will ordinarily not recognize gain, there generally will be a carryover basis for acquired property. If an acquisitive transaction fails to qualify as a reorganization, it will be treated as a taxable exchange. The basis of property acquired in a taxable exchange is always equal to its fair market value.

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Basis for Stock and Securities

CCH Federal TaxationComprehensive Topics

7. Shareholders and security holders determine their basis for stock and securities received under Code Sec. 358(a)(1). The basis for stock and securities received equals the basis of stock and securities transferred, plus any gain recognized, and minus any boot received. The basis for any boot property received is equal to its fair market value. Securities as Boot 8. The receipt of securities will be treated as boot if the principal amount of securities received exceeds the principal amount of securities transferred. The amount of boot equals the fair market value of the excess principal amount. Corporate debt is treated as a security if it has a maturity of at least five years. Boot Treated as Dividend 9. Code Sec. 356 indicates that gain recognized in a corporate reorganization will be treated as a dividend to the extent of a shareholders ratable share of earnings and profits if the receipt of boot has the effect of a distribution of a dividend. Any remaining gain would generally be treated as capital gain. Whether the receipt of boot has the effect of a distribution of a dividend is determined by applying the redemption tests of Code Sec. 302 (including the stock attribution rules of Code Sec. 318) to the shareholder. Definition of Type A 10. A Type A reorganization is a statutory merger or consolidation. In a statutory merger, one of the combining corporations is dissolved and one survives (e.g., A + B = A; A + B = B). In a consolidation, both combining corporations are dissolved, and a new corporation is formed (A + B = C). Advantages and Disadvantages of Type A 11. Advantages include: Most flexible type of reorganization; non-voting stock can be used, and boot can be 50 percent of consideration. The substantially all requirement does not apply. Disadvantages include: All liabilities (including unknown and contingent) of the acquired corporation must be assumed. A majority of the shareholders of both corporations must vote to approve the reorganization. Dissenting shareholders normally have the right to have their shares valued and purchased for cash. The acquired corporation may have assets that are not transferable. Type A Use of Boot 12. Non-voting stock and securities can be used in a Type A reorganization. There is a limit on the use of boot in a Type A reorganization. Stock of the acquiring corporation must be at least 50 percent of the total consideration going to the acquired corporations shareholders to satisfy the continuity of proprietary interest requirement. Definition of Type B 13. The acquisition of control of an acquired corporation solely in exchange for voting stock of the acquiring corporation (or voting stock of the corporation that is in control of the acquiring corporation). Only voting stock is permitted; no boot can be used. A limited exception permits cash to be used in lieu of issuing fractional shares. Advantages and Disadvantages of Type B 14. Advantages: The acquired corporation remains in existence. No shareholder vote is necessary; acquisition takes the form of a tender offer. The assets of the acquiring corporation are protected from the liabilities of the acquired corporation because of the continued separate legal existence of the acquired corporation. There is no substantially all requirement to prohibit the spin-off of unwanted assets. Disadvantages: Only voting stock can be used to make the acquisition. Desirable tax attributes of the acquired corporation remain segregated and cannot be used to benefit the acquiring corporation. Redemption of Shareholders in Type B 15. The target corporation may use its own cash to redeem those shareholders who do not want voting stock of the acquiring corporation. Tax Attributes in Type B 16. Since the acquired corporation remains in existence in a Type B reorganization, its tax attributes remain in it and do not carry over to the acquiring corporation.

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Definition of Type C 17. The acquisition of substantially all of an acquired corporations assets solely in exchange for voting stock of the acquiring corporation (or voting stock of the corporation in control of the acquiring corporation). Substantially All Requirement 18. For advance ruling purposes, the IRS indicates that substantially all means the acquisition of a least 90 percent of the acquired corporations net assets and at least 70 percent of its gross assets. Some courts have held that the acquisition of all operating assets may qualify. Boot Relaxation in Type C 19. The boot relaxation rule refers to the possibility of using up to 20 percent boot in a Type C reorganization. However, generally no boot can be used because the amount of boot permitted (20 percent) is reduced, dollar for dollar, by any liabilities of the acquired corporation that are assumed by the acquiring corporation. Avoiding Shareholder Consent in Type A 20. By making the acquisition through a triangular merger or reverse merger (i.e., forming a new subsidiary or using one of its existing subsidiaries to make the acquisition). Subsidiaries in Reorganizations 21. Subsidiaries are primarily used in the Type A, B, and C reorganization. Substantially All Requirement 22. It would qualify as a Type C reorganization only if the acquisition meets the substantially all test in terms of the acquired corporations assets in existence prior to the spin-off. It would qualify as a Type A reorganization since there is no substantially all requirement that applies. Definition of Type D 23. A transfer by a corporation of some or all of its assets to another corporation, if immediately after the transfer the transferor or its shareholders are in control of the corporation to which the assets were transferred, but only if the stock or securities of the corporation to which the assets were transferred are distributed to the transferors shareholders in a transaction qualifying under Code Sec. 354, 355, or 356. Definition of Spin-Off, Split-Off, Split-Up 24. A spin-off is the transfer of stock of a controlled corporation to shareholders. A split-off is the same as a spin-off, except that one or more shareholders in the transferor corporation surrender some or all of their stock in the transferor corporation. A split-up is a transfer of all assets to two or more corporations followed by an exchange of stock, so that the transferor is liquidated and the transferors former shareholders, in the aggregate, control the transferee corporations. Definition of Type E 25. A recapitalization is a change in the debt-equity structure of a single corporation. A recapitalization might be used to convert preferred stock into common stock to enable the corporation to make a subchapter S election.

ANSWERS TO PROBLEMSCHAPTER 17
26. 27. 28. 29. 30. 31. 32.

Topical List of Problems Bond Swaps ( 17,015) Type B Reorganization v. Sale ( 17,053) Type B Reorganization: Solely for Voting Stock ( 17,053) Boot in Type A and Type C Reorganizations ( 17,009) Spin-Offs ( 17,157) Identification of Transactions ( 17,157) Type A, B, and C Reorganizations v. Code Sec. 332 ( 17,105)

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33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55.

CCH Federal TaxationComprehensive Topics

Reorganization v. Liquidation ( 17,157) Recapitalization ( 17,217) Split-Offs ( 17,157) Type B Reorganizations v. Other Transactions ( 17,053) Distribution of Disqualified Stock ( 17,165) Net Operating Losses: Carryovers ( 17,485) Taxable Merger ( 17,009) Triangular Merger ( 17,351) Recapitalization ( 17,217) Spin-Off ( 17,157) Treatment of Boot in Reorganization ( 17,025) Split-Off ( 17,157) Use of Subsidiary in Type B ( 17,351) Reverse Merger ( 17,351) Shareholder Gain and Basis ( 17,009) Acquired Earnings and Profits Deficit ( 17,497) Acquired Net Capital Loss Carryforward ( 17,481) Acquired Earnings and Profits Deficit ( 17,497) Sec. 382 Limitation ( 17,485) Comprehensive ProblemType C Reorganizations ( 17,105) Comprehensive ProblemIdentification of Transactions ( 17,001) Research ProblemDividend v. Spin-Off ( 17,157) Research ProblemContingent Stock

Answers to Problems
Bond Swaps 26. The bondholders boot equals the fair market value of excess principal amount received (Section 356(d)(2)(B)). Thus, the realized gain, $750 $700 = $50, is recognized to the extent of this excess. $ 200 The boot equals $750 $1,200 Since the lesser of $125 or $50 is $50, the gain recognized is $50. The bondholders basis in the convertible bond equals the basis in the bond given up, $700, less boot of $125, plus gain recognized, $50, plus the portion of the bond that was treated as boot, $125, for a total of $750. Type B Reorganization v. Sale 27. a. Brad must recognize gain or loss on each individual asset. Thus, recapture income, ordinary losses, capital gains, and Section 1231 gains are all possible. b. Same as (a). Brad will have a fair market value basis in his new stock. c. Same as (b). The substance of the transactions is that he sold his business for marketable stock. d. Here we have a good Type B reorganization. The original incorporation was most likely tax-free under Code Sec. 351. In the exchange of stock for stock, Brad recognizes no gain, and if he sells his stock, he will have a long-term capital gain. = $125.

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Type B Reorganization: Solely for Voting Stock 28. a. Maxco must acquire Code Sec. 368(c) control, i.e., 80 percent of both voting power and 80 percent of each class of non-voting stock. Thus, it must acquire at least 400,000 shares of common and 80,000 of preferred stock. b. The cost of Maxcos treasury stock has no bearing on whether the Type B reorganization rules are met, or Maxcos basis in the acquired Minnow stock. c. A prompt liquidation recasts a Type B as a Type C reorganization. d. The redemption by Minnow will not invalidate the Type B reorganization. e. Yes, no common stock need be used as long as the preferred has meaningful voting rights. f. The IRS allows statistical sampling estimates to determine what the basis was to the former Minnow shareholders. Boot in Type A and Type C Reorganizations 29. a. Amount realized: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $400 1,800 $2,200 1,500 $700 $400

Adjusted basis in old stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recognized gain (to extent of boot) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New basis equals old basis, $1,500, less boot, $400, plus gain recognized, $400, or $1,500. b. The receipt of $400 of boot may be treated as a dividend, but the answers are the same as in (a).

c. Maximum cash is 20 percent of total consideration in a Type C reorganization (assuming the acquired corporation has no liabilities). If stock worth $18 per share is a constant this maximum is ($18 20) 80 = $4.50. If the total of $22 per share is a constant, the maximum cash equals $22 .20 = $4.40 (and stock $17.60). In a Type A reorganization, 50 percent cash is possible, e.g., $9 per share if the stock is not reduced, $11 if $22 is the total value of the consideration. Spin-Offs 30. a. Gain realized: $800,000 $200,000 = $600,000. b. Gain recognized: Liabilities in excess of basis result in a gain of $150,000 ($350,000 $200,000) under Code Sec. 357(c). c. Subsidiarys basis: $350,000, or carried-over basis of $200,000, plus gain recognized to parent corporation of $150,000 (Code Sec. 362(a)). d. Parents basis: $200,000 + $150,000 gain $350,000 liabilities = $0 (Code Sec. 358). e. Shareholders basis: $1,000. The shareholders basis in the old stock will be allocated between old and new stock in proportion to value if Code Sec. 355 applies since no gain is recognized. $2,000 $4,500 $9,000 The holding period tacks on (Code Sec. 1223). = $1,000

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Identification of Transactions 31. a. b. c. d.

CCH Federal TaxationComprehensive Topics

A divisive spin-off under Code Sec. 355. A divisive split-off under Code Sec. 355. A dividend, unless it qualifies as a partial liquidation under Code Sec. 302(b)(4). A divisive Type D split-up.

Type A, B, and C Reorganizations v. Code Sec. 332 32. a. No, the acquisition was not made for solely voting stock. b. No, the 20 percent boot relaxation rule is violated. c. Yes, it is a liquidation of an at-least-80-percent-owned subsidiary.

Reorganization v. Liquidation 33. The bottom line is a dividend distribution to the shareholders. In form, the transaction is structured as a Code Sec. 351 transfer, followed by a liquidation, leading to capital gains (Code Sec. 331). Alternatively, it may superficially look like a divisive Type D spin-off. However, a stock portfolio is not a trade or business and, therefore, would not satisfy Code Sec. 355. Thus, applying substance over form, or invoking the step-transaction doctrine, the steps can be collapsed into a distribution taxed as a dividend since it is covered by E&P. Recapitalization 34. a. Realized loss: $800 $1,000 = $200. Recognized loss: Zero (none allowed). Basis: $1,000. b. Realized gain: $1,050 $800 = $250. Recognized gain: None, since no boot. Basis: $800. c. Realized gain: $5,000 $2,000 = $3,000. Recognized gain: $3,000 since the full value of the bonds is boot ($5,000), representing an excess principal amount (Code Sec. 356(d)(2)(B)). Basis: $5,000 (fair market value) since realized gain is recognized in full. d. Realized gain: $1,500 $900 = $600. Recognized gain: Lesser of realized gain $600, or fair market value of excess principal amount, $1,500 ($500 $1,500) = $500. Thus, $500 is recognized. Basis: Old basis of $900 $500 boot + $500 gain recognized + the FMV of the boot portion of $500 = $1,400. Split-Offs 35. a. This is a tax-free, divisive Type D reorganization, known as a split-off. No gain or loss is recognized; the holding period of the new stock is the same as that of the old stock, and the basis is allocated between stocks on the basis of market values. Stock in Modern: New Stock: 800 shares $20 400 shares $10 = = $16,000 $4,000

b. If the five-year requirement is not met, Jims stock in Modern is redeemed for property (new stock). The result is a dividend to the extent of E&P in Modern. If covered, Jim has $12,000 of dividend income and retains his $20,000 basis in Modern. In the absence of E&P, Jim reduces his basis in his stock, with a similar result as in (a).

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Type B Reorganizations v. Other Transactions 36. a. Yes (solely for voting stock). b. Yes, because control is acquired and there is no step transaction. c. Yes, control is acquired for voting stock. d. Yes, cash may be paid for fractional shares. e. No, options are not voting stock. f. No, the transaction is tested as a Type C reorganization. g. No, cash consideration is not allowed. Distribution of Disqualified Stock 37. The distribution of Griffen stock is attributable to Carson stock purchased by Hall within the five-year period preceding the distribution, and represents a distribution on disqualified stock. As a result, Carson must recognize a gain of $50 million ($60 million FMV $10 million basis) on the distribution of the Griffen stock. However, since the distribution otherwise qualifies under Code Sec. 355, the distribution is nontaxable to Hall, and Halls basis for its Griffen stock is the same as Halls basis for its Carson stock. Net Operating Losses: Carryovers 38. a. There is no Code Sec. 382 limitation since the ownership change did not exceed 50 percentage points. However, Sec. 381(b) limits Pebbles NOL deduction for the year of acquisition to the amount of Pebbles taxable income earned after the acquisition date, determined by prorating Stones taxable income on a daily basis throughout the taxable year. The NOL deduction for 2008 would be limited to $240,000 (61 366) = $40,000. There would be no NOL limitation applicable to 2009. The remaining $260,000 of NOL could be used to offset Stones taxable income. b. Stones NOL would be subject to the Code Sec. 382 limitation because there has been an ownership change of more than 50 percentage points. The NOL deduction for 2008 would be limited by Code Sec. 382 to ($1 million 5%) (61 366) = $8,333. The remaining NOL ($300,000 $8,333 = $291,667) would be carried forward to 2008 and could be deducted to the extent of the Code Sec. 382 limitation. Pebble could deduct an NOL of $50,000 (i.e., $1 million 5%) in 2009. Taxable Merger 39. Since Superior stock represents only 30 percent of the total consideration, the acquisition fails to qualify as a reorganization because there is insufficient continuity of proprietary interest. A minimum of 50 percent of the total consideration must be stock to qualify as a reorganization. The result is a taxable merger. Superior: No gain or loss is recognized on the issuance of its stock and bonds. Since it is a taxable acquisition, Superior will have a fair market value basis in the acquired assets and will not succeed to any of Taylors tax attributes. Former Taylor shareholders: The exchange of Taylor stock for Superior stock, bonds, and cash is a taxable exchange and any realized gains or losses would be recognized. Taylor: Any gains or losses realized on the transfer of its assets would be recognized. Since Taylor is merged out of existence, its tax attributes (e.g., earning and profits, carryforwards) would expire. Triangular Merger 40. a. The acquisition of Mound qualifies as a forward triangular merger (Code Sec. 368(a)(2)(D)). Mound Corporation would recognize no gain or loss on the transfer of its assets, and its tax attributes would carry over to Hill Corporation. Since the former shareholders of Mound received solely stock of Mountain Corporation, no gain or loss would be recognized by Mounds shareholders. Mountain Corporation would

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recognize no gain or loss on the issuance of its stock. Mounds assets would have a carryover basis to Hill Corporation. b. The answers to (a) would not change. To qualify as a forward triangular merger, at least 50 percent of the consideration must be stock of the parent corporation (Mountain), but it does not have to be voting stock. Recapitalization 41. a. Johnson received $90,000 worth of stock and a bond worth $10,500 in exchange for stock with a basis of $91,000, resulting in a realized gain of $9,500. Since Johnson surrendered no bonds, the fair market value of the bond received is treated as boot and causes the recognition of Johnsons $9,500 gain. b. Since the bond is treated as other property (boot), its basis is equal to its fair market value of $10,500. c. Johnsons basis for his new stock is the basis of his old stock ($91,000), increased by the amount of gain recognized ($9,500), and decreased by the amount of boot received ($10,500), resulting in a basis for his new stock of $90,000. Spin-Off 42. a. Since control of White was acquired in a taxable transaction within the preceding five years, the transaction would fail to qualify as a spin-off, and instead would be treated as an ordinary Sec. 301 distribution taxable as a dividend. Green would recognize gain (but not loss) on the distribution of the White stock, and the fair market value of the White stock would be taxed as a dividend to Greens shareholders. The shareholders would have a fair market value basis for the White stock. b. Since no gain would have been recognized in the Type B acquisition of White, and since both Green and White have at least a five-year business history, the distribution of the White stock would qualify as a taxfree spin-off. No gain or loss would be recognized to Green on the distribution of the White stock. The shareholders of Green would recognize no gain and would allocate their basis proportionately between the Green and White stock. Treatment of Boot in Reorganization 43. a. Randys realized gain of $1,300,000 would be recognized to the extent of the cash boot received of $800,000. Since his ownership of the acquiring corporation is less than 50 percent, the receipt of the cash would not have the effect of a dividend and his gain would be reported as capital gain. b. Since Randy has a more-than-50-percent interest in Pear as a result of the transaction, the receipt of the cash would have the effect of a dividend. Thus, Randy must report dividend income of $800,000. Split-Off 44. a. The transfer of the Pine division to Nuwood and the distribution of the Nuwood stock to Baker in exchange for his Wood stock qualifies as a Type D reorganization in the form of a split-off. b. Because the transaction qualifies as a Type D reorganization, no gain is recognized by Wood Corporation on the transfer of the Pine division or on the distribution of the Nuwood stock. c. No gain is recognized by Baker on the exchange of his Wood stock for Nuwood stock. d. The basis of Bakers Nuwood stock is his former basis for his Wood stock, $200,000. Use of Subsidiary in Type B 45. a. No, the acquisition still qualifies as a Type B reorganization. The solely for voting stock requirement applies only to the consideration used to acquire Targets stock. The control requirement will still be met because only stock is considered in determining whether the requirement is met. b. The exchange of the Target debentures for Parent debentures is a taxable exchange (separate from the Type B reorganization), and any realized gains or losses of the debenture holders would be recognized.

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The acquisition of the Target debentures is not a part of the Type B reorganization and is a taxable exchange even though the debenture holders received Parent voting stock. c. Code Sec. 368(a)(2)(C) permits the drop-down of stock to a controlled corporation following a Type B reorganization. d. Yes, it qualifies as a Type B. A subsidiary may use the stock of its controlling parent to effect a Type B reorganization. See Sec. 368(a)(1)(B). No, the Regulations indicate that a transaction will not qualify as a Type B reorganization if stock of both the acquiring corporation and its controlling parent is used (Reg. 1.368-2(d)). Reverse Merger 46. a. Yes, the requirements of Code Sec. 368(a)(2)(E) are met. Control of Steel was acquired by Metal for voting stock in the merger transaction. b. The merger will no longer qualify. Steel Corporation must hold substantially all of its properties as well as the merged corporations (Irons) properties. This would include assets transferred immediately before the merger transaction. c. No, Metal would not acquire control (80 percent) of Steel in the merger transaction. Metal would acquire only 700 out of the 1,000 outstanding shares in the merger transaction. d. Any stock surrendered by Steel shareholders in exchange for consideration furnished by Steel Corporation is not treated as outstanding for purposes of determining whether Metal has acquired control of Steel solely for Metal voting stock. However, the redemption may cause Steel to fail the substantially all requirement if the cash used in the redemption is included for purposes of applying the test. Shareholder Gain and Basis 47. Siris realized gain of $24,000 $15,000 = $9,000 is not recognized because no boot was received. Her basis for the Rock stock is her former basis for the Stone stock, $15,000, and its holding period includes the holding period of the Rock stock. Acquired Earnings and Profit Deficit 48. Sec. 381 limits the use of the acquired deficit to the earnings and profits generated after the acquisition date. For 2008, the acquired deficit can be used to the extent of $40,000 61/366 = $6,667. Acquired Net Capital Loss Carryforward 49. Sec. 381 limits the use of the acquired net capital loss carryforward to the amount of net capital gain allocated to days after the acquisition date. For 2008, the acquired net capital loss carryforward can offset only $20,000 146/366 = $7,978 of capital gain. The remaining $80,000 $7,978 = $72,022 can be carried forward. Acquired Earnings and Profits Deficit 50. Sec. 381 limits the use of the acquired deficit to earnings and profits generated after the acquisition date. Since Diamond had accumulated earnings and profits of $400,000 before the acquisition date, all $300,000 distributed during 2008 must be reported as dividend income. Sec. 382 Limitation 51. The redemption of Clines 55 percent stock interest results in a more than 50 percentage point increase in Alans stock ownership and causes the Sec. 382 limitation to apply to Maples net operating loss carryforward. For 2009, the use of the NOL can not exceed the value of Maples outstanding stock on the change date ($1.8 million) multiplied by the long-term tax-exempt rate (5%), or $90,000. Comprehensive ProblemType C Reorganizations 52. a. Yes, any voting stock will do. b. Yes, the individual assets need not be retained as long as Barks business is continued and the substantially all test is met. c. Yes, unlimited liabilities may be assumed.

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d. No, the cash violates the 20 percent rule. e. Yes, the stock may be cumulative and convertible and preferred, as long as it is voting stock. f. No, convertible or not, bonds, are not voting stock. Comprehensive ProblemIdentification of Transactions 53. a. A Type F reorganization. b. A taxable purchase of stock is followed by a Code Sec. 332 liquidation. c. A Type E reorganization that is tax free to the bondholders but results in cancellation of indebtedness income of $10,000 to ABC Corp. d. A Type E reorganization, a recapitalization. e. A dividend and/or return of capital if Code Sec. 355 is not met, a spin-off (divisive Type D) if met. f. A tax-free stock dividend creating Code Sec. 306 stock. Research ProblemDividend v. Spin-Off 54. Clearly, a business reason exists for the sale of Skiing stock to Ms. Quinn. However, there is no business reason for the distribution of Skiing stock to Mr. Aslak, not even the 5 percent, since it could have been sold to Ms. Quinn by Shoes Inc. As a result, the distribution to Mr. Aslak is a dividend to the extent of Shoes Inc.s E&P. Code Sec. 355 is not applicable. Research ProblemContingent Stock 55. a. Yes, generally the contingent stock will qualify if it had qualified when issued initially. b. Negotiable certificates have a life apart from the underlying stock, similar to options. Thus, since options and warrants disqualify a Type B reorganization, so do certificates of contingent interest. The certificates count as boot in Type A and Type C reorganizations as well. c. Yes, the arrangement may be held to disqualify a Type B reorganization if done primarily for tax avoidance or if it serves no business purpose.

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2008 CCH. All Rights Reserved.