Definition and Overview
IRS Section 368 outlines various forms of corporate reorganizations that can be executed without immediate tax consequences under U.S. tax law. These reorganizations allow corporations to restructure, merge, or acquire other entities while deferring gains and losses, thus providing tax benefits and enabling smoother business transitions.
According to the Internal Revenue Code (IRC), these reorganizations must meet specific criteria to qualify. IRS Section 368 is critical for corporations considering structural changes and must be adhered to strictly to avoid unfavorable tax consequences.
Types of Reorganizations Under IRS Section 368
Type A Reorganizations: Statutory Mergers and Consolidations
Type A reorganizations involve statutory mergers and consolidations under state corporate law. In these cases:
- A merger entails one corporation absorbing another, with the absorbed corporation ceasing to exist.
- A consolidation results in two corporations combining to form a new entity, with both original corporations ceasing to exist.
Type B Reorganizations: Stock-for-Stock Acquisitions
In Type B reorganizations:
- One corporation acquires the stock of another in exchange for its voting stock.
- The acquiring corporation must gain at least 80% of the acquired corporation’s stock to meet the continuity of interest requirement.
Type C Reorganizations: Stock-for-Asset Acquisitions
Type C reorganizations involve:
- One corporation acquiring substantially all the assets of another in exchange for its voting stock.
- The acquired corporation must then liquidate, distributing the acquiring corporation’s stock to its shareholders.
Type D Reorganizations: Transfers of Assets
Type D reorganizations can be:
- Divisive D reorganizations: A corporation transfers some or all its assets to another corporation in a tax-free split-up, split-off, or spin-off.
- Acquisitive D reorganizations: One corporation transfers its assets to an acquiring corporation, followed by a liquidation of the transferor company.
Type E Reorganizations: Recapitalizations
Type E reorganizations involve altering the capital structure of a single corporation, such as:
- Exchanges of different classes of stock or bonds among the company’s shareholders.
Type F Reorganizations: Changes in Identity, Form, or Place of Organization
Type F reorganizations encompass:
- Simplistic changes such as changing the corporation’s name, state of incorporation, or other nominal alterations without substantive asset transfers.
Type G Reorganizations: Bankruptcy Reorganizations
Type G reorganizations apply when:
- A corporation transfers its assets to another corporation under a court-approved plan in a Title 11 or similar Bankruptcy Proceeding, aiming to resolve debts and continue operations.
Special Considerations
Continuity of Interest and Business Enterprise
To qualify under Section 368, reorganizations must meet the requirements of:
- Continuity of Interest: Existing shareholders retain a meaningful interest in the reorganized entity.
- Continuity of Business Enterprise: The acquirer continues the target’s business operations or uses a significant portion of its assets.
Example Scenarios
Example 1: Type A Reorganization
Corporation X merges into Corporation Y. Corporation Y continues to operate, and shareholders of Corporation X receive shares of Corporation Y. Corporation X ceases to exist.
Example 2: Type B Reorganization
Corporation A acquires 85% of Corporation B’s stock by issuing its voting shares to Corporation B’s shareholders, achieving the requisite continuity of interest.
Historical Context
Section 368 was incorporated in the IRC to facilitate business reorganizations without thwarting tax fairness. It traces its roots back to the Revenue Act of 1921 and has evolved to include various reorganization types to adjust to complex corporate structures and needs.
Applicability and Comparisons
Applicability
Corporations undergoing mergers, acquisitions, or restructures typically rely on Section 368 to execute these moves in a tax-efficient manner.
Comparisons
Unlike Section 351, which deals with the transfer of property to corporations in exchange for stock, Section 368 deals with the reorganization of the corporation itself.
Related Terms
- Section 351: Deals with tax implications of property transfers to corporations.
- Merger: The absorption of one corporation into another.
- Acquisition: One company obtaining control over another.
- Spin-off: A company creates a new independent company by selling or distributing new shares.
- Split-off: A company splits into two or more corporations, each continuing the original business.
FAQs
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What is the purpose of IRS Section 368? IRS Section 368 facilitates tax-efficient reorganizations of corporations by providing methods to defer gains and losses that would otherwise be taxable.
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Do all reorganizations qualify under Section 368? No, only those that meet the specific requirements of types A through G, including continuity of interest and business enterprise.
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How does Section 368 benefit corporations? It allows corporations to restructure, merge, or acquire other entities without immediate tax consequences, enabling smoother transitions and strategic growth.
References
- Internal Revenue Code, Section 368
- Treasury Regulations pertaining to Section 368
- Revenue Act of 1921
Summary
IRS Section 368 defines various types of corporate reorganizations and provides specific criteria each must meet to qualify for tax deferment. By understanding the provisions under Section 368, corporations can execute mergers, acquisitions, and restructuring in a tax-efficient manner, ensuring continuity and strategic growth.
