New Tax Limitations: Corporate Reorganization in the '90S
D'Uva, Joan, The CPA Journal
The 1980s were characterized by leveraged buyouts and mergers and acquisitions. As we begin the 1990s, there is some indication that this may prove to be the decade of reorganizations and liquidations. Business decisions to reorganize or liquidate require substantial planning, but with proper consideration of tax consequences, sellers or shareholders can minimize their tax liabilities. After the dramatic effects of the TRA 86, RRA 90 has even further limited the tax benefits in corporate restructuring and thus should prompt managers to weigh their actions very carefully.
In general, the following methods can be considered when disposing of an investment in a corporation:
* Sale or exchange of stock; and
* Sale of assets or asset distributions.
From the seller's perspective, a stock sale is preferable to a sale of assets, because it results in a capital gain as opposed to ordinary income. Although TRA 86 eliminates the tax rate differential for capital gains treatment, the offset of capital losses and capital gains still exists. Therefore, the realization of capital gains is still preferred. In addition, double taxation is avoided in a sale of stock. A sale of assets would be taxed at the corporate level, and the distribution of cash would be taxed at the shareholder level. A sale of stock results in tax only at the shareholder level.
To defer income on a sale, the installment sales method of income recognition may be used. This method is appropriate when at least one payment is received after the close of the tax year. Tax is paid only on the ratable profit percentage applied to each year's payment.
Non-recognition of income can, however, sometimes be achieved if the business acquisition or dissolution is accomplished through a reorganization. To qualify for non-recognition of income, Sec. 368(a)(1) defines several types of tax-free reorganizations:
* "A" -- a statutory merger or consolidation;
* "B" -- an acquisition of stock in exchange for stock;
* "C" -- an acquisition of assets in exchange for stock;
* "D" -- a division whereby assets are transferred to another corporation;
* "E" -- a recapitalization of a single corporation;
* "F" -- a change in identity, form, of place of organization;
* "G" -- a transfer of assets to a corporation pursuant to bankruptcy reorganization.
Types A, B, and C reorganizations refer to acquisitions of corporations; type D is a divisive reorganization or applies to a division such as a spin-off of a company. Types E and F refer to a continuing enterprise and type G only applies to reorganization out of bankruptcy.
A type A reorganization can be a hybrid transaction (taxable and tax-free). Such a transaction permits the use of non-voting stock and must meet a test of continuity of interest. Type A is the least well-defined of the three acquisition types.
In a type B transaction, an acquisition of stock in exchange for stock, no property may be exchanged in order to achieve tax-free status. No gains or losses are recognized to the seller. Stock exchanged must be voting common stock only, and the buyer must obtain 80% control of the corporation. In addition, the transaction must meet the following tests:
* Valid business purpose;
* Continuity of business enterprise; and,
* Continuity of interest.
An example of a valid business purpose is a company expanding into a new market through acquisition. Continuity of business enterprise means the business must continue to exist and not be liquidated. The last test, continuity of interest, requires that the stockholders of the selling corporation continue to have a "substantial equity" interest in the stock of the buying corporation.
In a type C reorganization, voting stock must be exchanged for "substantially all" of the assets of the selling corporation. "Substantially all" is defined as 90% of net assets or 70% of gross assets. …