Chapter 7: Homework Flashcards
Reorganization Type
Example: The acquisition by one corporation of another in a stock-for-stock exchange Type B
a. A recapitalization
Type E
b. A transfer by a corporation of all or part of its assets because of a bankruptcy
Type G
c. A consolidation
Type A
d. A spin-off
Type D
e. The acquisition by a corporation of another in a stock-for-asset exchange
Type C
f. A change in the state of incorporation from Nevada to Delaware
Type F
Complete the following statement regarding why a private letter ruling from the IRS is like an insurance policy for a corporate reorganization.
Requesting a letter ruling from the IRS about a reorganization will provide the parties involved information regarding the
______ of the proposed transactions. If the parties proceed with the transaction as proposed in the ruling request, a favorable ruling indicates the _____
______ for the restructuring.
income tax effect, tax treatment by the IRS.
Along with specific requirements in the Code, what four general requirements (coming from court decisions) must be met for a reorganization to receive tax-free status?
- The continuity of business enterprise requirement must be met.
True - The reorganization must meet the continuity of interest requirement.
True - The length of existence doctrine must be satisfied.
False - The judicial doctrine of having a sound business purpose must be met.
True - The step transaction doctrine should not be applicable.
True
In addition to the statutory requirements for reorganizations, several judicially created doctrines have become basic requirements for tax-free treatment. The reorganization transactions must exhibit these attributes or it will not be tax-free.
Indicate whether the following statements are “True” or “False” regarding how the receipt of boot affects the taxation of shareholders in a transaction that qualifies under § 368.
- No gain or loss is recognized by the shareholder. However, the corporation may be required to recognize a gain.
False - The gain recognized by the stockholder is the lesser of boot received or realized gain.
True - A loss, not gain may be recognized by the shareholder when the shareholder receives only boot and no stock.
True - The gain recognized by the stockholder is the greater of boot received or realized gain.
False
When an investor exchanges stock in one corporation for another, the exchange generally constitutes a taxable transaction. A qualifying reorganization avoids such treatment by creating a nontaxable exchange under § 368.
The shareholder’s basis in the new stock is the
fair market value of the new stock
less the
postponed gain
or plus the
postponed loss
. The
postponed
gain is equal to the gain that was
realized
but not
recognized
. This computation ensures that the gain not currently
recognized
will be
recognized
when the stock is sold at a later date.
The tax treatment for the parties involved in a tax-free reorganization almost exactly parallels the treatment under the like-kind exchange provisions of § 1031.
A “Type A” reorganization can be classified as
either a merger or a consolidation
. A
consolidation
occurs when
a new
corporation is created to take the place of two or more corporations. A
merger
is the union of two or more corporations, with
only one
of the corporations retaining corporate existence. To qualify as a “Type A” reorganization,
both mergers and consolidations
must comply with the requirements of foreign, state, or Federal statutes.
Each of the seven reorganizations authorized by the Code has specific requirements that must be met in order to qualify a restructuring to achieve the benefits of nontaxable treatment.
In a “Type B” reorganization, the acquiring corporation obtains at least an fill in the blank 1
80
% control of the target corporation in an exchange involving
solely its voting
stock for the
voting and nonvoting
stock of the target.
Voting stock
must be the sole consideration given by the acquiring corporation, a requirement that is
strictly
construed. After the restructuring,
a parent-subsidiary relationship
is created.
Each of the seven reorganizations authorized by the Code has specific requirements that must be met in order to qualify a restructuring to achieve the benefits of nontaxable treatment.
With regard to transferred liabilities, complete the paragraph below that outlines the advantages and disadvantages between a “Type C” reorganization and a “Type A” reorganization.
In a
“Type A”
reorganization, the acquiring corporation must assume all liabilities (including unknown and contingent liabilities) of the target as a matter of state law.
In a
“Type C”
reorganization, the acquiring corporation assumes only the target liabilities
that it chooses
. Cash and other property will not destroy this type of reorganization if
at least
80% of the fair market value of the target’s gross property is obtained with
voting stock
.
Liabilities can cause problems for a
“Type C”
reorganization. When the acquiring corporation gives
solely voting stock
for target assets, the target corporation’s liabilities are not considered other property (i.e. boot) in the exchange. However, when any property
other than voting stock
is given, liabilities assumed are treated as other property and the 80%-of-property-for-voting-stock requirement
may be
difficult to meet.
Each of the seven reorganizations authorized by the Code has specific requirements that qualify a transaction for the benefits of deferred income recognition.
Complete the statements below regarding the differences between a split-up, a spin-off, and a split-off.
A
split-off
is when a new corporation is formed to receive some assets from the distributing corporation and shareholders surrender distributing corporation stock in exchange for stock in the new corporation.
A
split-up
is when two or more new corporations are formed and receive all of the distributing corporation’s property.
A
spin-off
is when a new corporation is formed to receive some assets from the distributing corporation in exchange for the new corporation’s stock and none of the distributing corporation’s stock is surrendered.
Rather than combining, shareholders may want to divide the corporation by distributing its assets among two or more corporations. This might occur for many reasons, including antitrust problems, differences of opinion among the shareholders, product liability concerns, increasing shareholder value, and family tax planning. There are three different types of divisive “Type D” reorganizations: spin-offs, split-offs, and split-ups.
Complete the following statements that briefly describe the judicial doctrines of sound business purpose, continuity of business enterprise, and the step transaction doctrine.
The
step transaction doctrine
prevents taxpayers from engaging in a series of transactions for the purpose of obtaining tax benefits that otherwise would not be allowed if the transaction were accomplished in a single step.
The
continuity of business enterprise
requires the acquiring corporation to either continue the target corporation’s historic business or use a significant portion of the target corporation’s assets in its business.
The
sound business purpose
requires that the reorganization have economic consequences germane to the businesses.
Besides the statutory requirements for reorganizations, several judicially created doctrines have become basic requirements for tax-free treatment. These doctrines include the sound business purpose, continuity of interest, and continuity of business enterprise doctrines.
In a qualifying reorganization, Cato Corporation exchanges $1,200,000 worth of stock and property valued at $500,000 ($245,000 basis) for all of Firestar Corporation’s assets, which have a value of $1,700,000 and a $500,000 basis. Firestar distributes the property received from Cato. The exchange meets all Code requirements.
If an amount is zero, enter “0”.
a. What is Cato’s recognized gain/loss from the reorganization?
Cato recognizes
a gain
of $fill in the blank 2
255,000
.
b. What is Firestar’s recognized gain/loss from the reorganization?
Firestar recognizes
no gain or loss
of $fill in the blank 4
0
.
The tax treatment for the parties involved in a tax-free reorganization almost parallels the treatment under the like-kind exchange provisions of § 1031. In the simplest like-kind exchange, neither gain nor loss is recognized on the exchange of like-kind property. The general rule is that when an investor exchanges stock in one corporation for stock in another, the exchange is a taxable transaction. If the transaction qualifies as a reorganization under § 368, the tax treatment, in substance, is similar to a nontaxable exchange of like-kind property.
A. Cato’s recognized gain/loss from the reorganization:
Recognized gain: $255,000
Explanation:
This recognized gain signifies the realized increase in value as the property’s market worth surpasses its original adjusted basis. Cato will encounter a gain of $255,000, emblematic of the appreciation from the initial basis to the current market value of the assets exchanged.
B. Firestar refrains from immediate recognition of any loss in the reorganization, as it distributed the property obtained from Cato.
Explanation:
The entity disseminating assets typically avoids immediate gain or loss recognition. Firestar’s basis in the assets received from Cato carries over, postponing the recognition of any gain or loss until a future disposition of those assets. This deferred recognition aligns with the intricacies of reorganization processes, emphasizing the deferral of consequences until subsequent transactions occur.
Classify each of the following transactions as to the type of reorganization or, if applicable, a taxable transaction.
Alpha Corporation owns assets valued at $400,000 and liabilities of $100,000. Beta Corporation transfers $160,000 of its voting stock and $40,000 in cash for 75% of Alpha’s assets and all of its liabilities. Alpha distributes its remaining assets and the Beta stock to its shareholders. Alpha then liquidates.
Type A
b. Beta Corporation owns assets valued at $1,500,000 with liabilities of $700,000, and Alpha holds assets valued at $350,000 with liabilities of $150,000. Beta transfers 200,000 shares of stock and $50,000 cash, and it accepts $100,000 of Alpha’s liabilities, in exchange for all of the Alpha assets. Alpha distributes the Beta stock to its shareholders for their Alpha stock and then ceases to exist.
Taxable
c. Alpha Corporation obtained 200,000 shares of Beta Corporation’s stock 10 years ago. In the current year, Alpha exchanges 40% of its stock for 500,000 of the remaining 600,000 shares of Beta stock. After the transaction, Alpha owns 700,000 of the 800,000 Beta shares outstanding.
Type B
d. Alpha Corporation’s two divisions have existed for seven years. The nail division has assets valued at $500,000 and liabilities of $120,000, whereas the hammer division has assets valued at $645,000 and liabilities of $25,000. Alpha would like the two divisions to be separate corporations. It creates Beta Corporation and transfers all of the hammer division assets and liabilities in exchange for 100% of Beta’s stock. Alpha then distributes the Beta stock to its shareholders.
Type D
e. Alpha Corporation owns assets valued at $750,000 with liabilities of $230,000, and Beta holds assets valued at $1,500,000 with liabilities of $500,000. Beta transfers 33% of its stock for $700,000 of Alpha’s assets and $200,000 of its liabilities. Alpha distributes the Beta stock and its remaining assets and liabilities to its shareholders in exchange for their stock in Alpha. Alpha then terminates.
Type C
f. Beta Corporation has not been able to pay its creditors in the last year. To avoid foreclosure, Beta transfers its assets valued at $650,000 and liabilities of $700,000 to a new corporation, Alpha, Inc., in accordance with a state court proceeding. The creditors receive shares of Alpha voting stock valued at $300,000 and cancel the outstanding debt. The former Beta shareholders receive the remaining shares in Alpha.
Type G
Section 368(a) specifies seven corporate restructurings or reorganizations that will qualify as nontaxable exchanges. If the transaction fails to qualify as a reorganization, it will not receive the special tax-favored treatment. Therefore, a corporation considering a business reorganization must determine in advance if the proposed transaction specifically falls within one of these seven types.
Beach Corporation, a seaside restaurant, is owned by 20 unrelated shareholders. This year Beach made the national news for polluting the surrounding beach and ocean with garbage and was fined $200,000. Beach fired its chief executives and appointed a new board of directors. The new president, Sandy Shores, vowed to clean up Beach’s pollution and become more socially responsible.
To put this damaging episode behind them, the board of directors wants to change Beach’s name to Protected Bay. Further, it would like to change from a C corporation to an S corporation to make the owners feel more responsible for the business.
Complete the statements below to explain how these corporate changes can be accomplished and what the Federal income tax implications are for Beach.
Changing the structure of Beach from a C corporation to an S corporation qualifies as a
“Type F”
reorganization. The reorganization
is not a taxable
transaction and as such Beach’s tax attributes
carry over to Protected Bay
.
Section 368(a) specifies seven corporate restructurings or reorganizations that will qualify as nontaxable exchanges. If the transaction fails to qualify as a reorganization, it will not receive the special tax-favored treatment. Therefore, a corporation considering a business reorganization must determine in advance whether the proposed transaction specifically falls within one of these seven types.
Given the financial position of Rufous Corporation, it is likely that Rufous files for bankruptcy. Under the bankruptcy laws, Rufous could qualify for a
“Type G”
reorganization. In this kind of reorganization, the
assets
of Rufous are transferred by Federal or state court proceedings to an acquiring corporation. The
creditors
of Rufous receive
voting stock
in exchange for their claims upon Rufous. At least
80%
of the fair market value of the debt must be replaced with
voting stock
.
Because a
“Type G”
reorganization requires
filing for bankruptcy
, I suggest that Rufous contact its attorney as soon as possible if this is the route chosen for Rufous.
Section 368(a) specifies seven corporate restructurings or reorganizations that will qualify as nontaxable exchanges. If the transaction fails to qualify as a reorganization, it will not receive the special tax-favored treatment. Therefore, a corporation considering a business reorganization must determine in advance whether the proposed transaction specifically falls within one of these seven types.
Through an acquisitive “Type D” reorganization, Border, Inc., is merged into Collie Corporation on September 2 of the current calendar tax year. The Federal long-term tax-exempt rate for September is 3%. Border shareholders receive 70% of the Collie stock in exchange for all of their Border shares. Border liquidates immediately after the exchange. At the time of the merger, Border was worth $1,000,000 and held a $500,000 NOL.
If Collie reports taxable income of $400,000 for the current year, how much of the Border NOL can be utilized in the current year? How much of the Border NOL may Collie utilize next year if its taxable income remains the same? Assume a 365-day year.
The amount of Border NOL that Collie can utilize in the current year is
33%
. The § 382 limit
does not
apply because there was
less than a 50
percentage-point change in ownership. And next year, Collie can utilize
the remaining 67%
.
Some target corporation tax attributes (loss carryovers, tax credits, and E & P deficits) are welcomed by the successor corporation. Others may prove less desirable (positive E & P and assumption of liabilities). The mandatory carryover rules should be carefully considered in every corporate acquisition; they may, in fact, determine the form of the transaction.
