IRC Section 368 explained further
IRC Section 368 explained further
A corporation may undergo restructuring or reorganization for various strategic reasons, whether it be for increased operational efficiency or to cut costs. That reorganization may be conducted to increase profits. A tax-free reorganization is often implemented to find efficiencies within the law that allow for reduced tax. These types of reorganizations can be triggered by certain tactical actions, such as takeovers, buyouts, new acquisitions, or even the threat of Chapter 11.
These techniques are generally implemented with the mindset that the seller looks to avoid income tax on any realized gains, such as the gain on trading shares in another corporation. While there are other occurrences in which a seller would want to avoid income tax recognition, income tax deferral is often accomplished through using a proper reorganization that follows federal income tax recognition laws.
Managing a tax-free reorganization is entirely dependent on the tax jurisdiction a company is in. A tax-free reorganization is done not necessarily to grant a tax exemption, and thereby put the company at a better position. It is done to reduce any tax consequences of an already impending reorganization. In other words, a business reorganization is not triggered by the need to conduct a tax-free reorganization. Rather, the tax-free reorganization is triggered when a business reorganization is expected. With the incoming restructuring, the business hopes to neither incur a tax advantage nor a disadvantage.
In essence, the term “tax-free” is misleading because the expense is not entirely mitigated, but may be deferred, transferred or minimized.
To reduce tax concerns in a business reorganization, there are two factors to consider. The reorganization implies that:
This results in a deferred tax on unrealized gains, rather than an exemption to these taxes. So in essence, the reorganization is tax-free because the tax is not immediately due. The proper term, however, should be a tax-deferred reorganization.
Tax-free reorganizations can be divided into the following four types:
Acquisitive reorganizations, as the name implies, involves a restructuring where on corporation acquires another corporation. This can happen via a stock acquisition or asset deal. These reorganizations can be further divided into the four sub-categories. The letters attached to each type of category are based on their subsection clause as found in IRC Section 368.
These types of reorganizations can also be classified as triangular reorganizations (excluding reorganization type D). Types A, B and C can be used in conjunction with the three parties, involving a target corporation, a parent and a subsidiary.
As the name implies, a divisive reorganization involves a corporation dividing into smaller corporations. This results in two or more companies, and must qualify under the rules as set out in the divisive Type D reorganization under IRC 368(a)(1)(D). Divisive reorganizations take three different forms:
Restructuring, though sometimes used synonymously with reorganization, is another form of reorganization. This involves keeping the current corporate entity structure intact, but perhaps moving around the organization chart. T Here are two main types of restructurings:
Bankruptcy reorganizations are transactions that involve the transfer of assets from one corporation to another corporation in a bankruptcy or similar case and that qualify as Type G reorganizations under IRC 368(a)(1)(G).
Thank you for reading this guide to achieving a tax-free reorganization. To keep learning and advancing your career we highly recommend these additional resources: