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What are the different types of tax free corporate reorganizations?
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What Is IRC 368
IRC 368 refers to Section 368 of the Internal Revenue Code titled “Definitions relating to corporate reorganizations”.
In essence, IRC Section 368 provides the statutory definition and outline of seven different types of corporate reorganizations that are tax-free for income tax purposes.
In other words, corporations can go through a reorganization and defer their tax liability to the future by qualifying for a tax-free reorg.
To the extent a corporate transaction or reorganization satisfies the statutory requirements, it will not be subject to federal income tax.
The general tax rule is that corporations must pay taxes when selling shares or assets.
However, when the requirements of tax code 368 are met, corporations can defer their tax liability.
IRC Section 368 Overview
Section 368 reorganization is composed of several paragraphs and subparagraphs.
Let’s do a quick overview of IRS code 368:
- IRC 368(a) Reorganization
- IRC 368(a)(1) In general
- IRC 368(a)(2) Special rules relating to paragraph (1)
- IRC 368(a)(3) Additional rules relating to title 11 and similar cases
- IRC 368(b) Party to a reorganization
- IRC 368(c) Control defined
Section 368 Tax Free Reorganizations
Let’s look at the different types of reorganizations outlined in Code Section 368 that are tax-free.
In essence, 26 U.S. Code § 368 provides the outline of seven types of tax-free reorganizations, namely:
- IRC 368(a)(1)(A): tax-free mergers and consolidations
- IRC 368(a)(1)(B): Stock-for-stock exchanges
- IRC 368(a)(1)(C): Stock-for-asset exchanges
- IRC 368(a)(1)(D): Divisive reorganizations
- IRC 368(a)(1)(E): Recapitalizations
- IRC 368(a)(1)(F): Changes in place or form of organization
- IRC 368(a)(1)(G): Insolvency reorganization
As you can see, there are different types of tax-free reorganizations possible.
Companies and corporations going through a reorganization can structure their reorganization in such a way to qualify as a tax-free reorg.
It’s important to meet the statutory and judicial requirements to qualify for any of the 368 IRC reorganizations.
IRC 368(a)(1)(A), IRC 368(a)(1)(B), and IRC 368(a)(1)(C) refer to reorganizations involving a corporation’s subsidiary (these are acquisitive reorganizations) whereas the other subparagraphs deal with other types of reorganizations.
Let’s look at each of the seven types of reorganizations.
Mergers And Consolidations
IRC 368(a)(1)(A) states:
a statutory merger or consolidation
Section 368(a)(1)(A) refers to instances when a corporation (the parent) absorbs another corporation (the subsidiary).
This is called a merger.
Section 368(a)(1)(A) also refers to consolidations consisting of two corporations combining with one another to continue as one or under a new corporation.
Stock-For-Stock Reorganization
IRC 368(a)(1)(B) states:
the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition);
Section 368(a)(1)(B) refers to a stock-for-stock exchange where the target company shareholders sell their stock to the acquiring company in exchange for some stock in the acquiring company.
In the end, the target company’s shareholders no longer have any shares in the target company but have become minority shareholders in the acquiring company.
Stock-For-Asset Reorganization
IRC 368(a)(1)(C) states:
the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other shall be disregarded;
Section 368(a)(1)(C) refers to a stock-for-asset exchange where the acquiring company purchases all of the assets of the target company in exchange for its shares.
Divisive Reorganizations
IRC 368(a)(1)(D) states:
a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356
When there’s a reorganization where corporations are divided, we refer to these types of reorgs as divestitures or divisive reorganizations.
Section 368(a)(1)(D) states that a company dividing assets held by a corporation will qualify as a tax-free reorganization to the extent the holders of the divided parts have control of the assets after the transfer and they were previously shareholders in the parent company.
Recapitalization
IRC 368(a)(1)(E) states:
a recapitalization
Section 368(a)(1)(E) refers to a recapitalization of corporations where a company restructures debt and equity.
When common shareholders are issued preferred shares, that’s an upstream recapitalization.
On the other hand, when debt holders exchange their debt securities for equity securities, that’s a downstream recapitalization.
Relocation or Organizational Structure Change
IRC 368(a)(1)(F) states:
a mere change in identity, form, or place of organization of one corporation, however effected
Under the Internal Revenue Code, Section 368(a)(1)(F), when a corporation mergers into a shell company formed in another jurisdiction or changes form, this can qualify as a reorganization.
A change in identity, form, or place by a corporation can be a tax free reorganization.
Insolvency Reorganization
IRC 368(a)(1)(G) states:
a transfer by a corporation of all or part of its assets to another corporation in a title 11 or similar case; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356
Corporations going through a reorganization in the context of bankruptcy or insolvency will also qualify under IRC 368 for a tax free reorg.
Section 368 Reorganization Conditions
For reorganizations to qualify under IRS 368, several conditions must be satisfied.
The first condition that must be satisfied is that the transaction must meet the statutory requirements outlined in 368 IRS.
Then, corporations can qualify for the tax-deferral outlined in Section 368 when the following judicial conditions are met:
- There’s continuity of ownership interest
- There’s continuity of business enterprise
- There’s a valid business purpose
When both statutory and judicial requirements are met, corporations can take advantage of the tax deferral in Section 368 IRC.
IRC 368 Takeaways
So, there you have it folks!
What is IRS 368 in simple terms?
How does IRC 368 work?
In general, the sale of company stocks or assets by corporations is considered a taxable transaction.
However, certain types of transactions are tax-free to the corporation.
IRC Sec 368 outlines different types of tax-free reorganizations where corporations can reduce their tax liability by structuring their reorg in such a way that they qualify under the law.
There are seven types of tax-free reorganizations outlined in Section 368:
- Mergers and consolidations
- Stock-for-stock exchanges
- Stock-for-asset exchanges
- Divisive reorganizations
- Recapitalizations
- Changes in place or form of organization
- Insolvency reorganization
If you want your corporate reorganization to be tax-free and allow your taxes to be deferred over time, you need to make sure that you meet the statutory and judicial requirements.
Remember, this article is intended to give you general information on the Internal Revenue Code 368.
If you need legal advice on a corporate reorganization or have a legal issue to deal with, be sure to consult with a qualified business lawyer, tax attorney, or M&A lawyer.
Good luck!
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Understanding IRC 368
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