§ 5.8 INSOLVENCY REORGANIZATIONS

(a) Insolvency Reorganization other than G Reorganizations

(i) Introduction

A discussion of the fundamental case law and government pronouncements addressing insolvency reorganizations is important for two reasons. First, insolvency reorganizations may occur outside of a bankruptcy or similar case and thus not be subject to the G reorganization provisions. Second, this discussion also provides a helpful background to the G reorganization rules.264

(ii) Seminal Cases: Alabama Asphaltic and Southwest Consolidated

The seminal case in the area of insolvency reorganizations is Helvering v. Alabama Asphaltic Limestone Co.265 In Alabama Asphaltic, a bankrupt corporation (Oldco) merged into a corporation (Newco) that was formed by Oldco’s creditors. Pursuant to the plan, the Newco stock was issued to the creditors of Oldco and the historical shares of Oldco were canceled. The question at issue was whether the transaction qualified as a tax-free merger under a predecessor provision to I.R.C. section 368(a)(1)(A) and whether Oldco’s historical high basis in its assets carried over to Newco. The decision of whether the transaction qualified as a tax-free merger would depend on whether the COI requirement was satisfied. The IRS did not believe continuity was satisfied because the shareholders of Oldco did not receive stock (a continuing equity interest) in Newco.

The Supreme Court disagreed, stating:

[I]t is immaterial that the transfer shifted the ownership of the equity in the property from the stockholders to the creditors of the old corporation. Plainly, the old continuity of interest was broken. Technically that did not occur in this proceeding until the judicial sale took place. For practical purposes, however, it took place not later than the time when the creditors took steps to enforce their demands against their insolvent debtor. In this case, that was the date of the institution of bankruptcy proceedings. From that time on, they had effective command over the disposition of the property. . . . When the equity owners are excluded and the old creditors become the stockholders of the new corporation, it conforms to realities to date their equity ownership from the time when they invoked the processes of the law to enforce their rights of full priority. At that time they stepped into the shoes of the old stockholders. The sale “did nothing but recognize officially what had before been true in fact.”266

Thus, the Supreme Court held that the receipt of stock of an acquiring corporation by an insolvent corporation’s creditors that had taken legal action to enforce their claims satisfied the COI requirement necessary to qualify as a tax-free merger.

In the same year that Alabama Asphaltic was decided, the Supreme Court also resolved another cornerstone case in the bankruptcy/insolvency reorganization area: Helvering v. Southwest Consolidated Corporation.267 For the sake of simplicity, assume that the facts of Southwest Consolidated were the same as those at issue in Alabama Asphaltic with three exceptions: (1) Oldco did not merge into Newco pursuant to state law but merely transferred its assets to Newco and liquidated; (2) Newco transferred warrants to shareholders and some creditors in addition to the Newco stock that was transferred to Oldco’s creditors; and (3) there was not a significant overlap between Oldco’s historical shareholders and creditors. The Court concluded that although the transaction satisfied the COI requirement, it nevertheless failed to qualify as a tax-free reorganization. The transaction could not qualify as a tax-free merger because Oldco did not merge into Newco. The transaction did not qualify under the predecessor provisions to the C reorganization because warrants were issued, defeating the “solely for voting stock” requirement. In addition, the transaction did not qualify under the predecessor provision to the D reorganization because the “stockholders” of Oldco did not control Newco after the transaction. Although the Supreme Court was, under certain circumstances, willing to look to creditors as stepping into the shoes of the historical shareholders for purposes of establishing proprietary interest, it was unwilling to equate creditors with shareholders for purposes of determining whether the control requirement for a D reorganization was satisfied. I.R.C. section 368(a)(1)(D) requires that the stockholders and not the creditors of Oldco control Newco after the reorganization. Saying that creditors hold a proprietary interest is quite a different thing from concluding that a creditor is a stockholder, as required by statutory language. The Court also noted that the transaction did not qualify under the predecessor to the E recapitalization because it was not merely a “reshuffling of a capital structure . . . of an existing corporation”;268 the transfer of assets to another corporation made the transaction something more than just a recapitalization. Finally, the transaction did not qualify under the predecessor provision to the F reorganization because “a transaction which shifts the ownership of the proprietary interest in a corporation is hardly ‘a mere change in identity, form, or place of organization.’”269 Thus, the Southwest Consolidated transaction did not qualify as a tax-free reorganization.

(iii) Final Regulations: Application of the Continuity of Interest Requirement to Reorganizations of Insolvent Corporations and/or Corporations in a Title 11 or Similar Case

During 2008 and 2009, the IRS issued guidance to assist corporations affected by the economic downturn.270 One item of guidance issued provides a benefit to taxpayers seeking to treat certain acquisitions of insolvent companies as tax-free reorganizations under I.R.C. section 368(a)(1).271 Specifically, on December 12, 2008, the IRS published final regulations applicable to determining whether and to what extent the creditors of an insolvent corporation, or a corporation in a Title 11 or similar case, will be treated for purposes of satisfying the COI requirement as holding a proprietary interest in a target corporation immediately before a potential reorganization both in and out of bankruptcy. 272

(A) History of the Continuity of Interest Requirement in Bankruptcy Reorganizations

For a transaction to qualify as a tax-free reorganization, the transaction must meet certain statutory and nonstatutory requirements. Of relevance here is the judicially developed COI requirement now found in Treas. Reg. section 1.368-1(e)(1). That section provides that the purpose of the COI requirement is to prevent transactions that resemble sales from qualifying as reorganizations (and therefore qualifying for nonrecognition of gain or loss). To do so, COI requires that, in substance, a substantial part of the value of the proprietary interests in a target corporation be preserved in the reorganization.

A proprietary interest in a target corporation generally is represented by the ownership of stock. When a corporation is bankrupt or insolvent, however, the corporation’s stock is likely to be worthless. Thus, if a bankrupt or insolvent corporation engages in a potential reorganization, its creditors may receive acquiring corporation stock in exchange for their claims; the shareholders may receive nothing. Accordingly, if the shareholders of a bankrupt or insolvent corporation are considered the corporation’s only “proprietors,” most reorganizations of insolvent or bankrupt corporations would fail the COI requirement (and thus be taxable transactions).

In certain situations, however, the courts have concluded that a corporation’s creditors may become proprietors for purposes of satisfying the COI requirement. For example, as noted above, in Helvering v. Alabama Asphaltic Limestone Co.,273 the Supreme Court held that the proprietary interest of the shareholders effectively shifted to the creditors not later than the time “when the creditors took steps to enforce their demands against the insolvent debtor. In this case, that was the date of the institution of bankruptcy proceedings. From that time on, they had effective command over the property.”274 Similarly, in the companion case, Palm Springs Holding Corp. v. Commissioner,275 the Court viewed creditors as the owners of the proprietary interests in the debtor corporation when a foreclosure action commenced, because the debtor corporation “was insolvent and . . . its creditors took steps to obtain effective command over its property.”276

In contrast to these cases, in Atlas Oil & Refining Corp. v. Commissioner,277 the Tax Court stated that the mere fact that creditors have “effective command” over a corporation’s assets will not make them pre-reorganization proprietors if they do not in fact exercise their right to receive stock in the acquiring corporation. Specifically, the court stated that:

While “effective command” over the properties in an insolvency proceeding is necessary to change the creditors into equity owners to satisfy continuity of interest, the fact that a protected class may have had “effective command” over the assets in such proceedings will not make them equity owners for participation purposes if they do not in fact exercise their right to participate in the equity distribution of the new corporation.

Inasmuch as there is no requirement that any surviving creditor retain his status in the new corporation, and they are all permitted, although fully protected, to share in the new stock distribution, all creditors receiving stock may be deemed “former owners” at the time they receive it in determining whether the continuity-of-interest rule is satisfied.

In the situation where the value of the assets is less than the amount owed to the top priority creditors, there is no problem. The entire interest of the corporation, equity or debt, must vest in them whether they in fact received stock in the new corporation or not. There is no excess which can overflow on to other creditors. They are the only ones who can be deemed former owners whether they receive stock or not, and the retention of their status in the new corporation (the stock going to outside interests) will cause an absence of continuity of interest.

When there are two or more classes of creditors surviving the insolvency, however, there is some room for determination as to which are the “former owners” depending upon the options taken by the creditors. When fully protected bondholders retain their status in the new corporation, the equity will vest in the lowest unprotected creditor.278

This language contains at least two conclusions by the Tax Court. First, the court concluded that although having effective command of the corporation’s assets (such as through an insolvency proceeding) is a requirement for creditors to establish a proprietary interest, such action will not, in and of itself, confer proprietary status. Second, the court concluded that, generally speaking, only creditors who receive stock in the acquiring corporation may be treated as equity owners at the time of the transfer. This is often referred to as the “relation back” approach.

It is clear from the third paragraph of the language cited that the mere fact that a creditor does not receive stock is insufficient to conclude that the creditor did not have a pretransaction proprietary interest in the corporation. In other words, if the total amount of the corporation’s debt owed to senior creditors exceeds the fair market value of its assets, those creditors necessarily are the proprietary owners of the corporation—regardless of whether they receive stock in the new corporation. In such a case, according to the language cited, the COI requirement will not be satisfied if those senior creditors do not receive stock in the acquiring corporation, even if junior creditors and stockholders do.

In the Bankruptcy Tax Act of 1980 (the 1980 Act), Congress extended the statutory definition of a “reorganization” to include certain transactions undertaken by corporations in title 11 or similar cases.279 Although the 1980 Act did not specifically address the COI requirement with respect to I.R.C. section 368(a)(1)(G), the legislative history embraces certain case law principles from Alabama Asphaltic and Atlas Oil. Specifically, Congress stated its expectation that the IRS base a determination of whether COI is satisfied in a potential reorganization under I.R.C. section 368(a)(1)(G) by treating as proprietors the most senior class of creditors who received stock in the acquiring corporation, together with all interests equal and junior to them, including shareholders.280 If, however, the target shareholders receive nonstock consideration (while some or all of the creditors receive stock) in the reorganization, Congress indicated that the IRS may examine the overall transaction to determine whether it looks more like a purchase than a reorganization.281 Congress did not address the COI requirement with respect to other reorganizations of insolvent corporations outside of I.R.C. section 368(a)(1)(G).

It could be perilous to consider an issue resolved in the tax world. For example, it appeared that the legislative history to the 1980 Act resolved (prior to the final regulation discussed above) how to determine COI in a reorganization that occurs in bankruptcy. That resolution was: (1) look to the mixture of consideration received by the most senior level of creditors to receive stock and all junior creditors and (2) actions of the creditors to control the corporation are no longer relevant in the bankruptcy context. This position was shaken in the Tax Court’s Memorandum decision in Ralphs Grocery Co & Subsidiaries v. Commissioner.282 In Ralphs Grocery the court stated that a creditor of corporation in a Title 11 case does not count for COI in a situation in which the corporation is in bankruptcy due to a voluntary petition, as opposed to an involuntary petition in which creditors are enforcing rights, as in Alabama Asphaltic. According to the court, such creditors did not take steps to enforce their rights nor object to or reject the proposed plan. It appears that in the context of a reorganization in bankruptcy (in the post–1980 Act, pre–final regulation time frame), this decision is inconsistent with the legislative history to the 1980 Act. It is interesting to note that in Ralphs Grocery, the creditors that received the stock of the acquiring corporation were not the creditors of the target corporation (which was in bankruptcy) but rather were creditors of the parent of the target, which was also in bankruptcy. The latter situation would have been a more interesting COI issue to analyze.283 It appears that Ralphs Grocery is of limited import for transactions after the effective date of the Final Regulations discussed below, because they include specific rules in this area.

(B) Creditor Continuity outside Bankruptcy

In certain cases, the courts have found that creditors can become proprietors for purposes of satisfying the COI requirement without a formal insolvency proceeding.284 In each case, however, a significant creditor receiving stock of the acquiring corporation was also a significant shareholder of the target corporation. Thus, prior to publication of the final regulations, it was not “clear when creditors of an insolvent corporation not in a title 11 or similar case may be considered proprietors for purposes of satisfying the COI requirement.”285

(C) Final Regulations

The IRS published final regulations (the Final Regulations) describing whether and to what extent one or more classes of creditors will be treated as holding a proprietary interest in a target corporation for purposes of the COI requirement.286 The Final Regulations adopted rules proposed in March 2005 (the Proposed Regulations)287 with minor modifications. The Final Regulations embrace and extend certain of the judicial concepts discussed earlier in this chapter. Specifically, under the Final Regulations, a creditor’s claim against a target corporation may be a proprietary interest in the target corporation if either:

• The target corporation is in a title 11 or similar case (as defined in I.R.C. section 368(a)(3)), or
• The amount of the target corporation’s liabilities exceeds the fair market value of its assets immediately prior to the potential reorganization.

Thus, the Final Regulations extend the application of creditor COI to corporations that are not in bankruptcy but are nevertheless insolvent. Further, the Final Regulations treat certain creditors as proprietors, even though these creditors take no action to obtain effective command over the target corporation’s property (other than their agreement to receive stock in the potential reorganization).

(1) “Relation Back” Approach

The Final Regulations also adopt the “relation back” approach taken by the Tax Court in Atlas Oil. Thus, the Final Regulations provide that if any creditor receives a proprietary interest (i.e., stock) in the issuing corporation in exchange for its claim, every claim of that class of creditors and of all equal and junior classes of creditors and the shareholders is a proprietary interest in the target corporation immediately prior to the potential reorganization to the extent determined under the Final Regulations.

Note, however, that the Final Regulations do not adopt the Tax Court’s approach in Atlas Oil in full. As described, the Tax Court in Atlas Oil suggested that, in some cases, even a creditor that did not receive stock could be treated as a proprietary owner of the corporation. The Final Regulations do not appear to allow for this possibility.

(2) Bifurcation of Senior Claims

Although the legislative history accompanying the 1980 Act appears to take the position that the entire interest of a creditor that receives stock is to be treated as a proprietary interest, the Final Regulations bifurcate the claims of the most senior creditors (and a claim of any equal class of creditors) that receive stock by treating only a portion of the claim as a proprietary interest. The value of a proprietary interest in the target corporation held by a particular senior creditor is determined by multiplying the fair market value of the senior claim by the ratio of stock received by all senior creditors over the total consideration received by all senior creditors. The value of a proprietary interest in the target corporation held by a junior creditor is the fair market value of the junior creditor’s claim (which generally equals the fair market value of all the consideration received in the reorganization).

The rule bifurcating the claims of the most senior class of creditors receiving stock is a favorable rule in situations in which reorganization treatment is desirable but is an unfavorable rule if a taxpayer seeks a taxable transaction. In many bankruptcy reorganizations, senior creditors may seek primarily cash (or other nonstock) compensation in exchange for their claims but may accept some stock consideration as well. Thus, treating the entire claim of the most senior class of creditors taking stock would make the COI requirement difficult to satisfy.

Under the Final Regulations, however, there should be 100 percent continuity in every situation in which: (1) the senior creditors receive the same ratio of stock to nonstock consideration, and (2) neither the junior creditors nor the shareholders receive nonstock consideration.

In contrast, there will not be 100 percent continuity if the senior creditors receive stock and nonstock consideration in different proportions, or if the junior creditors receive cash.

To prevent manipulation of the split-claim approach to satisfy the COI requirement, however, the regulations provide a de minimis rule under which certain stock received by creditors will not be counted for purposes of the COI requirement. Specifically, if only one class (or one set of equal classes) of creditors receives issuing corporation stock in exchange for the creditor’s proprietary interest, such stock will be counted for measuring COI only if the stock issued by the acquiring corporation is not de minimis in relation to the total consideration received by the insolvent target corporation, its shareholders, and its creditors. If the stock is de minimis, it will not be counted for COI purposes.

In this regard, it is interesting to note that, by its terms, the de minimis rule applies only if one class (or one set of equal classes) of creditors receives issuing corporation stock in the transaction. This seems to restrict the IRS’s ability to apply the de minimis rule to ignore the issuance of stock to situations in which just one class of creditors receives de minimis stock. Thus, the issuance of de minimis stock arguably could not be ignored if two classes of creditors received de minimis stock. When this possibility was raised informally with IRS officials, they dismissed it as a situation unlikely to occur.

Unfortunately, as is the case in other areas of the federal tax law, “de minimis” is not defined.288 Because it is an anti-abuse rule, however, it should probably be interpreted as applying only to prevent the potential manipulation at which it is directed. Presumably, the IRS included the rule to prevent the acquiring company from issuing stock to one class of creditors in an amount so small that it would not affect the “real” economics of the deal, while nevertheless permitting the transaction to qualify as a tax-free reorganization. Consider the following example.

As the example illustrates, the de minimis rule prevents the parties from disguising what is, in reality, a sale of assets as a reorganization, solely through manipulation of the bifurcated claims approach.289 The authors agree that the application of the rule is appropriate if: (1) only the most junior class of creditors receives stock and (2) the total value of stock issued is so small that it is clear that it had no impact on the true economics agreed to by the parties. Nevertheless, some guidance regarding what percentage the IRS views as de minimis would be helpful. In the interim, taxpayers and their representatives will have to rely on other authorities interpreting the phrase, or on a sense that, in the context of a particular factual scenario, de minimis is much like pornography and thus they will know it when they see it.290

(3) Bifurcation between Secured and Unsecured Claims of a Creditor

In certain instances, a creditor’s claim is bifurcated into a secured and an unsecured claim in bankruptcy, or pursuant to an agreement between the creditor and the debtor. In either situation, the Final Regulations respect bifurcation of the claim and the allocation of consideration to each of the resulting claims pursuant to bankruptcy or agreement by the parties. It is not unusual, however, for a creditor with a bifurcated claim to receive one payment of stock and nonstock consideration with no specification of how much is applicable to either claim. Unfortunately, the Final Regulations do not address the treatment of bifurcated claims when there is one payment of stock and nonstock consideration, and no specification of how much is applicable to either claim. It is unclear whether it would be reasonable in such a case to treat all of the nonstock consideration as attributable to the secured claim, as the more senior claim.291

(4) Pre-Reorganization Distributions to Creditors

The Final Regulations corrected what was presumably an oversight in the Proposed Regulations relating to distributions to creditors prior to the reorganization. The Proposed Regulations provided that a proprietary interest in a target corporation is not preserved if and to the extent the target’s creditors (or former creditors) that own (or would be treated as owning) a proprietary interest in the corporation under the rules discussed above receive payment for their claim “prior to the potential reorganization.” Clearly, that statement was overly broad in that, read literally, it would include any payment by the target on its debt prior to the reorganization—regardless of whether any such payment was connected to the transaction.

Fortunately, in the Final Regulations the IRS adopted a more appropriate standard. Specifically, the Final Regulations do not preserve a proprietary interest in the target corporation if the prior payment would have been treated as boot received in an exchange for purposes of I.R.C. section 356, if it had been received in a distribution with respect to stock. That rule is consistent with the general continuity requirement, and necessarily requires a connection between the payment and the reorganization.292

(5) Treatment of Shareholders

The Final Regulations make it clear that treatment of a creditor’s claim as a proprietary interest in the target corporation does not preclude treating stock held by the target corporation’s shareholders as pre-reorganization proprietary interests in the target corporation. In other words, stock in a bankrupt or insolvent corporation continues to represent a proprietary interest in the target corporation—at least to the extent the target shareholder receives stock in the acquiring corporation or some other property in the reorganization. This could have interesting implications in a common situation.

In this situation, it is not clear that the target corporation has sufficient equity to entitle the shareholders to receive something of value. That debate is not likely to be resolved (and, if it is resolved, it will be only after the passage of time). Nevertheless, the Final Regulations make it clear that the shareholders in this situation will be treated as having a pre-reorganization proprietary interest in the target corporation for purposes of the COI requirement. Thus, their receipt of warrants (i.e., nonstock consideration) will count against satisfying the COI requirement and will potentially disqualify the transaction as a tax-free reorganization.

Regardless of whether the shareholders have a proprietary interest for purposes of satisfying the COI requirement, they will be treated as the shareholders of the corporation for purposes of satisfying other provisions of the Code. In contrast, although the Final Regulations treat certain creditors as having a proprietary interest in the target corporation for purposes of satisfying the COI requirement, they do not treat the creditors as holding stock for purposes of satisfying other provisions in the I.R.C. Thus, for example, a creditor will not be treated as a shareholder for purposes of satisfying the requirement in I.R.C. section 368(a)(1)(D) that the target corporation or its shareholders control the acquiring corporation.293

Further, a creditor will not be treated as exchanging “stock” in the target corporation in the reorganization for purposes of I.R.C. section 354. I.R.C. section 354 provides, in relevant part, that no gain or loss is recognized if stock or securities in one party to a reorganization are exchanged for stock or securities in another party to a reorganization. Thus, to satisfy COI and for nonrecognition to apply in the reorganization context, a party must give up stock or securities of the target corporation in exchange for stock in the acquiring corporation (or, in certain situations, its parent). Once the reorganization requirements are satisfied, a securities-for-securities exchange may also qualify for nonrecognition treatment.

If a creditor’s claim with respect to the target corporation does not qualify as a “security” because, for example, it is a short-term debt, the creditor will not fall under the nonrecognition rule of I.R.C. section 354.294 Thus, somewhat ironically, a short-term creditor’s claim satisfied with stock in the acquiring corporation will count for purposes of determining whether the COI requirement is satisfied, but the short-term creditor may recognize any gain or loss realized on the exchange.295

(D) Conclusion

The Final Regulations extend the principles espoused by Congress in enacting I.R.C. section 368(a)(1)(G) for insolvent corporations, by attempting to provide similarly situated corporations (inside and outside bankruptcy) with similar tax results. For those desiring tax-free treatment for a restructuring, the Final Regulations provide relatively clear guidance to corporations with financial difficulties, thus providing certainty in an otherwise uncertain time.

In tax (as virtually everywhere else), however, beauty is in the eye of the beholder. Certain changes since the 1980 Act have restricted a creditor’s ability to use a corporation’s tax benefits when the corporation’s creditors acquire the stock of a corporation in exchange for debt outside of bankruptcy. In light of these changes, a corporation’s creditors may prefer a taxable restructuring over a tax-free exchange. Unfortunately, the certainty provided by the Final Regulations comes with a price. Specifically, the bifurcation of senior claims results in a loss of flexibility for those hoping to treat a stock-for-debt exchange as a taxable transaction. Thus, whether the regulations are a welcome friend or a menacing foe depends on whom you ask.

(iv) Recapitalizations Coupled with Insolvency Reorganizations

It is interesting to consider what the tax consequences would be if a transaction similar to that in Southwest Consolidated were accomplished by means of a recapitalization of the target (i.e., creditors receive stock in exchange for their debts) followed by a merger of the target into a newly formed corporation (Newco). Would this form be respected and treated as an E recapitalization followed by an F reorganization? This is exactly what the IRS concluded in P.L.R. 7821047296 in the context of a bankruptcy reorganization.297 In light of Southwest Consolidated and the Step Transaction and Substance over Form doctrines, this might seem a curious result. Nevertheless, the ruling seems correct in the wake of Rev. Rul. 96-29,298 which arguably stands for the proposition that an F reorganization stands alone and is not affected by the Step Transaction doctrine.299

Rev. Rul. 59-222300 presents another bankruptcy two-step transaction involving a recapitalization. This ruling does not, however, address an acquisitive reorganization in the sense that a target corporation transfers its assets to another corporation and then liquidates. Rather, in the ruling, an insolvent corporation, M, filed for bankruptcy, and an unrelated corporation, N, proposed an acquisition of M. N issued common stock to M in exchange for newly issued common stock of M, constituting all of M’s outstanding stock, and the newly issued N stock was used to satisfy the outstanding debt of M. Pursuant to this plan, M emerged as a wholly owned subsidiary of N. The IRS recast the transaction and treated it as if the N debt holders first exchanged their N debt for N stock in a tax-free E recapitalization and then exchanged their newly received N stock for voting stock in M in a tax-free reorganization. This recast resulted in an extremely favorable result. Because N was viewed as satisfying its indebtedness with its own stock, under the former stock-for-debt exception, N would not realize discharge of indebtedness income on the exchange.

This ruling has also been interpreted to apply to situations in which stock of a parent corporation is used to satisfy debt of an existing subsidiary. In such a case, the transaction may be recast as if the subsidiary satisfied its outstanding indebtedness with its own stock (a potential tax-free recapitalization, provided the debts are securities) followed by parent’s acquisition of the stock of the subsidiary with its own voting stock in a B reorganization.

Subsequent statutory and regulatory developments may either (1) cast doubts on the continuing validity of Rev. Rul. 59-222, or (2) at least enhance a taxpayer’s comfort if it does not follow the recast set forth in the revenue ruling. First, as discussed in § 2.4(c), the stock-for-debt exception has been repealed. Second, Treasury issued regulations governing the computation of basis when parent transfers its own stock to a wholly owned subsidiary and the subsidiary uses the parent stock to buy property, pay for services, satisfy debt, and so forth. Absent these regulations, parent’s zero basis in its own stock would be inherited by the subsidiary, causing subsidiary to recognize gain when it uses that stock as consideration in a later transaction. The regulations provide for proper basis adjustments when parent transfers its stock to a subsidiary and that stock is immediately used by the subsidiary to acquire property.301 The preamble to the regulations acknowledges that the regulation applies when the parent stock is used to satisfy debt of a subsidiary.302 In the wake of these regulations, it is unlikely that the IRS could successfully apply a Rev. Rul. 59-222 recast when parent, in form, transfers its stock to a subsidiary and the subsidiary then uses the parent stock to satisfy its debt. Both the form and substance of the transaction are now recognized by regulatory fiat. If a parent corporation acquires debt of the subsidiary with its own (i.e., parent) stock and then pursuant to an integrated plan immediately contributes the debt to the capital of the subsidiary, other provisions (such as I.R.C. section 108(e)(4), Treas. Reg. section 1.1502-13(g), and I.R.C. section 108(e)(6)) provide regimes that deal with such transactions. This also provides some comfort to taxpayers looking not to apply the Rev. Rul. 59-222 recast.

If, however, the form of the transaction matches the Rev. Rul. 59-222 recast (i.e., a recapitalization at the subsidiary level followed by a B reorganization) it would appear that the form of the transaction should be respected given that the revenue ruling has been outstanding for over 50 years. If the transaction that achieves the same end result is formless (namely parent stock is used to satisfy or replace subsidiary debt but neither the transaction documents nor applicable law describe how this happens), the proper federal income tax characterization of the transaction is less clear. Perhaps this is a situation in which Rev. Rul. 59-222 may have its strongest remaining vitality and could be relied on to set a deemed structure for the transaction. Finally, despite all of the discussion above, it may be feasible for taxpayers to rely on Rev. Rul. 59-222 to recast transactions that take a different form (such as the ones discussed above) given that the ruling has remained on the books and addressed a murky area for so many years.

(v) Norman Scott

The Norman Scott303 decision is another important precedent addressing insolvency reorganizations among related parties that occur outside of the bankruptcy context.

The transaction at issue involved three corporations, Norman Scott Inc. (Acquiring), River Oaks, and Continental (Continental and River Oaks, jointly referred to as the Targets). Norman and his wife owned 99 percent of the stock of each corporation.304 The Targets were insolvent and had debts outstanding to the bank as well as to Acquiring. Norman also served as an accommodation endorser on the bank notes of River Oaks and Continental. River Oaks and Continental both merged into Acquiring, and Norman and his wife received additional Acquiring stock. The issue was whether the mergers qualified as reorganizations under I.R.C. section 368(a)(1)(A) such that the NOLs of the Targets would carry over to Acquiring pursuant to I.R.C. section 381.

The Tax Court concluded that Norman and his wife held the proprietary interest in River Oaks and Continental in their capacity as shareholders (assuming the corporations were solvent) or as creditors (assuming the corporations were insolvent) and received stock in Acquiring in the merger in that capacity. In short, the Tax Court’s view was that the continuity of proprietary interest requirement was satisfied and that the transaction qualified as an A reorganization.

The IRS’s position on the issues presented in Norman Scott is summarized in General Counsel Memorandum (G.C.M.) 33859 and the attached Action on Decision.305 The IRS agreed with the Tax Court’s conclusion that the mergers qualified as A reorganizations but based its conclusion on different rationale, as stated in the G.C.M.

The IRS first disagreed that the mere insolvency of a corporation shifts the proprietary interest from the shareholders to the creditors. According to the G.C.M., the creditors of the insolvent corporation must take some affirmative action to assert their claims in order to effectuate such a shift. This assertion is supported by three of the four cases cited by the Tax Court on this issue.306 In the fourth case, Seiberling Rubber Co. v. Commissioner,307 an insolvent corporation transferred its assets to a new corporation. The sole shareholder and creditor of the insolvent corporation was the majority shareholder of the newly formed corporation. The Sixth Circuit held that the transaction qualified as a tax-free reorganization under a predecessor provision to I.R.C. section 368(a)(1)(D) and that it did not make a difference that the shareholder/creditor received stock of the newly formed corporation in his capacity as a creditor rather than in his capacity as a shareholder. It was enough that the control requirement was satisfied, namely that persons in control of the new corporation were shareholders of the target corporation.

The G.C.M. also acknowledges that the IRS accepted the Seiberling decision in Rev. Rul. 54-610.308 In that ruling, the bondholders of an insolvent corporation also owned over 80 percent of the corporation’s stock. When a newly formed corporation (Newco) acquired the assets of the insolvent corporation, these bondholders/stockholders received Newco stock in satisfaction of their bonds. Citing Seiberling, the revenue ruling concludes that COI was satisfied and that the transaction qualified as a reorganization under a predecessor provision to I.R.C. section 368(a)(1))(C).

Based on the authorities just described, the IRS concluded in the G.C.M. that the insolvency of the Norman Scott Targets shifted the proprietary interests from the outstanding stock of these corporations to their outstanding indebtedness. Nevertheless, because Norman and his wife were the shareholders of the Targets and the Acquiring corporation both before and after the transactions, COI was satisfied. The fact that they received stock in Acquiring with respect to their creditor position and not their shareholder position did not alter this result.

The next issue considered in the G.C.M. was whether the mergers should be viewed as asset transfers by the Targets in an I.R.C. section 368 reorganization or merely as transfers in satisfaction of indebtedness to Acquiring. To resolve this issue, both the Tax Court and the IRS needed to address the position set forth in Rev. Rul. 59-296.309 In that ruling a parent corporation was also a creditor of its wholly owned subsidiary in an amount in excess of the fair market value of the stock of the subsidiary. The subsidiary merged upstream into its parent. The ruling concludes that because the subsidiary’s property was worth less than its debt to its parent, no part of the transfer was attributable to the stock interest of the parent. The transaction was therefore neither a tax-free liquidation under I.R.C. section 332 nor a tax-free A reorganization.310 Both the Tax Court and the G.C.M. concluded that the merger of an insolvent corporation into its brother corporation was distinguishable from an upstream merger of an insolvent subsidiary into its parent/creditor.311

Thus, the Tax Court and the IRS concluded that the merger could qualify as an A reorganization despite the fact that the acquiring corporation was a creditor of the target.312 In fact, the Tax Court specifically noted that the taxpayer had the choice of merging the debtor corporation into the creditor corporation in an A reorganization or of writing off the bad debts. If the reorganization transaction is forgone and a bad debt deduction is taken, the debtor would presumably realize discharge of indebtedness income with respect to its indebtedness to the acquiring corporation subject to the exceptions under I.R.C. section 108. In addition, under the current state of the law, the target corporation in the Norman Scott transaction would realize discharge of indebtedness income (also subject to the I.R.C. section 108 exceptions) to the extent the amount of its indebtedness to its shareholders exceeds the fair market value of the acquiring stock issued or deemed issued to such shareholders in the merger.313

(vi) Exchange of Net Value Requirement

The Treasury Department and the IRS released proposed regulations on transactions involving the transfer of no net value, providing guidance on the reorganization and liquidation of insolvent corporations.314 The exchange of net value requirement may apply to I.R.C. section 368 reorganizations, I.R.C. section 351 exchanges, and I.R.C. section 332 liquidations. These rules will not be effective until published as final regulations.

The exchange of net value requirement applies to both asset and stock reorganizations. However, the exchange of net value is not required for an acquisitive D reorganization, a recapitalization (E reorganization), or a mere change of identity (F reorganization). With regard to the first of these (the acquisitive D reorganizations), the preamble to the proposed regulations indicates that the possible application of the exchange of net value requirement is subject to further study.

The proposed regulations adopt an exchange of net value requirement to prevent transactions that resemble sales from qualifying for nonrecognition of gain or loss. For example, an acquisition of assets solely in exchange for the assumption of liabilities resembles a sale and should not be tax free. The proposed regulations generally require both a surrender of net value and a receipt of net value. Thus, for example, in order for a merger to be tax free, the target corporation must transfer property with net value and receive stock with net value.

The proposed regulations do not define “liabilities” for purposes of applying the exchange of net value requirement; however, the Treasury Department and the IRS broadly interpret the term to include any obligation that reduces the net worth of the obligor. Various methods for determining the amount of liabilities are under consideration, but there is no clear interim approach regarding nonrecourse liabilities. If more than one person might be responsible for a liability, then the principles of I.R.C. section 357(d) should apply. Transfers of assets in satisfaction of liabilities are treated the same as transfers of assets in exchange for the assumption of liabilities. Liabilities assumed before, during, and after the exchange are taken into account when determining whether the exchange of net value requirement is satisfied. Substance over Form and other nonstatutory doctrines may be used to determine whether an assumption of liabilities is in connection with the exchange.

(b) G Reorganization

(i) Purpose

A G reorganization under I.R.C. section 368(a)(1)(G) represents Congress’s attempt to deal with reorganizations of insolvent corporations.315 As will be seen, Congress was trying to facilitate this type of transaction by relaxing some of the rules while maintaining the integrity of the reorganization provisions. In addition to the requirements for G reorganizations to be discussed, proposed regulations, discussed in § 5.8(a)(v), create an exchange of net value requirement.

(ii) Transfer of Assets

The I.R.C. provides that a G reorganization is one in which a corporation transfers all or part of its assets to another corporation in a “title 11 or similar case,” but only if, pursuant to the plan, stock or securities of the transferee corporation are distributed in a transaction that qualifies under I.R.C. section 354, 355, or 356.316 The transfer of assets must be pursuant to a case under title 11 of the United States Code or a receivership, foreclosure, or similar proceeding in a federal or state court,317 and must be made pursuant to a plan that has received the approval of the court.318 In cases in which the transferor corporation is a financial institution to which I.R.C. section 581 or 591 applies and there is a receivership, foreclosure, or similar proceeding before a federal or state agency, then that agency is considered to be a court.319 Although either the target or the acquiring corporation can be in a title 11 or similar case for purposes of qualifying a transaction as a G reorganization, the most common scenario involves a bankrupt target corporation. Therefore, the various G reorganization issues are discussed below in the context of a bankrupt target corporation transferring its assets to a nonbankrupt acquiring corporation.

(iii) “Substantially All”

In a G reorganization, as in a D reorganization, there must be a distribution of stock or securities in accordance with the provisions of I.R.C. section 354, 355, or 356. Thus, as was discussed in conjunction with a D reorganization, in order for the distribution to qualify under I.R.C. section 354, the acquiring corporation must acquire substantially all of the assets of the target corporation and the target corporation must liquidate. The concept of “substantially all” does not, however, have the same meaning in a G reorganization as it has in other reorganizations to which it applies. For example, it would not be feasible to use the IRS’s advance ruling guidelines that mandate the acquisition of 90 percent of the net assets and 70 percent of the gross assets of the target for C and D reorganizations,320 because bankrupt corporations are often insolvent and therefore do not have net assets. The legislative history of the G reorganization indicates that the “substantially all” requirement should be interpreted in light of the underlying intent of the statute: to facilitate reorganizations of financially distressed corporations.321 A general rule of thumb that has arisen out of the private letter ruling process is that the IRS will be satisfied that the “substantially all” requirement has been satisfied in a G reorganization if the acquiring corporation acquires more than 50 percent of the gross assets and more than 70 percent of the operating assets of the bankrupt target.322

Because the concept of COBE and its relationship to the “substantially all” requirement applies to all acquisition reorganizations, including the G, precedent set in the context of other acquisitive reorganizations may provide some guidance on the proportion of acquired assets that must be retained by the acquiring corporation. The IRS has stated that the COBE test will be satisfied if the acquiring corporation continues a significant line of business of the target corporation or uses a significant portion of the target corporation’s assets in a business. This is further defined to mean a business that represents approximately one-third of the value of the target corporation.323 Thus, a retention of one-third of the target corporation’s assets should satisfy the “substantially all” test in a G reorganization.

There is, however, some uncertainty in this area because the IRS has stated that in a G reorganization involving a financial institution, there must be a transfer and retention of at least 50 percent of the fair market value of the target corporation’s assets in order to satisfy the “significant portion of assets” test for COBE purposes.324 This requirement contradicts the Treasury Regulations on COBE and congressional intent that G reorganizations be facilitated. Indeed, this 50 percent requirement was later modified to permit satisfaction of the test if the acquiring corporation continued the historical business of the target corporation.325 Nonetheless, this effort to make the COBE test more stringent must be considered in structuring any G reorganization, because it represents one of the few published positions regarding this type of reorganization.

(iv) Triangular G Reorganization

Congress also authorized the use of triangular G reorganizations. I.R.C. section 368(a)(2)(D) was amended to permit a forward triangular G, which would operate in the same manner as the forward triangular merger (see Exhibit 5.2).326 Congress added I.R.C. section 368(a)(3)(E) to permit a reverse triangular G, similar to a reverse triangular merger (see Exhibit 5.4), with two major exceptions. First, in a reverse triangular G, no former shareholder of the target corporation (i.e., the financially distressed corporation which will be the “survivor” of the transaction) may receive any consideration in return for his or her stock. Second, the former creditors of the target corporation must exchange at least 80 percent of the fair market value of their debt solely for voting stock of the controlling (parent) corporation.327

(v) Dominance of G Reorganization

If a transaction qualifies as both a G reorganization and another type of I.R.C. section 368 reorganization, or a tax-free 332 liquidation, or a tax-free I.R.C. section 351 exchange, the transaction will be considered to be a G reorganization only.328 I.R.C. section 357(c) does not apply to acquisitive G reorganizations.329

If possible, the debtor may prefer to structure a transaction as a recapitalization of an existing corporation under I.R.C. section 368(a)(1)(E) rather than as a G reorganization. Under the E reorganization, there is no COI requirement. Thus, if there is some concern about meeting this requirement, a recapitalization may be preferable.330

In P.L.R. 200617024,331 the IRS determined that the liquidation of an insurance subsidiary, while the subsidiary was in receivership, was tax free under I.R.C. sections 332 and 337. In the ruling, Subsidiary was a non–life insurance company that, prior to 2004, was exempt from tax under I.R.C. section 501(c)(15). Following changes in the law that year, Subsidiary would generally not be exempt under that provision. A grandfather rule applied to certain companies in a rehabilitation or liquidation.

After that date, a court issued a final order placing Subsidiary and other members of its related group of corporations into receivership and appointing the insurance commission as the receiver. The receiver suspended issuance of new insurance business. However, policies issued by Subsidiary were not canceled.

To wind up Subsidiary and other members of its group, the receiver adopted a plan of complete liquidation of Subsidiary. Although the IRS ruled that the liquidation qualified for tax-free treatment under section 332, this transaction could have qualified as an upstream G reorganization because G reorganization treatment trumps section 332 treatment. Interestingly, this is contrary to what practitioners generally assume.

The legislative history of the Bankruptcy Tax Act of 1980 provides that if a transaction in bankruptcy does not satisfy the requirements for a G reorganization, it is not precluded from qualifying as a tax-free reorganization under another category in I.R.C. section 368(a)(1).332 For example, in one ruling, the IRS treated a reorganization in bankruptcy as an F reorganization. Although the ruling does not explicitly say why, it is possible that the G qualification was problematic due to any number of reasons, such as step-transaction issues or the “substantially all” requirement.333

(vi) Tax Treatment

The tax treatment of the participants in a G reorganization follows the traditional rules, with certain exceptions. The target corporation will recognize no gain or loss on the assumption of its liabilities (unless I.R.C. section 357(c) applies) nor on the receipt of the acquiring corporation’s stock or securities in exchange for its assets.334 The acquiring corporation will recognize no gain or loss on the issuance of its stock in exchange for the target corporation’s assets.335 In general, it will also take a transferred basis in those assets,336 but this basis, unlike the transferred basis in other reorganizations, may be subject to adjustment.337 As with the other reorganizations, the holding period of the assets will be tacked onto the acquiring corporation’s holding period.338

Tax treatment of the stockholders and creditors of the target corporation in the context of a G reorganization is more complex. If stock of the acquiring corporation is received in exchange for stock of the target corporation, then no gain or loss will be recognized by the stockholder. If stock or securities of the acquiring corporation are received in exchange for securities of the target corporation, then no gain or loss will generally be recognized by the target security holder with a few exceptions.339 If the proprietor receives consideration for accrued interest on a security of the target corporation, this consideration will be treated as interest income.340 This rule applies to all reorganizations, but it is more likely to occur in a G reorganization. Also, if the principal amount of a security received by a security holder exceeds the principal amount of the security surrendered, then the fair market value of this excess principal amount should be taxable as a capital gain, if there is a realized gain in the transaction.341 This rule also applies to all reorganizations. If nonrecognition treatment is afforded the stockholder or security holder, then both transferred basis and tacking on of the holding period would be applicable as in other reorganizations.342 If stock or securities are received in exchange for a nonsecurity debt, a gain or loss will be recognized by the proprietor on the exchange. The gain or loss will be based on the difference between the value of the stock exchanged and the basis of the claim.

§ 5.9 SUMMARY

Common threads run through the reorganization provisions. These include business purpose, continuity of business enterprise, continuity of interest, the “solely for voting stock” requirement, and the “substantially all” requirement. Despite this commonality, these concepts can have different meanings when applied to specific reorganizations. Care must be taken in structuring a transaction to determine the precise concepts that apply. In overlap situations, careful consideration must be given to the form of reorganization that will take precedence.

As will be seen in Chapter 6, the determination of the applicable reorganization provision will be important in determining whether a corporation restructuring its debt will be able to make use of pre-reorganization losses.

1 Treas. Reg. § 1.368-1(b).

2 I.R.C. § 361.

3 I.R.C. § 354.

4 I.R.C. §§ 362(b) (corporations); 358 (shareholders).

5 I.R.C. §§ 1223(2) (corporations); 1223(1) (shareholders).

6 It is generally accepted that E and F reorganizations do not require COBE (discussed in § 5.2(c)) or COI (discussed in § 5.2(d)).

7 Treas. Reg. § 1.368-2(g).

8 Treas. Reg. § 1.368-1(b).

9Appeal of Laure, 653 F.2d 253 (6th Cir. 1981); United States v. Adkins-Phelps, Inc., 400 F.2d 737 (8th Cir. 1968); Becher v. Commissioner, 221 F.2d 252 (2d Cir. 1955); Bentsen v. Phinney, 199 F. Supp. 363 (S.D. Tex. 1961).

10 T.D. 7745, 45 Fed. Reg. 86433 (Dec. 31, 1980).

11 T.D. 8760, 63 Fed. Reg. 4174 (Jan. 28, 1998). The final regulations are generally effective for transactions occurring after January 28, 1998.

12 Treas. Reg. § 1.368-1(d)(1).

13 Treas. Reg. § 1.368-1(d)(5), Example 1 (business continuity), Example 2 (asset continuity). This one-third concept also existed in the 1980 regulations.

14See, e.g., Rev. Rul. 87-76, 1987-2 C.B. 84 (COBE violation when a target corporation engaged in historical business of trading in stocks and bonds disposes of that business, at the behest of the acquiring corporation, and begins trading in municipal bonds); Rev. Rul. 85-197, 1985-2 C.B. 120 (COBE satisfied when a holding company merges downstream into its subsidiary because the holding company is considered engaged in the business of its operating subsidiary); Rev. Rul. 81-25, 1981-1 C.B. 132 (COBE violation when target corporation engaged in manufacturing sells all its assets to an unrelated party for cash and uses the cash to engage in a business unrelated to manufacturing).

15 “Control” for this purpose is defined as stock possessing 80 percent of voting power and 80 percent of the number of shares of nonvoting stock on a class-by-class basis. I.R.C. § 368(c); Rev. Rul. 59-259, 1959-2 C.B. 115.

16 2002-2 C.B. 986.

17See also Treas. Reg. § 1.368-2(k)(2) Example 6.

18 Treas. Reg. § 1.368-1(b). T.D. 9182, 70 Fed. Reg. 9219 (Feb. 25, 2005).

19See § 5.2(c)(ii) of this volume, “COBE Regulations for Transactions after October 25, 2007.”

20 Treas. Reg. § 1.368-1(d)(4).

21 For the purposes of simplicity, the term “acquiring corporation” is used in this book. The regulations use the term “issuing corporation” to refer to the corporation in control of the acquiring corporation (when the stock of such corporation is used as consideration in a triangular reorganization) and the acquiring corporation (when the stock of the acquiring corporation is used as consideration in the reorganization).

22 The acquiring corporation must own directly stock meeting the requirements of I.R.C. § 368(c) (80 percent voting power and 80 percent total number of shares of each nonvoting class of stock) in at least one of the corporations, and stock meeting the requirements of I.R.C. § 368(c) in each of the corporations must be owned directly by one of the other corporations. Treas. Reg. § 1.368-1(d)(4)(ii).

23 Treas. Reg. §§ 1.368-2(f); 1.368-2(k). The proposed regulations had not imposed this restriction.

24 Treas. Reg. § 1.368-2(k)(2).

25 Rev. Rul. 2001-24, 2001-1 C.B. 1290 (forward subsidiary merger will not be disqualified or recharacterized due to the parent’s postmerger contribution of the acquiring stock to another wholly owned subsidiary).

26 Treas. Reg. § 1.368-1(d)(4)(iii)(A).

27 Treas. Reg. §§ 1.368-1(d)(4)(iii)(B)(1); 1.368-1(d)(5), Example 11.

28 Treas. Reg. §§ 1.368-1(d)(4)(iii)(B)(2); 1.368-1(d)(5), Example 7, Example 8.

29 Treas. Reg. § 1.368-1(a).

30 Treas. Reg. § 1.368-2(k)(3), Example 3.

31See supra, notes 17 and 18 and accompanying text.

32 T.D. 9361 and Treas. Reg. § 1.368-1(d)(4) and (5).

33 Treas. Reg. § 1.368-1(d)(4)(ii).

34 Treas. Reg. § 1.368-1(d)(4)(iii)(D).

35 T.D. 9361 and Treas. Reg. § 1.368-2(k)(1).

36 Treas. Reg. § 1.368-2(k)(1)(i) and (ii).

37 Treas. Reg. § 1.368-2(k)(1)(i)(A)(2) and (ii)(B)(2).

38 Treas. Reg. § 1.368-2(k)(1)(i)(A)(1).

39 Treas. Reg. § 1.368-2(k)(1)(ii).

40 Treas. Reg. § 1.368-2(k)(1)(i)(A)(2), (ii)(B)(2).

41 Continuity-providing stock may be stock of the acquiring corporation or stock of the parent of the acquiring corporation, which is referred to in the regulations as stock in the “issuing corporation.” Treas. Reg. § 1.368-1(b).

42See Treas. Reg. §§ 1.368-1(e)(1), -1(b); LeTulle v. Scofield, 308 U.S. 415 (1940); Cortland Specialty Co. v. Commissioner, 60 F.2d 937 (2d Cir. 1932).

43 Rev. Proc. 77-37, 1977-2 C.B. 568, § 3.02, amplified by Rev. Proc. 86-42, 1986-2 C.B. 722 and Rev. Proc. 89-50, 1989-2 C.B. 631.

44See John A. Nelson Co. v. Helvering, 296 U.S. 374 (1935).

45 Temporary and proposed regulations governing additional COI issues were also issued on January 23, 1998. T.D. 8761, 63 Fed. Reg. 4183 (Jan. 28, 1998). These temporary and proposed regulations have the same effective date as do the final regulations.

46 Treas. Reg. § 1.368-1(e)(6), Example 1.

47 Before regulations were issued in 1998, a post-reorganization disposition of stock, however, could undo an otherwise qualifying reorganization. The uncertainty this issue created was exacerbated by contradictory case law. Compare McDonald’s Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir. 1982) (no COI when target corporation’s shareholders received stock from the acquiring corporation and, pursuant to an overall plan, registered the stock with the SEC and disposed of it to third parties for cash), with Penrod v. Commissioner, 88 T.C. 1415 (1987) (COI satisfied under similar facts, where the sale of 90 percent of an acquiring corporation’s stock within eight months of the reorganization was held to be an independent step).

48 Treas. Reg. §§ 1.368-1(e)(1)(i); 1.368-1(e)(6), Example 1. For preregulation case law addressing pre-reorganization COI see J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (1995), in which the court found a tax-free reorganization by treating Seagram as a historical shareholder of Conoco, even though Seagram’s interest in Conoco had been recently purchased in a failed takeover attempt. For a more extensive discussion of this development in the law of COI, see Bloom, Taxpayers Have More Flexibility in Reorganizations After Seagram— If It Survives, 82 J. Tax’n 334 (June 1995).

49 Treas. Reg. § 1.368-1(e)(1)(ii). See Rev. Rul. 71-364, 1971-2 C.B. 182; Debra J. Bennett and Nelson F. Couch, The Effect of Target Redemptions and Distributions on Continuity of Interest, 89 Tax Notes 1301 (Dec. 4, 2000).

50 Treas. Reg. § 1.368-1(e)(l).

51 Treas. Reg. § 1.368-1(e)(2).

52 Treas. Reg. § 1.368-1(e)(3).

53 Treas. Reg. § 1.368-1(e)(2). Thus a sale, transfer, or distribution of stock of the acquiring corporation after a reorganization between two members of an affiliated group will not have a negative impact on COI, because the ultimate indirect owners of the stock remain the same. The regulations are consistent with the prior position of the IRS. See, e.g., Rev. Rul. 84-30, 1984-1 C.B. 114 (stock received by target corporation can be distributed to target’s shareholders, which in turn can distribute the stock up the chain without violating COI).

54See Treas. Reg. §§ 1.338-3(d); 1.368-1(e)(6), Example 4. See discussion of I.R.C. § 338 in Chapter 7. For purposes of a broad overview, a QSP is generally defined in I.R.C. § 338(d)(3) as a purchase or series of purchases of the stock of a target corporation by an acquiring corporation over a 12-month period that constitutes 80 percent or more of the stock of the target corporation as defined in I.R.C. § 1504(a)(2). This exception may lead to strange results. For example, assume that parent corporation (P) owns 100 percent of subsidiary (S). P purchases 100 percent of the stock of a target corporation (T) for cash and S then merges into T. COI would be satisfied because the merger followed a QSP. If P had purchased 75 percent (rather than 100 percent) of the T stock for cash, the purchase would not be a QSP and COI would not be satisfied. I.R.C. § 338 also raises other interesting COI issues. See, e.g., Rev. Rul. 2001-46, 2001-2 C.B. 321; Rev. Rul. 90-95, 1990-2 C.B. 67; T.D. 9071, 68 Fed. Reg. 40766 (July 9, 2003).

55 T.D. 8760, 63 Fed. Reg. 4174 (Jan. 28, 1998) (preamble).

56Treas. Reg. § 1.368-1(b).

57 Final regulations issued in 2005 adopt the position that COI is not required in an E and an F reorganization. Treas. Reg. § 1.368-1(b), 1.368-2(m), T.D. 9182, 70 Fed. Reg. 9219 (Feb. 25, 2005). For a discussion of COI in the context of insolvency reorganizations, see infra § 5.8(a)(iii).

58 Treas. Reg. § 1.368-1(b).

59 T.D. 9316, 72 Fed. Reg. 12974 (Mar. 20, 2007).

60 I.R.C. § 368(c); Rev. Rul. 59-259, 1959-2 C.B. 115.

61 I.R.C. § 332.

62 I.R.C. § 1504(a)(2).

63See I.R.C. § 1504(a)(4) (excluding certain preferred stock—so-called vanilla preferred—from the definition of “stock” for purposes of I.R.C. § 1504(a)).

64 Rev. Rul. 56-613, 1956-2 C.B. 212. However, stock may now be transferred after a B reorganization or specified other acquisitions within a qualified group or to certain controlled partnerships without running afoul of the control requirement. See supra § 5.2(c)(ii).

65 165 F.3d 822 (11th Cir. 1999), aff’g 109 T.C 133 (1997).

66See also T.A.M. 9452002 (Aug. 26, 1994) (taxpayer did not satisfy the control requirement, because the power of the board of directors was too restricted, even though it met the numerical 80 percent threshold).

67 Treas. Reg. § 1.368-1(e). See Bateman v. Commissioner, 40 T.C. 108 (1963), nonacq., 1965-2 C.B. 7.

68 1984-1 C.B. 521.

69See Rev. Rul. 76-42, 1976-1 C.B. 102; see also Rev. Rul. 76-334, 1976-2 C.B. 108 (escrow agreement separate from reorganization).

70 Rev. Rul. 78-376, 1978-2 C.B. 149.

71 The “solely for voting stock” requirement of B and C reorganizations should also be satisfied.

72 The purpose of this chapter is to give a general overview of the reorganization provisions. Although some exceptions to the general rules are mentioned, a discussion of every exception is beyond the scope of this book. In addition, other provisions, such as the consolidated return regulations, could have an impact on the tax consequences.

73See I.R.C. §§ 361(a); 357(a). But see I.R.C. §§ 361(b), 357(b), and 357(c), which may result in corporate-level gain in a reorganization in the event that other property is used to acquire the target corporation assets and such property is not distributed pursuant to the plan of reorganization, liabilities of the target are assumed by the acquiring corporation for avoidance purpose, or the acquiring corporation assumes liabilities of the target in excess of target’s basis in its assets. See infra § 5.4(d)(v).

74 I.R.C. § 361(c).

75See I.R.C. §§ 1032; 362(b); 1223(2). The American Jobs Creation Act of 2004 imposes a limitation on the transfer or importation of built-in loss property. Under old law, the basis of property received by a corporation—whether from domestic or foreign transferors—in a tax-free reorganization is the same as the adjusted basis of that property in the hands of the transferor, adjusted for gain or loss recognized by the transferor. I.R.C. § 362.

The legislative history to the Act provides generally that in certain reorganizations involving the importation of built-in loss property, the basis of the property in the hands of the transferee should not be transferred basis but rather should be the fair market value of the transferred property immediately after the transfer. See S. Rep. No. 108-192 (2003).

The Act generally fixes a corporation’s basis in property acquired in certain I.R.C. § 362 transfers at fair market value. The limitation applies to importations of net built-in loss properties into the U.S. tax system subject to I.R.C. § 362 (i.e., reorganizations). Property is imported into the U.S. tax system if gain or loss with respect to the property is not subject to U.S. income tax in the hands of the transferor immediately before the transfer, and gain or loss with respect to the property is subject to U.S. income tax in the hands of the transferee immediately after the transfer. If the transferee’s total basis in all such properties transferred otherwise exceeds the total fair market value of the properties at the time of the transfer, the properties have a net built-in loss. Under the Act, all such properties have a fair market value basis in the hands of the transferee immediately after the transfer. (There is no provision affecting the transferor’s basis in the stock of the transferee received in exchange for the properties.) Pub. L. No. 108-357, § 836 (2004). See § 7.3 for a brief description of this rule and other I.R.C. § 362 basis limitations that apply in an I.R.C. § 351 transaction and for a discussion of proposed regulations issued with respect to I.R.C. § 362(e). This could apply to reorganizations that overlap with I.R.C. § 351 transactions.

76 In the context of a triangular reorganization, stock of a corporation in control of the acquiring corporation.

77See I.R.C. §§ 354; 358(a); 1223(1).

78 “Long-term” is not defined. The conventional rule of thumb is that an average maturity date of less than 5 years is short-term, more than 10 years is long-term, and between 5 and 10 years is inconclusive. The maturity date is not the only factor that determines whether a security is long-term, however. See Boris I. Bittker and James S. Eustice, Federal Income Taxation of Corporations and Shareholders, 12.41[3] (7th ed. 2002). In Rev. Rul. 2004-78, 2004-2 C.B. 108, a security of a target corporation (issued with a 12-year term to maturity) was exchanged 10 years after its issuance for acquiring corporation debt (with the same maturity date, now two years later). Except for a change in the yield, this was a significant modification under the terms. The IRS ruled that the exchange will be treated as a security-for-security exchange that qualifies for nonrecognition treatment. One interesting aspect of this ruling is that the acquiring security only had a two-year term to maturity when issued, to match the maturity date of the target security. Rev. Rul. 2004-78, 2004-2 C.B. 108. This ruling may not be a taxpayer-favorable rule in all situations. For example, nonrecognition treatment would prevent the recognition of losses as well as gains.

79 In the context of a triangular reorganization, stock of a corporation in control of the acquiring corporation.

80See I.R.C. § 356.

81 I.R.C. § 356(d). In addition, the I.R.C. § 354 nonrecognition provisions do not apply to stock, securities, or other property that are attributable to interest that has accrued on such securities on or after the beginning of the holder’s holding period.

82See I.R.C. § 354(a)(2)(B); Treas. Reg. § 1.356-7.

83See I.R.C. §§ 354(a)(2)(C)(i); 351(g)(2). In the American Jobs Creation Act of 2004, Congress responded to a concern that taxpayers may attempt to avoid characterization of an instrument as nonqualified preferred stock by including illusory participation rights or including terms that taxpayers argue create an unlimited dividend. Congress amended I.R.C. § 351(g)(3)(A) to provide that stock will “not be treated as participating in corporate growth to any significant extent unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation.” Pub. L. No. 108-357, § 899 (2004).

The legislative history provides two examples:

The first example involves instruments that are preferred on liquidation but that are entitled to the same dividends as may be declared on common stock. Such instruments cannot avoid being classified as preferred stock if the corporation does not in fact pay dividends to either its common or its preferred stockholders.

The second example involves stock that entitles the holder to a dividend that is the greater of 7 percent or the dividends common shareholders receive. Such stock cannot avoid being classified as preferred stock if the common shareholders are not expected to receive dividends greater than 7 percent.

See S. Rep. No. 108-192 (2003).

84 I.R.C. § 354(a)(2)(B). An exception to the preferred-stock-as-boot rule is provided for the recapitalization of a family-owned corporation, defined as a corporation with at least 50 percent of the total combined voting power of all classes of stock entitled to vote and at least 50 percent of all other classes of stock owned by members of the same family for five years before and three years after the recapitalization. “Members of the same family” include children, parents, grandparents, brothers, sisters, and spouses. I.R.C. §§ 447(e); 354(a)(2)(C)(ii).

85See Pub. L. No. 105-34, 105th Cong., 1st Sess. §1014, 111 Stat. 788 (1997).

86 The rules regarding nonqualified preferred stock generally apply to issuances of preferred stock after June 8, 1997. Pub. L. No. 105-34 at § 1014(f) (1997).

87 Treas. Reg. § 1.356-3; T.D. 8752, 63 Fed. Reg. 409 (Jan. 6, 1998).

88See Treas. Reg. § 1.354-1, Example 3.

89 Treas. Reg. § 1.356-6; T.D. 8753, 63 Fed. Reg. 411 (Jan. 6, 1998), amended by T.D. 8882, 65 Fed. Reg. 31708 (May 16, 2000).

90 The regulations regarding warrants and nonqualified preferred stock are generally effective for stock rights received in connection with a transaction occurring on or after March 9, 1998. T.D. 8752, 63 Fed. Reg. 409 (Jan. 6, 1998); T.D. 8753, 63 Fed. Reg. 411 (Jan. 6, 1998).

91See Gregory v. Helvering, 293 U.S. 465 (1935) (regarded by many as the seminal case in the area, existence of a transitory corporation is disregarded to recast a series of otherwise tax-free steps into a taxable transaction); Rev. Rul. 70-140, 1970-1 C.B. 73 (transfer of assets to corporation (target) before target is transferred to acquiring corporation in a B reorganization is recast as a taxable sale of the assets to the acquiring corporation followed by the transfer of those assets to the target corporation). But see Weikel v. Commissioner, 51 T.C.M. (CCH) 432 (1986) (transaction is not recast in appropriate circumstances); Vest v. Commissioner, 57 T.C. 128 (1971), aff’d in part, rev’d in part, 481 F.2d 238 (5th Cir. 1973); Rev. Rul. 2003-51, 2003-1 C.B. 938 (back-to-back I.R.C. § 351 exchanges would not be recast; Rev. Rul. 70-140 distinguished). See also Rev. Rul. 68-349, 1968-2 C.B. 143 (transfer of property by an individual to a newly formed corporation does not qualify for tax-free treatment if another corporation makes an accommodating asset transfer for the purpose of qualifying the individual’s transfer for tax-free treatment); Rev. Rul. 76-123, 1976-1 C.B. 94 (distinguishing Rev. Rul. 68-349 and respecting a similar transaction); Rev. Rul. 68-357, 1968-2 C.B. 144 (transaction similar to Rev. Rul. 68-349 is not recast because the corporations are participating in reorganizations); Rev. Rul. 2008-25, 2008-21 C.B. 986 (I.R.C. § 368(a)(2)(E) reverse triangular reorganization followed by liquidation of target (not accomplished by upstream merger) treated as taxable qualified stock purchase under I.R.C. § 338(d)(3) followed by a tax-free I.R.C. § 332 liquidation);

92See, e.g., Rev. Rul. 83-142, 1983-2 C.B. 68; Rev. Rul. 78-397, 1978-2 C.B. 150 (disregarding circular cash flows results in tax-free treatment). See also Rev. Rul. 80-154, 1980-1 C.B. 68 (foreign corporation’s capitalization of undistributed corporate profits treated as a distribution of stock under I.R.C. § 305(a)). See also Rev. Rul. 2004-83; 2004-2 C.B. 157 (stock purchase otherwise subject to I.R.C. § 304 followed by a liquidation as a D reorganization). Rev. Rul. 2001-46; 2001-2 C.B. 321 (stock purchase other than qualifying as an I.R.C. § 338 qualified stock purchase followed by an upstream merger treated as an A reorganization).

93See, e.g., Rev. Rul. 2001-46, 2001-2 C.B. 321 (I.R.C. § 368(a)(2)(E) reverse triangular merger followed by an A reorganization upstream merger of target into acquiring is treated as a single A reorganization of target into acquiring); Rev. Rul. 72-405, 1972-2 C.B. 217 (I.R.C. § 368(a)(2)(D) forward triangular merger followed by liquidation of the acquiring corporation treated as a C reorganization); Rev. Rul. 67-274, 1967-2 C.B. 141 (B reorganization followed by liquidation of target treated as a C reorganization). But see Rev. Rul. 2003-51, 2003-1 C.B. 938 (two valid I.R.C. § 351 transactions where the first is followed (pursuant to a binding agreement) by a second in which the original transferor transfers the stock received in the first, and a third party transferor transfers other property).

94See Treas. Reg. § 1.368-2T(b)(1)(ii).

95 Treas. Reg. § 1.381(c)(1)-1(b), Examples 1, 2.

96See, e.g., Rev. Rul. 69-6, 1969-1 C.B. 104.

97 Rev. Rul. 2000-5, 2000-1 C.B. 436 (to qualify as an A reorganization, a transaction must result in one corporation acquiring the assets of a target corporation by operation of a corporate law merger statute and the target corporation must cease to exist, in contrast to a divisive transaction in which a corporation’s assets are divided between two or more corporations).

98 Treas. Reg. § 1.368-2.

99 I.R.C. § 368(a)(2)(C) previously referred to liabilities to which any acquired property is “subject” in addition to assumed liabilities. This reference was deleted as part of the changes to I.R.C. § 357(c) discussed in § 5.4(d)(v), infra. Pub. L. No. 106-36, 106th Cong. 1st Sess. § 3001, 113 Stat. 127 (1999) (effective for transfers after Oct. 18, 1998).

100 Treas. Reg. § 1.368-2(d)(4). The final regulation generally applies to transactions occurring after December 31, 1999. Notwithstanding the effective date, taxpayers can rely on Notice 2000-1 to request a private letter ruling to apply the final regulation to transactions generally occurring on or after June 11, 1999. To receive a favorable ruling, a taxpayer must satisfy the IRS that there is not a significant risk of different parties to the transaction taking inconsistent positions. Notice 2000-1, 2000-1 C.B. 288.

101 30 T.C. 602 (1958), aff’d, 267 F.2d 75 (2d Cir. 1959).

102See Rev. Rul. 54-396, 1954-2 C.B. 147.

103See Rev. Proc. 77-37, 1977-2 C.B. 568, § 3.01.

104 642 F.2d 894 (5th Cir. 1981) (involving satisfaction of the substantially all requirement in a D reorganization).

105Id. See also Atlas Tool Co. v. Commissioner, 614 F.2d 860, 865 (3d Cir. 1980); Rev. Rul. 78-47, 1978-1 C.B. 113. In American Mfg. Co. v. Commissioner, 55 T.C. 204, 221-22 (1970), substantially all of the assets were transferred for purposes of a D reorganization, even though only 20 percent of the assets were acquired, but those assets were all the assets essential to the conduct of the business.

106See generally Rev. Proc. 77-37, 1977-2 C.B. 568.

107See Rev. Rul. 88-48, 1988-1 C.B. 117 (valid C reorganization where target corporation, prior to the reorganization, sold 50 percent of its historical assets to an unrelated purchaser for cash that was transferred to the acquiring corporation in the reorganization).

108 Rev. Rul. 68-358, 1968-2 C.B. 156, obsoleted by Rev. Rul. 95-71, 1995-2 C.B. 323; Rev. Rul. 73-552, 1973-2 C.B. 116, obsoleted by Rev. Rul. 95-71.

109 I.R.C. § 368(a)(2)(G)(i).

110 I.R.C. § 368(a)(2)(G)(ii).

111 H.R. Rep. No. 861, 98th Cong., 2d Sess. 846 (1984).

112 Rev. Proc. 89-50, 1989-2 C.B. 631.

113 I.R.C. § 354(b)(1)(B).

114 I.R.C. § 368(a)(2)(G)(i), second sentence.

115 If boot is issued, however, the transaction may be disqualified as a C reorganization, but it may still qualify as an I.R.C. § 368(a)(2)(D) forward triangular merger. See § 5.4(a)(ii) discussion of boot relaxation rule in a C reorganization and § 5.4(a)(iii) discussion of boot in a forward triangular merger.

116 “Substantially all” has the same meaning for purposes of I.R.C. § 368(a)(2)(D) as discussed for a C reorganization in § 5.4(a)(ii)(B). Treas. Reg. § 1.368-2(b)(2).

117 I.R.C. § 368(a)(2)(D); Treas. Reg. § 1.368-2(b)(2).

118 Treas. Reg. § 1.368-2(b)(2); Rev. Rul. 79-155, 1979-1 C.B. 153. Sufficient stock must be issued to satisfy the COI requirement discussed in § 5.2(d).

119 Treas. Reg. § 1.358-6(c)(1). If the liabilities that were assumed exceed target’s basis in its assets, the amount of the adjustment would be zero and parent would not recognize gain under I.R.C. § 357(c). The amount of parent’s basis in its stock in subsidiary would be decreased by the value of any consideration not provided by parent, however. This provision does not apply to target liabilities assumed by the subsidiary. In addition, there is no adjustment to parent’s basis in subsidiary stock if the decrease resulting from subsidiary-provided consideration equals or exceeds the general basis increase resulting from the over-the-top model. Treas. Reg. § 1.358-6(c)(1)(ii). If parent and subsidiary file a consolidated return, parent will be required to reduce its basis by such excess, which could result in negative basis or an excess loss account. Treas. Reg. § 1.1502-30.

120 Rev. Rul. 72-576, 1972-2 C.B. 217.

121 Rev. Rul. 2001-24, 2001-1 C.B. 1290.

122See I.R.C. § 354(b)(1)(A).

123 In Simon v. Commissioner, 644 F.2d 339, 343 (5th Cir. 1981), the “substantially all” requirement was satisfied even though the target corporation’s principal operating asset, a nonassignable franchise, was transferred to the acquiring corporation by an unrelated party, albeit through the efforts of the individuals who wholly owned both target and acquiring.

124Atlas Tool Co. v. Commissioner, 614 F.2d 860 (3d Cir. 1980); Reef Corp. v. Commissioner, 368 F.2d 125 (5th Cir. 1966); Commissioner v. Morgan, 288 F.2d 676 (3d Cir. 1961); American Mfg. Co. v. Commissioner, 55 T.C. 204 (1970); Rev. Rul. 70-240, 1970-1 C.B. 81. See also P.L.R. 9111055 (Dec. 19, 1990) (extending this analysis to target corporation owned by daughter and acquiring corporation owned by mother).

125 T.D. 9303, 71 Fed. Reg. 75879-01 (Dec. 19, 2006).

126 T.D. 9475, 75 Fed. Reg. 3160-01 (Jan. 20, 2010).

127 Treas. Reg. § 1.368-2(l)(2). For purposes of this requirement, de minimis variations in ownership are not taken into account.

128Id.

129Id.

130See I.R.C. § 356(a)(2) and cases supra note 124.

131 Rev. Rul. 69-617, 1969-2 C.B. 57 (ruling based on fact pattern that included a minority shareholder).

132See, e.g., P.L.R. 200250024 (Sept. 4, 2002); P.L.R. 200028027 (Apr. 18, 2000). Furthermore, Treas. Reg. § 1.368-2(k) now supports respecting the form of such a transaction as opposed to recharacterizing it into a cross-chain D reorganization. See § 5.3(h).

133 I.R.C. § 368(a)(2)(H) incorporates the attribution rules of I.R.C. § 304. Although it is unclear, Treasury Regulations seem to indicate that COI is not a requirement in a D reorganization. Treas. Reg. § 1.368(b)-1.

134See Rev. Rul. 75-161,1975-1 C.B. 114. (I.R.C. § 357(c) applied in an A/D reorganization overlap); but see Rev. Rul. 79-289, 1979-2 C.B. 145 (I.R.C. § 357(c) did not apply in a D/F reorganization overlap).

135 Pub. L. No. 108-357, § 898 (2004).

136 2007-1 C.B. 469.

137 For a brief discussion of I.R.C. § 351, see supra § 2.4(c)(ii)(A).

138See Focht v. Commissioner, 68 T.C. 223 (1977).

139 Pub. L. No. 106-36, 106th Cong. 1st Sess. § 3001, 113 Stat. 127 (1999). In addition, certain transactions (usually in the context of an I.R.C. § 351 exchange) involving liabilities could also result in duplication or acceleration of losses. I.R.C. §§ 357(d), 358(d), and (h) were amended to address such issues. Pub. L. No. 106-554, 106th Cong. 2d Sess. § 309, 114 Stat. 2763 (2000); Pub. L. No. 107-147, 107th Cong. 2d Sess. § 412, 116 Stat. 21 (2002). I.R.C. § 358(h)(2) provided for certain exceptions to the statutory amendments that, as noted above, were designed to limit loss duplication and acceleration. I.R.C. § 358(h)(3) provided Treasury authority to limit the exceptions. Treasury exercised its authority and issued broad final regulations that made the exceptions envisioned by Congress completely unavailable for exchanges occurring on or after May 9, 2008. See Treas. Reg. § 1.358-5(a).

140 I.R.C. § 357(d)(2). Fair market value is determined without regard to I.R.C. § 7701(g), which provides that for purposes of determining gain or loss on property, the fair market value of property shall not be treated as being less than the amount of any nonrecourse debt to which the property is subject.

141See also REG-100818-01, 68 Fed. Reg. 23931 (May 6, 2003) (advance notice of proposed rulemaking soliciting comments on possible forthcoming I.R.C. § 357(d) proposed regulations). Such regulations have yet to be proposed.

142 I.R.C. § 362(d). Fair market value for this purpose is determined without regard to I.R.C. § 7701(g). See supra note 140.

143 Treas. Reg. § 1.1502-80(d). This rule applies if it occurs in a consolidated return year beginning on or after January 1, 1995.

144 Treas. Reg. § 1.1502-80(d)(1).

145See Rev. Rul. 74-545, 1974-2 C.B. 122.

146See I.R.C. § 368(a)(2)(G); Rev. Proc. 89-50, 1989-2 C.B. 631.

147 2002-2 C.B. 986.

148See also Treas. Reg. §§ 1.368-2(k)(2) Example 6.

149See Treas. Reg. §§ 1.358-6 and 1.1502-30 to determine parent corporation’s adjustment to basis in stock of its subsidiary in the context of a parenthetical B reorganization.

150See supra § 5.2(e) for a general discussion of “control.”

151 Rev. Rul. 66-365, 1966-2 C.B. 116, amplified by Rev. Rul. 81-81,1981-1 C.B. 122.

152See Treas. Reg. § 1.354-1(e); Rev. Rul. 72-72, 1972-1 C.B. 104; Rev. Rul. 70-269, 1970-1 C.B. 82, amplified by Rev. Rul. 98-10, 1980-1 C.B. 643; Rev. Rul. 69-91, 1969-1 C.B. 106.

153 Rev. Rul. 73-28, 1973-1 C.B. 187.

154 Rev. Rul. 71-83, 1971-1 C.B. 268.

155See supra notes 65–68 and accompanying text.

156See Rev. Rul. 69-443, 1969-2 C.B. 54; Rev. Rul. 55-440, 1955-2 C.B. 226.

157 In Rev. Rul. 69-142, 1969-1 C.B. 107, the IRS determined that the parties had undertaken a valid B reorganization but that a simultaneous exchange of debentures was a separate taxable exchange. Rev. Rul. 98-10, 1998-1 C.B. 643, affirms the conclusion in Rev. Rul. 69-142 that the solely for voting stock requirement is not violated by a concomitant exchange by debenture holders. More important, instead of treating the debenture exchange as a taxable exchange, Rev. Rul. 98-10 provides that I.R.C. § 354 applies to the debenture exchange (and a tax-free exchange occurs), provided the debentures constitute securities for purposes of I.R.C. § 354(a)(1).

158 Rev. Rul. 75-123, 1975-1 C.B. 115.

159See Heverly v. Commissioner, 621 F.2d 1227 (3d Cir. 1980); Chapman v. Commissioner, 618 F.2d 856 (1st Cir. 1980).

160 Rev. Rul. 85-139, 1985-2 C.B. 123. Cf. Rev. Rul. 68-562, 1968-2 C.B. 157 (valid B reorganization where individual shareholder owning 90 percent of P purchased 50 percent of T’s stock for cash; P then acquired 100 percent of the T stock (including the stock held by the individual shareholder) solely for voting stock of P). The distinction between the two revenue rulings is probably based on the fact that S, in this context, is treated as the alter ego of P, a corporation. An individual (even a majority shareholder), however, is not an alter ego but is a separate taxpayer whose actions are not attributable to the corporation.

161 Rev. Rul. 79-4, 1979-1 C.B. 150; cf. Rev. Rul. 79-89, 1979-1 C.B. 152.

162 Rev. Rul. 70-65, 1970-1 C.B. 77.

163 Rev. Rul. 69-294, 1969-1 C.B. 110; cf. Rev. Rul. 69-585, 1969-2 C.B. 56.

164 Rev. Rul. 72-354, 1972-2 C.B. 216.

165 I.R.C. § 368(a)(2)(E)(i).

166See supra § 5.2(e).

167 I.R.C. § 368(a)(2)(E)(ii).

168 I.R.C. § 368(a)(3)(E).

169See Treas. Reg. § 1.368-2(j)(6), Examples 4, 5. See also Rev. Rul. 67-448, 1967-2 C.B. 144.

170See Treas. Reg. § 1.368-2(j)(6), Examples 2, 3.

171 Rev. Rul. 2001-26, 2001-1 C.B. 1297. The IRS also ruled that if, pursuant to a plan, a newly formed wholly owned subsidiary of an acquiring corporation merges into a target corporation, followed by the merger of the target corporation into the acquiring corporation, the transaction is treated as a single statutory merger of the target corporation into the acquiring corporation that qualifies as a reorganization under I.R.C. § 368(a)(1)(A). Rev. Rul. 2001-46, 2001-2 C.B. 321. See generally § 5.2(h) regarding Substance over Form and Step Transaction doctrines.

172 Adjustments, however, may be required if P acquired less than all of T’s stock in the transaction. See Treas. Reg. § 1.358-6(c)(2)(i).

173 Treas. Reg. § 1.358-6(c)(2)(ii).

174 Treas. Reg. § 1.368-2(j)(3)(iii).

175 Treas. Reg. § 1.368-2(k)(2). The assets or stock of the target could be transferred to a partnership as discussed in § 5.2(c) if the “control” requirement is not violated. See Treas. Reg. § 1.368-2(k), Example 3. Final regulations confirm this result provided the assets are dropped to a member of a “qualified group” or certain controlled partnerships. See infra § 5.2(c)(ii).

176 2001-1 C.B. 1291.

177See G.C.M. 36111 (Dec. 18, 1974) (determining that a merger of a target corporation into a parent corporation’s wholly owned subsidiary in exchange for parent stock followed by a “push-up” of approximately 80 to 85 percent of the value of target’s assets (shares of parent stock) qualifies as a forward triangular merger); P.L.R. 9215032 (Jan. 10, 1992) (finding that a distribution of assets after a forward triangular merger will be disregarded in determining whether the “substantially all” requirement is satisfied). However, if the “pushed-up” assets constitute substantially all of the target’s assets, the IRS is more likely to recast the transaction in a taxable form. See G.C.M. 37905 (Mar. 29, 1979) (amplifying G.C.M. 36111 to provide that a merger of a target corporation into a parent corporation’s wholly owned subsidiary in exchange for parent stock followed by a “push-up” of substantially all of target’s assets will not be treated as a forward triangular merger but alternatively will be viewed as a direct acquisition of assets by the parent corporation); G.C.M. 39102 (Dec. 21, 1983) (following G.C.M. 37905 position that a postmerger push-up of substantially all the assets of a target corporation will not be treated as a forward triangular merger).

178 Rev. Rul. 2001-25 could have been based solely on a substitution of assets theory. See supra note 107.

179See supra § 5.2(c)(ii). See also Rev. Rul. 72-405, 1972-2 C.B. 217 (merger of a target corporation into a subsidiary in exchange for stock of the subsidiary’s parent, followed by the liquidation of the subsidiary into the parent is not treated as a forward triangular merger followed by a liquidation of the subsidiary; rather, it is treated as a C reorganization). Final regulations allow for a push-up of assets by a target corporation after a reverse triangular reorganization without disqualifying treatment under I.R.C. § 368(a)(2)(E) or subjecting the transaction to recast, provided the distribution would not result in the target being treated as liquidated for federal income tax purposes (disregarding any assets of the corporation that is merged into the target).

180 This deemed liquidation analysis excludes assets of an acquiring corporation (as, for example, in an I.R.C. § 368(a)(1)(C), or (a)(1)(D), or (a)(2)(D) reorganization) or assets held by the surviving corporation (as in an I.R.C. 368(a)(2)(E) reorganization).

181 Rev. Rul. 77-428, 1977-2 C.B. 117.

182 The IRS ruling standard is 50% stock (including nonvoting stock) for the forward triangular merger and 80% voting stock for the reverse triangular merger.

183See supra §§ 5.2(c)(ii) and 5.2(h) .

184 Rev. Rul. 72-405, 1972-2 C.B. 217.

185 It would be problematic to respect the preliquidation acquisition of the target as an independent reverse triangular merger, because the acquiring corporation does not retain control of the target immediately after the transaction. Therefore, the transaction should be respected as a stock purchase prior to a liquidation. Treas. Reg. § 1.368-2(j)(3)(ii); Rev. Rul. 90-95, 1990-2 C.B. 67.

186King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969).

187 This analysis assumes that the forward or reverse triangular merger occurs as part of the same plan as the subsequent upstream merger of acquiring of target into parent.

188See Rev. Rul. 70-16, 1976-1 C.B. 186; P.L.R. 8506031 (Nov. 9, 1984).

189 Rev. Rul. 2001-46, 2001-2 C.B. 321.

190See supra note 78.

191 I.R.C. § 354. Nonrecognition treatment does not apply to the extent that any stock or securities are issued for interest that has accrued on securities on or after the beginning of the holder’s holding period. I.R.C. § 354(a)(2)(B).

192 I.R.C. § 354(a)(2)(C). As discussed in § 5.2(g), nonqualified preferred stock that is received in exchange for stock other than nonqualified preferred stock is taxable boot.

193 I.R.C. § 302(b). The determination of capital or dividend treatment is based on whether and to what extent the shareholder has reduced the interest held in the corporation, after the attribution rules of I.R.C. § 318 are applied.

194 I.R.C. § 166.

195See I.R.C. § 317(a).

196 I.R.C. § 351 cannot apply because short-term debt (not a security) is being transferred. See I.R.C. § 351(d)(2).

197See I.R.C. § 108(e)(8). For a discussion of discharge of indebtedness income, see Chapter 2.

198 Treas. Reg. § 1.368-1(b), T.D. 9182, 70 Fed. Reg. 9219 (Feb. 25, 2005). See also Rev. Rul. 82-34, 1982-1 C.B. 59.

199 Treas. Reg. § 1.368-1(b), T.D. 9182, 70 Fed. Reg. 9219 (Feb. 25, 2005). See also Rev. Rul. 77-415, 1977-2 C.B. 311; Rev. Rul. 77-479, 1977-2 C.B. 119.

200See Rev. Rul. 77-238, 1977-2 C.B. 115 (the conversion of common stock into preferred stock of equal value of the same corporation, or the conversion of preferred stock into common stock of equal value of the same corporation is an E reorganization); Rev. Rul. 56-179, 1956-1 C.B. 187 (the conversion of first preference stock into common stock is an E reorganization) (in each revenue ruling, assume that nonqualified preferred stock is not received in exchange for stock other than nonqualified preferred stock). If debt is exchanged for the equity of the issuer pursuant to the terms of the debt instrument (which may occur either automatically or as a result of an option to make such change), the exchange is not treated as a modification of the debt and therefore does not result in a realization event. Treas. Reg. § 1.1001-3(c)(2)(ii); Rev. Rul. 72-265, 1972-1 C.B. 222.

201 Rev. Rul. 71-427, 1971-2 C.B. 183.

202 I.R.C. §§ 354(a)(2); 356(d)(2)(B). But see Bazley v. Commissioner, 332 U.S. 737 (1947); Treas. Reg. § 1.301-1(l) (a distribution to shareholders may be treated as a dividend even if it takes place at the same time as another transaction; this is most likely to occur in the case of a recapitalization, reincorporation, or merger into a newly formed corporation that holds no property).

203 Basis is determined under I.R.C. § 358 (exchanged basis of $1,000 less $150 cash received).

204 I.R.C. §§108(a), (b), (e)(8).

205Estate of Stauffer v. Commissioner, 403 F.2d 611 (9th Cir. 1968); Performance Systems, Inc. v. Commissioner, 501 F.2d 1338 (6th Cir. 1974).

206Home Construction Corp. v. United States, 439 F.2d 1165 (5th Cir. 1971).

207 Rev. Rul. 75-561, 1975-2 C.B. 129, amplified by Rev. Rul. 78-287, 1978-2 C.B. 146, and modified by Rev. Rul. 78-441, 1978-2 C.B. 152. See also Prop. Reg. § 1.368-2(m), REG-106889-04 (Aug. 11, 2004).

208 Rev. Rul. 66-284, 1966-2 C.B. 115, amplified by Rev. Rul. 78-441, 1978-2 C.B. 152.

209Cf. Aetna Casualty & Surety Co. v. United States, 568 F.2d 811 (2d Cir. 1976) (61% continuity is sufficient) with Spinoza, Inc. v. United States, 375 F. Supp. 439 (S.D. Tex. 1974) (37% continuity is insufficient) and Role v. Commissioner, 70 T.C. 341 (1978) (89% continuity is insufficient).

210 Treas. Reg. § 1.368-1(b), T.D. 9182, 70 Fed. Reg. 9219 (Feb. 5, 2005).

211 Rev. Rul. 69-516, 1969-2 C.B. 56.

212Dunlap & Associates, Inc. v. Commissioner, 47 T.C. 542 (1967).

213 Rev. Rul. 58-422, 1958-2 C.B. 145, amplified by Rev. Rul. 66-284, 1966-2 C.B. 115, amplified by Rev. Rul. 78-441, 1978-2 C.B. 152.

214 Rev. Rul. 79-250, 1979-2 C.B. 156, modified by Rev. Rul. 96-29, 1996-1 C.B. 50 (see infra text accompanying note 216); Rev. Rul. 61-156, 1961-2 C.B. 62.

215Reef Corp. v. Commissioner, 368 F.2d 125 (5th Cir. 1966); Casco Products Corp. v. Commissioner, 49 T.C. 32 (1967).

216 Rev. Rul. 79-250, 1979-2 C.B. 156.

217 Rev. Rul. 68-349, 1968-2 C.B. 143.

218 1996-1 C.B. 50.

219 1979-2 C.B. 156.

220 Oct. 19, 2007.

221 I.R.C. § 381(b)(3); Treas. Reg. § 1.381(b)-1(a)(2). An added benefit of an F reorganization compared to a D reorganization is the ability to avoid gain where the liabilities assumed are in excess of the basis of the assets transferred. See Rev. Rul. 79-289, 1979-2 C.B. 145 (I.R.C. § 357 is not applicable to an F reorganization).

222 Prop. Reg. § 1.368-2(m), REG-106889-04 (Aug. 11, 2004).

223 One rule that applies to D reorganizations is I.R.C. § 361(b), which states that a transferor corporation will not recognize gain if it receives money or other properties in return for a transfer to a controlled corporation, and distributes that money or other properties to its shareholders or creditors. The American Jobs Creation Act of 2004 changed this rule for divisive D reorganization. In the case of a divisive D reorganization, the amount of money plus the fair market value of other properties that a transferor (distributing corporation) can receive tax-free under I.R.C. § 361(b) and then distribute to its creditors without gain recognition under I.R.C. § 361(b) is limited to the total adjusted basis of the properties the transferor transfers to the controlled corporation. Pub. L. No. 108-357, § 898 (2004).

224See supra discussion at § 5.4(d)(v). An I.R.C. § 355 distribution can follow a transfer of property to a controlled corporation that qualifies as a divisive D reorganization. In such a situation, the transaction will be subject to the rules governing I.R.C. § 355 and those governing divisive D reorganizations. These transactions were and remain subject to I.R.C. § 357(c). See supra § 5.4(d)(v).

225 For a more comprehensive analysis, see Rev. Proc. 96-30, 1996-1 C.B. 696 (prior to its modification by Rev. Proc. 2003-48); Wessel, Prewett, D’Avino, and Pari, Corporate Distributions Under Section 355, Practising Law Institute (2002).

226 I.R.C. § 368(c); Rev. Rul. 59-259, 1959-2 C.B. 115; see supra § 5.2(e).

227 I.R.C. § 355(a)(1)(D).

228 I.R.C. § 355(a)(1)(D)(ii).

229 Rev. Rul. 75-321, 1975-2 C.B. 123; Rev. Rul. 75-469, 1975-2 C.B. 126; P.L.R. 9003050 (Oct. 26, 1989).

230 Temp. Treas. Reg. § 1.355-2T(g), T.D. 9435 (Dec. 15, 2008). See analysis of active trade or business requirement and definition of SAG described below.

231 I.R.C. § 1504(a) is generally the consolidated group affiliation rule.

232 This exception will not prevent corporations that are ineligible from being included in a consolidated return from being included in the SAG.

233 Rev. Rul. 86-126, 1986-2 C.B. 58; Rev. Rul. 86-125, 1986-2 C.B. 57; Rev. Rul. 73-234, 1973-1 C.B. 180; Rev. Rul. 73-237, 1973-1 C.B. 184.

234 Rev. Rul. 68-284, 1968-1 C.B. 143; Rev. Rul. 56-512, 1956-2 C.B. 173.

235 Treas. Reg. § 1.355-3(c), Example 1; Rev. Rul. 66-204, 1966-2 C.B. 113. Cf. Wilson v. Commissioner, 42 T.C. 914 (1964), rev’d on other grounds, 353 F.2d 184 (9th Cir. 1965).

236 Rev. Rul. 57-492, 1957-2 C.B. 247.

237 Treas. Reg. § 1.355-3(b)(2)(iv)(B); Rafferty v. Commissioner, 55 T.C. 490 (1970), aff’d, 452 F.2d 767 (1st Cir. 1971); Bonsall v. Commissioner, 317 F.2d 61 (2d Cir. 1963); Rev. Rul. 56-266, 1956-1 C.B. 184. Cf. King v. Commissioner, 458 F.2d 245 (6th Cir. 1972).

238See Rev. Rul. 92-17, 1992-1 C.B. 142, amplified by Rev. Rul. 2002-49, 2002-2 CB 50 (extending Rev. Rul. 92-17 to apply to limited liability companies in certain situations).

239See Rev. Rul. 74-79, 1974-1 C.B. 81 (one-third active); Rev. Rul. 73-44, 1973-1 C.B. 182, clarified by Rev. Rul. 76-54, 1976-1 C.B. 96 (less than 50% active); Rev. Rul. 64-102, 1964-1 C.B. 136 (less than 50% active); G.C.M. 36069 (Nov. 5, 1974) (no minimum percentage required). The IRS did not ordinarily rule on whether a distribution qualified under I.R.C. § 355 if the gross assets relied on to satisfy the active trade or business assets represented less than 5% of the corporation’s assets. Rev. Proc. 96-43,1996-2 C.B. 330. The IRS changed its no-rule position with regard to the 5% threshold and may now issue rulings when the active trade or business assets constitute less than 5% of the assets. As the percentage of active trade or business assets is reduced, more pressure is placed on the “device” requirement. The device concerns are tempered by (and the risk is shifted to the taxpayer by) a required representation to the effect that the transaction is not being carried out for a device purpose. Rev. Proc. 2003-48, 2003-29 I.R.B. 86.

240 For this purpose, the IRS believes that “substantially all” means at least 90% of the corporation’s gross assets. Rev. Proc. 96-30, 1996-1 C.B. 696 4.30(5).

241See Pub. L. No. 109-222, § 202 (2006); Pub. L. No. 109-432, § 4(b)(3) (2006); Pub. L. No. 110-172, § 4(b) (2007).

242 § 1504(a) is generally the consolidated group affiliation rule.

243 This exception will not prevent corporations that are ineligible from being included in a consolidated return from being included in the SAG.

244See Prop. Reg. § 1.355-3, REG-123354-03 (May 8, 2007, corrected June 5, 2007) for a complex set of proposed regulations on this provision.

245See, e.g., Treas. Reg. § 1.355-3(c), Examples 6, 7, 9–11; Rev. Rul. 79-394, 1979-2 C.B. 141, amplified by Rev. Rul. 80-181, 1980-2 C.B. 121.

246See, e.g., Rev. Rul. 69-407, 1969-2 C.B. 50; Rev. Rul. 56-117, 1956-1 C.B. 180; Rev. Rul. 71-593, 1971-2 C.B. 181; Rev. Rul. 70-18, 1970-1 C.B. 74; Rev. Rul. 57-144, 1957-1 C.B. 123; Rev. Rul. 63-260, 1963-2 C.B. 147.

247 Treas. Reg. §§ 1.355-3(b)(3)(ii); 1.355-3(c), Examples 7, 8; 1.355-2(c), Example 1.

248 Treas. Reg. § 1.355-2(c), Examples 3, 4. The regulations that relax the COI standard discussed in § 5.2(d) do not apply to I.R.C. § 355 distributions.

249 Pub. L. No. 101-508, 101st Cong., 2d Sess. §11321, 104 Stat. 1388 (1990).

250 See I.R.C. §§ 355(d)(5), (7), and (8) for the definition of “purchase” and rules regarding aggregation of shareholders as well as attribution rules regarding stock ownership.

251 T.D. 8913, 65 Fed. Reg. 79719 (Dec. 20, 2000). These regulations are generally effective for transactions occurring after December 20, 2000.

252 Gregory v. Helvering, 293 U.S. 465 (1935).

253 See, e.g., Commissioner v. Wilson, 353 F.2d 184 (9th Cir. 1965); Gada v. United States, 460 F. Supp. 859 (D. Conn. 1978).

254 Treas. Reg. § 1.355-2(b)(5), Example 2; Coady v. Commissioner, 33 T.C. 771 (1960), aff’d, 289 F.2d 490 (6th Cir. 1961); Rev. Proc. 96-30, App. A, § 2.05, 1996-1 C.B. 696; Rev. Rul. 82-20, 1982-1 C.B. 6; Rev. Rul. 75-337, 1975-2 C.B. 124; Rev. Rul. 69-460, 1969-2 C.B. 51; Rev. Rul. 64-102, 1964-1 C.B. 136; Rev. Rul. 56-655, 1956-2 C.B. 214.

255 See Treas. Reg. § 1.355-2(b)(5), Examples 1, 8; Olson v. Commissioner, 48 T.C. 855 (1967), supplemental opinion, 49 T.C. 84 (1967), acq. 1968-2 C.B. 2, 3; Rev. Rul. 88-34, 1988-1 C.B. 116; Rev. Rul. 82-131, 1982-2 C.B. 83; Rev. Rul. 82-130, 1982-2 C.B. 83; Rev. Rul. 78-383, 1978-2 C.B. 142; Rev. Rul. 77-22, 1977-1 C.B. 91; Rev. Rul. 76-527, 1976-2 C.B. 103; Rev. Rul. 72-530, 1972-2 C.B. 212; Rev. Rul. 69-460, 1969-2 C.B. 51; Rev. Rul. 68-603, 1968-2 C.B. 148; Rul. 56-450, 1956-2 C.B. 201. See also Rev. Proc. 96-30, App. A, §§ 2.01, 2.03, 2.06, 2.08, 1996-1 C.B. 696.

256 See Treas. Reg. § 1.355-2(b)(2); Rev. Proc. 96-30, App. A, § 2.04, 1996-1 C.B. 696; Rev. Rul. 89-101, 1989-2 C.B. 67; Rev. Rul. 76-187, 1976-1 C.B. 97.

257 Device factors are: pro rata distribution, liquidation after the distribution, sale of stock of either corporation after the distribution, a high level of passive assets in either corporation, and the presence of related functions between the companies. Nondevice factors are: a strong business purpose, distribution of corporate stock that is widely held, a distributee shareholder that is a domestic corporation, and a lack of earnings and profits.

258 T.D. 9198, 70 Fed. Reg. 20279 (Apr. 19, 2005). Temporary regulations generally apply to distributions described in I.R.C. § 355 that occur after April 26, 2002, but before April 19, 2005. T.D. 8960, 67 Fed. Reg. 20632 (Apr. 26, 2002).

259 For more detail on the I.R.C. § 355(e) temporary regulations, see Wessel, D’Avino, and Pari, Corporate Distributions Under Section 355, Practising Law Institute (2010).

260 Rev. Rul. 77-133, 1977-1 C.B. 96, amplified by Rev. Rul. 56-373, 1956-2 C.B. 217.

261 2003 2 C.B. 86.

262 Rev. Proc. 96-30, 1996-1 C.B. 696.

263 2003-1 C.B. 113.

264 For an in-depth discussion of the law in this area, see “Reorganizations Involving Insolvent Subsidiaries,” Report of the New York State Bar Association Tax Section, reprinted in Tax Notes (Nov. 10, 2003). Also note that there are many special rules applicable to financial institutions. Some of these special rules were first added to the I.R.C. by the Economic Recovery Tax Act of 1981. They have since been revised by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, and by subsequent legislative and administrative modifications.

265 315 U.S. 179 (1942). The G reorganization provisions were not at issue because the case occurred prior to the enactment of I.R.C. § 368(a)(1)(G).

266 Alabama Asphaltic, 315 U.S. at 183 (emphasis added) (citations omitted).

267 315 U.S. 194 (1942).

268 Id. at 202.

269 Id. at 202–03.

270 See, e.g., Notice 2008-83, 2008-42 I.R.B. 905; Notice 2008-100, 2008-44 I.R.B. 1081; Notice 2009-14, 2009-7 I.R.B. 516.

271 As discussed below, however, certain taxpayers may want these acquisitions to fail to qualify as reorganizations. Thus, the IRS’s potential reason for issuing the regulations discussed here may not have been only to help taxpayers affected by the economic downturn. Rather, it may have also been to prevent the government from being whipsawed by parties to the same transaction taking different positions with respect to the transaction’s taxability.

272 The analysis of this topic is reprinted in significant part from: Harris, Zywan, and Liquerman, Final Regulations Address Application of the Continuity of Interest Requirement to Reorganizations of Insolvent Corporations, 36 WGL-CTAX 3 (July /Aug. 2009).

273 315 U.S. 179 (1942).

274 Id. at 183.

275 315 U.S. 185 (1942).

276 Id. at 188–89.

277 36 T.C. 675 (1961).

278 Id. at 688 (citations omitted).

279 See I.R.C. § 368(a)(1)(G).

280 See S. Rep. No. 96-1035, 36-37 (1980) (the Senate Report). Thus, the Senate Report arguably indicates that Congress did not intend for the IRS to apply the conclusion in Atlas Oil that the mere fact that senior creditors do not get stock does not necessarily mean they did not hold proprietary interests in determining whether the COI requirement is satisfied in situations where the corporation’s assets were insufficient to satisfy the senior creditors. It could be, however, that Congress believed that, under the absolute priority rule, the most senior claims would be fully satisfied in new debt, stock, or other property before junior creditors or shareholders received anything in the transaction. In other words, if the value of the corporation’s assets was less than the total amount owed to senior creditors, under the absolute priority rule, only the senior creditors would ever be entitled to anything (stock, cash, or new debt) in the transaction. Thus, Congress may have assumed that this point in Atlas Oil was moot.

281 Id.

282 101 T.C.M. (CCH) 1087 (2011).

283 Cf. Treas. Reg § 1.368-1(e)(3) and (e)(8) Example 8; Rev. Rul. 84-30, 1984-1C.B. 114 (distributions of stock of an acquiring corporation received by a corporate shareholder of target corporation permitted for COI purposes).

284 See, e.g., Sieberling Rubber Co. v. Commissioner, 169 F.2d 595 (6th Cir. 1948).

285 Preamble to the Final Regulations.

286 T.D. 9434, 73 Fed. Reg. 78969-01 (Dec. 24, 2008). These Final Regulations are generally effective beginning on December 12, 2008.

287 70 Fed. Reg. 11903-01 (Mar. 10, 2005), 2005-1 C.B. 835. The Final Regulations finalized only the portions of that regulation package relating to COI. Thus, the Proposed Regulations relating to the so-called net value requirement remain proposed.

288 See, e.g., I.R.C. § 856(c)(7)(B) (assets with a total value that does not exceed the lesser of 1% of total asset value or $10 million are de minimis); I.R.C. § 954(b)(3) (5% of gross income or $1 million is de minimis); Treas. Reg. § 1.367(b)-3(c)(4) (stock with a fair market value less than $50,000 is de minimis); Treas. Reg. § 1.368-2T(l)(3), Example 4 (1% variance in stock ownership is de minimis for purposes of determining whether two corporations are owned by the same shareholders).

289 See also Detroit-Michigan Stove Co. v. United States, 128 Ct. Cl. 585 (1954) (concluding that “gratuitous stock” did not count toward satisfaction of the COI requirement).

290 See Justice Stewart’s oft-cited concurring opinion in Jacobellis v. Ohio, 378 U.S. 184 (1964).

291 Cf. former Treas. Reg. § 1.108-1(d)(6) prior to removal by T.D. 9304 on December 21, 2006 (determining the secured portion of an under-secured debt for purposes of I.R.C. § 108(e)(8)(B)).

292 See Treas. Reg. § 1.368-1(e)(1)(ii). Although addition of this standard to the Final Regulations is helpful, it does not provide absolute certainty. Rather, determining whether a pre-reorganization distribution is boot in the reorganization or a separate distribution is a complex issue in its own right.

293 See, e.g., Helvering v. Southwest Consolidated Corp., 315 U.S. 194 (1942).

294 In this regard, consider Rev. Rul. 2004-78, 2004-2 C.B. 108. That ruling provides that a short-term debt of the acquiring corporation may qualify as a security if it is received in a reorganization in exchange for a security in the target corporation and bears the same terms (other than interest rate) as the target security exchanged. Thus, a 2-year instrument issued by the acquiring corporation issued in exchange for an identical 15-year security of the target corporation issued 13 years earlier may qualify as a security.

295 See Senate Report, supra note 280. Such a loss may, however, be restricted or disallowed under some other provision of the Code. See, e.g., I.R.C. § 267.

296 Feb. 23, 1978.

297 See also Rev. Rul. 69-407, 1969-2 C.B. 50; P.L.R. 8104101 (Oct. 30, 1980); P.L.R. 7938044 (June 20, 1979); P.L.R. 7819071(Feb. 13, 1978). One would wonder if it would be preferable (if possible) to have the F reorganization precede the E recapitalization to make it clear that the recapitalization results in a permanent change to the capital structure of the corporation and thus satisfies this I.R.C. § 368(a)(1)(E) requirement. See Rev. Rul. 69-407, 1969-2 C.B. 50; Rev. Rul. 63-260, 1963-2 C.B. 147.

298 1996-1 C.B. 50.

299 The impact of proposed regulations (if they were finalized as currently drafted) on this position is unclear (Prop. Reg. §§ 1.368-1(b), 1.368-2(m), REG-106889-04 (Aug. 11, 2004)). On one hand, the Proposed Regulations and the preamble thereto provide that (generally) to qualify as an F reorganization, all the stock of the resulting (newly formed) corporation, including stock issued before the transfer, must be issued in respect of stock of the transferring corporation. This requirement prevents a transaction that involves the introduction of new capital to the corporation as qualifying as an F reorganization. If stock of the newly formed corporation could not be issued for debt of the transferring corporation under this provision, one may question whether this requirement would be satisfied if stock of the newly formed corporation is issued for stock of the transferring corporation that was recently issued in a recapitalization in exchange for debt. However, the Proposed Regulations and the preamble thereto also provide that, consistent with Rev. Rul. 96-29, related events preceding or following the transaction or series of transactions that constitute a mere change do not cause the transaction or series of transactions to fail to qualify as an F reorganization. This would appear to provide that an E recapitalization before or after a change in identity, form, or place of reorganization should not cause such change to fail to qualify as an F reorganization. As noted in the preceding note, one must also consider whether a recapitalization that precedes an F reorganization results in a meaningful and permanent change to the capital structure of the corporation. The IRS should clarify this issue. The treatment of a transaction as an E reorganization and an F reorganization is more liberal, however, for banks and insurance companies. See Rev. Rul. 2003-19, 2003-1 C.B. 468 (conversions of mutual insurance companies to stock insurance corporations qualify as both E and F reorganizations); Rev. Rul. 2003-48, 2003-1 C.B. 863 (conversions of state mutual savings banks into state stock banks qualify as both E and F reorganizations, as well as reverse triangular mergers and I.R.C. § 351 exchanges).

300 1959-1 C.B. 80.

301 The regulations apply only to avoid the zero-basis issue if certain conditions are satisfied. See Treas. Reg. § 1.1032-2.

302 See T.D. 8883, 65 Fed. Reg. 31073 (May 16, 2000) (preamble).

303 Norman Scott, Inc. v. Commissioner, 48 T.C. 598 (1967).

304 The Tax Court concluded that River Oaks was insolvent and that Continental was probably insolvent.

305 June 25, 1968. The Action on Decision is dated December 7, 1967.

306 Norman Scott, 48 T.C. at 604, citing Alabama Asphaltic, 315 U.S. 179; Meyer v. United States, 121 F. Supp. 898 (Ct. Cl. 1954); Duncan v. Commissioner, 9 T.C. 468 (1947).

307 169 F.2d 595 (6th Cir. 1948).

308 1954-2 C.B. 152.

309 1959-2 C.B. 87, amplified by Rev. Rul. 2003-125, 2003-52 I.R.B. 1243.

310 A liquidation of an insolvent corporation into its shareholder/creditor cannot qualify for tax-free treatment under I.R.C. § 332. See § 7.4(e) for a discussion of this issue. In addition, after the issuance of the Norman Scott G.C.M., the IRS issued Rev. Rul. 70-489, allowing a parent to liquidate an insolvent subsidiary (by merging it upstream) and continue to operate the subsidiary’s business as a branch, without jeopardizing the position of the parent with respect to the bad debt deduction. Rev. Rul. 70-489, 1970-2 C.B. 53, superseded by Rev. Rul. 2003-125, 2003-2 C.B. 1243 (Rev. Rul. 2003-125 does not change the result of Rev. Rul. 70-489). But see Chief Counsel Attorney Memorandum 2011-003, 2011 TNT 168-22 (Aug. 30, 2011) (denying bad debt deduction with respect to debts of an insolvent corporation that made a check-the-box election to be treated as a partnership).

311 The Tax Court and the IRS reached this conclusion for different reasons. The Tax Court distinguished Rev. Rul. 59-296 because it was based on case law under the predecessor to I.R.C. § 332, which requires a distribution with respect to stock if a distribution is to qualify as a tax-free I.R.C. § 332 liquidation. The IRS based its conclusion on the historical development of I.R.C. § 332 and a consistent interpretation of the liquidation provisions and I.R.C. § 368(a)(1)(A) in the context of upstream mergers.

312 Once again the IRS did not agree (at least in part) with the Tax Court’s rationale for reaching this result. The G.C.M. criticized the Tax Court’s reliance on the Seiberling decision to reach this result. The IRS relied on case law that treated mergers of solvent corporations into creditor corporations as tax-free reorganizations. See, e.g., Forest Hotel Corp. v. Fly, 112 F. Supp. 782 (S.D. Miss. 1953) (debtor corporation was acquired by creditor corporation and stock of creditor corporation was distributed to debtor’s shareholders; COI maintained); Edwards Motor Transit v. Commissioner, 23 T.C.M. (CCH) 1968 (1964) (downstream merger of a solvent debtor corporation into its creditor subsidiary treated as an A reorganization, and did not result in discharge of indebtedness to the target or debtor). In Edwards Motor Transit, the subsidiary’s assumption of the parent’s obligations (including its indebtedness to the subsidiary) was respected. The IRS was somewhat skeptical of following cases such as Edwards Motor Transit that involve a virtually complete overlap of shareholders in the target and acquiring corporation, because in such cases it is difficult to give meaning to the shareholder’s receipt of additional stock. The G.C.M. concludes, however, that if a taxpayer is able to establish a business purpose for merging commonly owned corporations, the transaction should be respected as an A reorganization even though the merger also extinguishes intercorporate debt.

313 Note that a Norman Scott–type transaction would raise distinct issues if it occurred in a consolidated return setting. See supra § 5.8(a)(v), discussing the exchange of net value requirement.

314 70 Fed. Reg. 11903 (Mar. 10, 2005).

315 Earlier attempts to address this problem can be found in now-repealed I.R.C. §§ 371, 372, and 374.

316 I.R.C. § 368(a)(1)(G).

317 I.R.C. § 368(a)(3)(A).

318 The statute does not specify whether the “plan of reorganization” referred to therein is a plan of reorganization adopted pursuant to Chapter 11 of the Bankruptcy Code or a plan of reorganization as that term is defined in the Internal Revenue Code. A court recently held that the “plan of reorganization” required for a G reorganization is a plan of reorganization as defined in the Internal Revenue Code and that a formal Bankruptcy Plan of Reorganization is not required. In Re Motors Liquidation Company, 430 B.R. 65 (S.D.N.Y. 2010).

319 I.R.C. § 368(a)(3)(D).

320 Rev. Proc. 77-37, 1977-2 C.B. 568; Rev. Proc. 86-42, 1986-2 C.B. 722.

321 S. Rep. No. 1035, 96th Cong., 2d Sess. 35, at 35–36 (1980).

322 P.L.R. 9629016 (Apr. 22, 1996); P.L.R. 9409037 (Dec. 7, 1993); P.L.R. 9335029 (June 4, 1993); P.L.R. 9313020 (Dec. 30, 1992); P.L.R. 9229039 (Apr. 23, 1992); P.L.R. 9217040 (Jan. 28, 1992); P.L.R. 201025018 (July 9, 2009).

323 Treas. Reg. § 1.368-1(d)(5), Example 1.

324 Rev. Proc. 82-23, 82-1 C.B. 474.

325 Rev. Proc. 83-81, 83-2 C.B. 598.

326 See P.L.R. 9544026 (Aug. 4, 1995) (transfer of substantially all of the assets of a mutual insurer to a Newco in exchange for Newco’s assumption of the mutual insurer’s liabilities (via an assumption reinsurance agreement) treated as a G/(a)(2)(D)).

327 I.R.C. § 368(a)(3)(E). See also P.L.R. 9229039 (Apr. 23, 1992) (merger of parent into subsidiary coupled with cancellation of worthless stock of other subsidiaries when undertaken to simplify corporate structure and facilitate administration of bankruptcy qualifies as a G reorganization).

328 I.R.C. § 368(a)(3)(C).

329 See § 5.4(d)(v) (discussing partial repeal of I.R.C. § 357(c) for acquisitive reorganizations).

330 See § 5.8(a)(iii) (issues arising when recapitalizations are coupled with insolvency reorganizations).

331 Jan. 25, 2006. See Richard W. Bailine, “G”-Whiz, What a Ruling, 33 Corp. Tax’n 37 (July/Aug. 2007) (discussing P.L.R. 200617024).

332 S. Rep. 96-1035 (Nov. 25, 1980).

333 See P.L.R. 200803005 (Oct. 19, 2007). See infra §5.6(b) for a more in-depth discussion of the letter ruling.

334 I.R.C. § 361(a). If, as is often the case, the G reorganization involves a discharge of indebtedness, I.R.C. § 108 will control the tax treatment of the target corporation.

335 I.R.C. § 1032.

336 I.R.C. § 362(b).

337 I.R.C. §§ 108, 1017. See also Temp. Treas. Reg. §§ 1.108-7T; 1.1017-1T (attributes, including basis, are reduced due to I.R.C. §§108 and 1017 before they are inherited by acquiring corporation).

338 I.R.C. § 1223(2).

339 I.R.C. § 354(a)(1).

340 I.R.C. §§ 354(a)(2)(B); 354(a)(3)(B). See In re Dow Corning Corp., 244 B.R. 678 (E.D. Mich. 1999) (involving postpetition interest; this topic is discussed further in Chapter 7).

341 I.R.C. § 356(d)(2). In a G reorganization the “other property” would not be distributed to a shareholder with respect to stock and, therefore, should not be treated under I.R.C. § 356(a)(2) as equivalent to a dividend.

342 I.R.C. §§ 358; 1223(1).