TAXABLE ACQUISITIONS

1
TAXABLE ACQUISITIONS
Stock v. Assets.
Methods of stock acquisition

A
Direct purchase
Reverse Triangular Merger
Why pick one over the other?
Consequences of stock acquisition
T keeps all attributes, including ASSET BASIS,
EP, but Net Operating Losses may be limited
NO TAX ON T
Tax consequences differ. Asset purchase often
cumbersome. Often cant transfer some assets.
Acquiring stock, however, includes historic,
contingent and unknown liabilities of Target
(T).
A recognizes gain or loss equal to the difference
between the consideration received and the basis
in his or her stock. Installment basis o.k. if
not publicly traded stock or notes.
2
TAXABLE ACQUISITIONS
Stock v. Assets.
Methods of asset acquisition

A
Direct purchase

Forward Triangular Merger
Liquidate T and buy assets
Cash merger into P or LLC
Assets
Assets
Assets
Assets
Consequences of asset acquisition
T has taxable income or loss consideration
liabilities - basis. Ts tax assumed by A if
liquidation or P if by merger ASSET BASIS BECOMES
FMV PRICE HIGHER THAN FOR STOCK PURCHASE FMV
BASIS
Purchase price allocated among assets - 1060
residual method Class I cash and cash
equivalents Class II marketable securities
Class III everything not in Classes I, II, IV
and V Class IV 197 intangibles other than
goodwill and GCV Class V Goodwill and going
concern value (GCV).
TWO LAYERS OF TAX! A, ALSO, recognizes gain or
loss equal to the difference between the
consideration received (less any tax assumed) and
the basis in his or her stock. Installment
method o.k.
3
TAXABLE ACQUISITIONS338
338 permits buyer (P) to elect to treat a
stock purchase as an asset purchase. History
Kimbell-Diamond 334(b)(2)
If no election, then liquidation or merger not
create asset purchase.
Requires Qualified Stock Purchase (QSP),
CORPORATE buyer and buyer election (15th
day of 9th month after QSP).
Treatment sale of all assets to new co owned
by T. Asset sale for Aggregate Deemed Sales
Price (ADSP) Basis in assets equals
Aggregate Grossed Up Basis (AGUB)
Election is rarely made unless T has NOLs. Why?
Tax is generally higher than the value of the
step up in basis in assets.
ADSP Price of stock (S) Ts liabilities
including any tax generated. ADSP S L T on
sale (i.e. (ADSP-assets basis)Tax Rate)
Solve (SL-(BTR))/1-TR, but only if T has
no NOLs. If 100 of stock not
acquired then gross up S. (rare) P
bears tax, because owns T, which has the
liability.
QSP acquire stock in a taxable transaction
amount of stock acquired is 1504(a)(2)
control (80 v v) within 12 month
period.
AGUB generally same as ADSP, but old stock adj,
unless election.
Seller is simply treated as selling stock
(installment sale o.k., etc.)
4
TAXABLE ACQUISITIONS338(h)(10)
338(h)(10) permits P and seller (S) to jointly
elect to treat a stock purchase as an asset
purchase.
Requires QSP Corporate P T is
part of AFFILIATED GROUP or an S CORPORATION
Joint P and S election
(h)(10) election generally made, if possible.
Why?
Only one layer of tax and step up in basis is
valuable.
Treatment Sale of assets to new T, just before
stock acquisition.
Liquidation of of old T into S
SELLER HAS TAX LIABILITY, but O.K. Why?
ADSP in (h)(10) not include taxes.
Gain on sale of stock often equals gain on sale
of assets if from a consolidated group and S corp
because inside and outside basis is often the
same and only one level of tax. (Beware of
character difference and 1374 gain for S corp.)
5
TAXABLE ACQUISITIONSSOME CLEAN UP ISSUES
Interest expenses often in leveraged
acquisitions IRS wants to limit interest
deduction (Thank Milken, LBO days) 279 Acq.
Indebtedness Int deduction over 5M
Debt to equity ratio over 2 to 1 or
earnings not 3x int. ded. Debt is
convertible to equity Debt is
subordinate to trade creditors (structurally, too
(in P)) Lose ded. if proceeds used to
buy stock or asset (2/3 of T/B) 163(e) and (i)
applicable high yield discount obligations
(AHYDO) Significant OID or PIK and not current
in 5 years. Yield more than 5 points over AFR
defer deduction until paid. Yield more than 6
points over AFR excess over 5 is a
dividend. 163(j) Limitation on int. ded. for
debt to related exempt (usually foreign)
lender. Debt to equity ratio 1.5 to 1 or worse.
Int. expense exceeds 50 of taxable income. Int.
ded. deferred. 172(h) Limit on NOLs created by
int. ded. on debt to buy stock. Int. ded. over
1M. Debt to acquire 50 or more of another corp
stock or make significant unusual distros (stock
repurchases)
Ts expenses in a stock acquisition (338 treats
appropriately), but if no 338 election is it a
dividend (IRS has never so contended). However,
INDOPCO case says no deduction, but regulations
allow many deductions. Similar issues on hostile
take over defense, generally generates a loss,
win or lose.
6
TAX-FREE ACQUISITIVE
REORGANIZATIONS - 368
Theory continued investment in stock (P stock)
by Ts shareholders is not an
appropriate time to tax them, if the transaction
is a stock or asset acquisition by P of Ts
historic business.
Consequences Tax-free except to the extent of
boot. 354 and 356 to Ts shareholders
tax only on boot. 358 basis to Ts
shareholders same as 351 361 to T no
gain, even on boot. 1032 no gain to P on
issuance of stock. 362 basis of stock or
assets to P.
General requirements Not in statute, by courts
and regs. Plan of Reorganization. Business
Purposes Continuity of Interest (COI) T
sholders receive P stock equal to 40 by
FMV. Continuity of Business Enterprise (COBE)
P P continues a T business or
uses Ts assets in its TorB.
Statutory Requirements 368(a) defines a
reorganization (A) an A reorg T mergers
into P (B) a B reorg P controls T using
solely P voting stock (C) a C reorg P
acquires T assets for voting stock
T then liquidates (unless
IRS waives). (a)(2)(D) a forward triangular
merger (a)(2)(E) a reverse triangular
merger Others later D, E, F and G.
Principles Recognition is defined event under
income tax. Certain exchanges of stock and
securities to restructure corporate holdings is
not a recognition event. It is, of course, only
deferral of gain due to carry-over basis. Boot
is always taxed.
7
TAX-FREE ACQUISITIVE REORGS CONSEQUENCES
354, 356, 358, 361, 362, 1032
All reorganizations are taxed the same under the
same provisions, to the extent applicable.
Some basic definitions
Party to the reorganization (368(b)) Resultin
g corp Target Acquiring Parent in, e.g.,
triangular.
Securities All equity Debt undefined, but
over 10 clear, most believe over 5
duration tested only on date of
issuance. Warrants are treated as security with
zero principal.
Control 368(c) 80 of vote and 80 of each
class of non-voting.
8
TAX-FREE ACQUISITIVE REORGS CONSEQUENCES
354, 356, 358T STOCK AND SECURITY HOLDERS
Gain only to the extent of boot. No loss. (Same
as 351.)
Boot is anything other than stock or securities
but boot does include securities, if receive
securities with greater principal amount than
principal amount of securities relinquished.
Warrants can be received, but if give up they
are securities with a zero principal amount.
Character of income when boot test under our old
favorite 302 assuming received all stock,
then boot used to redeem the amount of stock
that wasnt actually received. Of course, now
with 15 rate, what difference does it make?
Capital losses, short term c/g, installment
reporting, DRD.
Basis of stock and boot received - 358, so?
New stock and securities basis old basis gain
boot allocated based on FMV. Boot basis FMV
Holding period carry over, but boot new H/P
1223.
9
TAX-FREE ACQUISITIVE REORGS CONSEQUENCES
361, 357, 362 TAXATION OF T AND P
No tax to T if stock acquisition, obviously.
If an asset transaction (A, C or a2D) then
no tax if distribute property (implicit in A
and a2D, required in C), including to
creditors. 361(b).
No gain on distribution (liquidation) per 361(c).
Basis and holding period T gone or if not
carryover.
P is not taxed under 1032 unless distributed
appreciated property never happens.
Basis in assets acquired carries over
(technically plus T gain, but T never
recognizes gain, even though sholders do on
boot). If stock acquired, basis in stock carrys
over from old sholders. If public shareholders
then can do sampling. Strange if a2E (which is
a stock deal) basis in stock is net asset basis,
but if also B then election more later.
10
TAX-FREE ACQUISITIVE REORGS CARRY-OVER OF TAX
ATTRIBUTES 381
Corporate Attributes Numerous, see 381 list
Examples Net operating losses, account
conventions (FIFO/LIFO), holding periods,
depreciation lives, EP.
Carry-overs are often limited 382, 383, 384
and 269, more later.
EP deficit cant be used against pre-existing P
EP.
Taxable year ends, so short year, in almost all
instances. Joining new consolidated group
Disappearing in asset transactions.
11
TAX-FREE ACQUISITIVE REORGS GENERAL
REQUIREMENTSTREAS. REG. 1.368-1 AND -2(a), (b)
BUSINESS PURPOSE All tax-free reorganizations
must have a business purpose. Very rarely an
issue in an acquisitive reorg.
CONTINUITY OF INTEREST (COI) Quality must
be STOCK, any kind counts, but no other
securities or other interests do.
Quantity 40 (arguably less) T sholders must
receive P stock for 40 of
the value of their T stock. Acquisition
for or other property (a) by P or related
corp in transaction that would be a dividend
(304) or (b) by T, if in substance by
P, counted against COI. Who The T sholders
in the aggregate, not individually T
sholders can immediately sell, if not to P, etc.
CONTINUITY OF BUSINESS ENTERPRISE (COBE) P
or subs continue a significant business of T, or
continues to use a significant portion (1/3)
of Ts assets in Ps or subs T or B. Can
place assets in pship if control or have
significant interest.
PLAN OF REORGANIZATION Never seen it as an issue.
12
TAX-FREE ACQUISITIVE REORGS A
REORGANIZATION PROBLEMS ON P. 445
T Sholders
Must be a statutory merger Can be under foreign
law.
Stock gt 40
Must only meet Plan of Reorg Business
Purpose COI COBE
Assets
13
TAX-FREE ACQUISITIVE REORGS B
REORGANIZATION
T Sholders

• Requirements
• 4 General requirements
• Solely voting stock
• No boot in a B
• Control under 368(c)
• immediately after

Voting stock 100
Assets
Solely voting stock - strictly construed Cant
pay T sholders expenses. Can pay T expenses and
fractional shares. P can own T stock before, but
only if old cold 5 yrs? Vote elects
board of directors Contingent escrowed shares
o.k., but IRS position lt50
Control Immediately After 368(c) 80 of vote
80 of each other class Need not acquire
control, so long as control after so
creeping B o.k., but if old stock for must be
OC. T can redeem stock, e.g. preferred, before
hand if it is clear cash comes from T.
14
TAX-FREE ACQUISITIVE REORGS TRIANGULAR B AND
MISC. RULES
T Sholders
Requirements

• General
• Same as B

Voting stock 100
T
S
Assets
A direct transfer of the T stock, or the merger
of a second tier subsidiary into T, is permitted.
But cant use grandfather stock.
In reorganization subsequent integrated
transactions can change the analysis.
The merger of T into an LLC wholly owned by P is
an A.
The merger of T, after the B into P (or P owned
LLC) is an A.
The liquidation of T, after the B, must meet
the requirements of a C
15
TAX-FREE ACQUISITIVE REORGS C
REORGANIZATION
T Sholders

• Requirements
• General
• Sub all assets (90/70)
• 3. 80 voting stock
• liabilities not boot alone.
• 4. T must liquidate unless
• IRS approves (real rare).

Voting
Voting
Assets
P must acquire substantially all Ps assets for
80 (368(a)(2)(B)) voting stock. T must then
liquidate unless IRS approves.
Substantially all means 90 of net and 70 of
gross assets by FMV. Sub all looks primarily
to operating assets. Sale of some transfer ok.
Problem usually arises as a result of a prior
redemption or dividend.
Voting stock is the same as in a B. For the
80 test, liabilities only counted if other boot
given. So if 30 debt o.k., but not if 1 also.
Liquidation required, rarely approved, if
approved then liq.-reincorp.
P can own T stock before the transaction.
C reorgs very rare, because hassle to transfer
assets, except intlly.
16
TAX-FREE ACQUISITIVE REORGS a2D FORWARD
TRIANGULAR
T Sholders
Requirements

• General
• Sub all
• Cant use both P S stock

P Stock
T
S
Assets
P Stock
Formation of sub, or can, but rarely do, use
existing sub. Viewed as P contributing its stock
to S, but not essential. Forward merger of T
into S with stock and boot to T sholders
(forward - toward P).
Must satisfy Sub All requirement, same
definition 90 net, 70 - gross.
Essentially the same as an A and drop down, w/
sub all requirement.
How much boot can be used in a2D?
Same as A up to 60 - COI.
No voting stock or acquire control requirement.
If it fails, what is it?
Asset transaction Ps (and Ts Sholders) risk.
17
TAX-FREE ACQUISITIVE REORGS
TRIANGULAR B
TAX-FREE ACQUISITIVE REORGS a2E REVERSE
TRIANGULAR
T Sholders
Requirements

• General
• Sub all
• 80 Voting stock
• ACQUIRE control

Voting stock 100
Voting stock 80
T
S
Assets
a2E reverse triangular must satisfy Sub All
(same 90/70 test) and solely voting stock, but
can have 20 boot.
Mechanically the same as a triangular B, so if
fails as a2E might be a B and visa versa.
If fails as an a2E and B, what is it?
Stock Transaction just Ts S/Hs risk.
Followed by a merger of T into a P-owned LLC is
an A - often used.
18

TAX-FREE ACQUISITIVE REORGS REVERSE DOUBLE
DUMMY
P Sholders
T Sholders
New Co
The reverse double dummy can qualify as either
two a2Es or a 351 transaction. If qualifying as
a 351 transaction then 357(c) applies.
Note than 351 can be used as an acquisitive
device however, securities holders (debt and
warrants) get no protection .
19

TAX-FREE ACQUISITIVE REORGS
REVIEW
400 S 100
500 S 000
300 S 200
100 face 120 FMV 90 basis
120 face
V - 500 B - 100
T assets V 600 B 300
What kind of tax-free reorg is this? What are the
consequences to P, T, S, T Sholders, and T
Bholders (gain and basis)?
None taxable stock purchase. If no 338, then
Tholders 400 gain T Bholders 30 gain and
both basis FMV.
a2E or triangular B note Boot in B to T
Bholders else, no gain to anyone. P basis in T
stock is either 100 or 300.
a2E. P same as a2D T Bholders, same as a2D T
Sholders Gain 100 P Stock B 100.
a2D. P No Tax, S stock B 300 S No tax, T
assets B 300 T sholders 200 gain, P stock
B100 T Bholders 20 gain, B 110.
20

TAX-FREE ACQUISITIVE REORGS REVIEW
CHART
Type Stock type Sub all Merger Stock
v Acquire Amount Asset Control A
B Rev B C a2D a2E 351
21
DIVISIVE REORGS THE BASICS
355
355 is the major exception to double tax upon
distributions from a corporation. If rules met,
then neither the distributing corporation nor
the shareholders are subject to tax.
If the requirements are not met, then, of course,
both are taxed Under some circumstances, only the
distributing corp is taxed.
SPIN-OFF Distribution pro rata to all
shareholders like a dividend. SPLIT-OFF
Distribution to some shareholders like a
redemption. SPLIT-UP Liquidation of
Distributing rare.
The transactions involve a distributing
corporation (Distributing) distributing all the
stock of a controlled corporation (Controlled).
BASIC RULE Distribute control of a subsidiary,
where both Controlled and Distributing each own
an active trade or business carried on for 5
years or more. The distribution is not a device
for the distribution of EP, has a business
purpose and meets COI.
Mechanics may involve forming a new subsidiary.
Will qualify as a D reorganization (discussed
later).
22
DIVISIVE REORGS THE BASICS
355
Spin-off
Split-off
Requirements Business Purpose 5 yr. Trade or
Businesses Not a Device COI of both C D
D
X
Y
D must control C under 368(c) before the
distro and must distribute all it owns.
23
DIVISIVE REORGS BUSINESS PURPOSE
Non-tax motives for division of companies
Shareholder disputes split-offs, not spins
Insulation from creditors but limited
Regulatory decree Fit and focus
marketability Break-up business but other
issues.
Division must further the purpose and the purpose
could not be furthered in another way that is not
unduly expensive or impractical.
Not a sholder purpose alone (often overlap) and
not avoidance of state taxes, if similar fed
taxes invovled. To allow S election? No
An alternative to a spin, can be tracking stock,
but often impractical.
24
DIVISIVE REORGS 5-YR. TRADE OR BUSINESS
Both D C must be actively engaged in a trade or
business for five years. All steps to make money.
Can be the expansion of an existing business
add new store, hold for three years, then spin.
May be difficult to determine in a software
business is a new application an expansion or new
business.
Cant have acquired the business w/in 5 years in
a taxable transaction. Tax-free o.k. Cant
distribute stock acquired w/in 5 years, but what
if expansion? 355(b)(2) and 355(a)(3)(B).
Separate trade or business if servicing own
assets (e.g. real estate?) Active management
activity one room not enough, but lease to
many. Never if raw land to be developed.
Vertical and horizontal divisions o.k. In
vertical, o.k. to provide services to D but
beware of device.
What percentage of C or Ds assets must be in the
T or B? (5?)
Notice the similarity to the rules for Partial
Liquidations.
25
DIVISIVE REORGS JUDICIAL STATUTORY
Business Purpose covered. Ruling Guidelines
no rulings on business purpose currently
COI Prior sholders must own continuity in
both corps. (50?) Not clear whether 368
rules apply, but old historic shareholder
rules (cant sell in taxable transaction) might
apply. Tax-free disposition never breaks
continuity.
No Device Cant be a device to distribute
EP. Used to be rate differential now
basis recovery etc. Non-device factors
Strength of business purpose D is public
traded and widely held Sholders are corps
No EP, taking into account potential gain
Redemption to pay death taxes. Would
otherwise be a redemption. Device factors
Spin-0ff Subsequent taxable sale of D or C
Nature and use of assets (lots of cash in C)
Serves only D and could be sold w/out
impacting business it serves.
D C both carry on trade or business for 5 years
covered D not acquire C stock w/in 5 years in
taxable (avoidable) D controls (368(c)) C and
distributes all it has.
26
DIVISIVE REORGS CONSEQUENCES
355, 356, 358
D reorg often precedes 355 to form C. Will
cover later, but for now, no tax on formation
(like 351, including 357(c) but sec. o.k.).
381 not apply, so only EP split, but if
distribute existing C from consolidated group
everything carries over, even part of NOL.
Both stock and securities holders are protected
(except our old friend the increased face amount
for securities holders).
Boot rules and BASIS in stock the same. What are
they?
Basis of received stock, if complete redemption
is old basis, plus gain minus boot. However, if
spin-off so old stock kept then SPLIT BASIS OF D
STOCK between D C stock based on relative FMV,
then adjust for gain and boot. (358) NOTE
basis of C stock held by D is ALWAYS irrelevant!!!
Special types of boot stock acquired in taxable
transaction w/in 5 years (355(a)(2)(B) and NQP
unless for NQP.
Boot is gain or dividend depending on whether
spin or split.
Failed 355 will generate double level of tax, so
be careful.
27
DIVISIVE REORGS PROBLEM ON P. 557
F
FMV 1.5M B 158K
FMV 2M B 200K
S Co
EP 400K
EP 300K
Sec V 100K B 20
Sec V 100K B 100
Stock V 400K B 80K
Stock V 400K B 42K
EP 100K
28
DIVISIVE REORGS ANTI-ABUSE
PROVISIONS355(b)(2)(D), 355(d), 355(e)
355(b)(2)(D) Target transactions are internal
spins. Distributee corp cant have acquired
distributing w/in 5 yrs in fully taxable trans.
The abuse Acquire distributing so FMV basis in
stock. Distribute controlled, thereby
increasing basis in its stock to FMV. Sell
controlled.
355(d) The abuse A, B C want different T
subsidiaries, but dont want to pay tax at T
level. They acquire T, wait a bit,
then liquidate T in a split-up. Another abuse
P wants C, so it acquires part of D, then
split-off C. Rule Immediately after distro,
any person holds 50 by vote or value of D or C
as a result of acquiring stock of D or C in a
taxable transaction w/in 5 years. Lots of
anti-avoidance rules. Result D is taxed on
distribution. (D sholders still no tax if
355.)
355(e) Morris Trust abuse. C borrows cash,
distributes to D. D splits-off C. C is merged
into P, or goes public. Similar to
installment purchase of C, without D level tax.
(Reverse facts and acquire D.) Rule One or more
persons acquires 50 (by V or V) of either D or
C w/in 2 years before or after spin, pursuant to
Plan. Tax-free acq, redeem, or issue. Plan is
liberally construed, so hostile not count
safe-harbors 6-month hot window, afterwards
factor based. Result again, tax only at D level,
not sholder. Despite tax no basis adj. Internal
spins can be impacted see 355(f).
29
DIVISIVE REORGS PROBLEM ON P. 568(a)

Public II
Public
Forms M Inc. Spins M Inc. (Spin?) Contributes A
to D for D V Stock Liquidates (C?)
Denim Corp
L Inc
Apparel
Motel
30
DIVISIVE REORGS PROBLEM ON P. 568(b)

Public II
Public
Forms M Inc. Spins M Inc. (Spin?) Merges into D
Denim Corp
L Inc
Apparel
Motel
31
DIVISIVE REORGS PROBLEM ON P. 568(c)

Public II
Public
Forms C Inc. Spins C Inc. Stock C Merges into D
Denim Corp
L Inc
Apparel
Motel
Apparel
32
TAX-FREE RESTRUCTURING REORGANIZATIONS
368(a)(1)(D), (E), (F) AND (G)
368(a)(1)(E) E reorg Recapitalization or
Recap One corporation involved change in
capital structure. No COBE or COI required and BP
not very strong. Normal 358 rules.
Stock for stock? Any kind and any amount, but
305 and 306 can apply Bonds received for
stock? 356 taxes due to excess principal
amount. Bonds received for bonds? Again, 356
to the extent of excess principal, also both
must be securities, and accrued interest is
taxed. Stock received for bonds? No tax to
recipient but corp may have discharge of
indebtedness under 108 principal in excess of
value.
33
TAX-FREE RESTRUCTURINGSLIQUIDATION -
REINCORPORATION 368(a)(1)(D)
Treating a transaction as a D had been used by
IRS to challenge liquidations-reincorporations.
After the repeal of General Utilities Its use is
not generally in the IRSs interest.
A typical transaction involved the transfer of
some operating assets, to a subsidiary,
retaining investment assets, followed by the
liquidation of the transferor of the seller. When
liquidations could be done without a corporate
level tax, the sholders could receive the cash
at capital gains rather than dividend tax rates.
The Courts had no problem ignoring the lack of a
plan of reorganization, and finding the
transaction was a D reorganization with boot.
Now, however, the IRS would be happy to treat the
transaction as a liquidation.
The technical requirements are (i) a transfer of
some or all the assets of a corporation (ii) to
a corporation controlled by the transferor or its
shareholders (iii) in exchange for stock or
securities of the transferee, (iv) followed by a
distribution of the stock or securities to (v)
the transferors shareholders pursuant to a plan
of reorganization.
Divisive Ds used for 355 transactions require
the application of 357(c), while non-divisive Ds
do not.
The courts regularly ignored one of the steps
such as transfer of significant assets or
issuance of stock.
34
TAX-FREE RESTRUCTURINGSCHANGE IN FORM OR
LOCATION 368(a)(1)(F)
Used to move a single corporation from, e.g.,
incorporation in California to incorporation in
Delaware.
Must be single corporation with complete COI and
COBE, but not integrated with other transactions.
Cant itself be divisive or combinitive.
F reorgs usually takes the form of an A, but
can take any form see Problem on 597
35
TAX-FREE RESTRUCTURINGSBANKRUPTCY REORGANIZATION
368(a)(1)(G)
In Alabama Asphaltic, the court treated the debt
holders as equity holders for continuity
purposes, because the equity had lost all of its
value. 368(a)(1)(G) codifies this concept.
Continuity is in effect applied by looking at the
creditors. COBE is not changed. Discharge of
indebtedness can occur with attribute reduction.
G reorganizations are a focus of a separate
bankruptcy tax class.
36
LIMITS ON CARRYOVER AND USE OF TAX ATTRIBUTES -
NOLS 382, 383, 384, SRLY
Pursuant to 172 a C corporation can carry back
its unused net operating losses (NOLs) for 2
years and carry them over for 20 years. Current,
then oldest. Carryback can be waived. 1212
allows capital losses to be carried over for 5
years and unused tax credits can often be carried
over indefinitely. Thus, NOLs are a corporate
asset which can be used to reduce a
corporations taxes in future years. A 100 NOL
is worth about 35. A failing corporation may
have little or no other assets. Profitable
corporations would acquire the failing corp and
use its NOLs to shelter its income. And what is
the policy - why not?
The methods for using NOLs are numerous Acquire
the loss corp and file a consolidated
return Acquire the stock and liquidate under
382 Acquire corp or assets in a tax-free
reorganization. Acquire stock and infuse built-in
gain or profitable assets Even have the loss
corporation acquire you and your BIG assets.
Congress was concerned that the corporate tax
would become a tax on the national net income of
all corporations if NOLs were fully used. Thus,
after many false starts they enacted 382, 383
384.
37
LIMITS ON CARRYOVER OF NET OPERATING LOSSES
382
382 CHANGE IN OWNERSHIP subjects losses to
limitation equal to the value of the companys
stock just before the change times long
term tax-exempt rate (similar to AFR), unless
change business then zero. CHANGE IN OWNERSHIP
OWNER SHIFT OR EQUITY SHIFT OWNER SHIFT
The ownership by 5 shareholders (by value)
increase by more then 50 w/in 3-year
testing period. Test counting 5
shareholders ownership have they increased
their ownership by more than 5 since 3
years prior to test? Sale, issuance (with
minor exceptions), redemption of stock can cause
Change in stock value in different classes
not cause. E.g., preferred is worth 10 of
company, but common goes down in value, so
preferred becomes worth 60.
EQUITY SHIFT Same concept, but through
mergers, acquisitions and certain issuance.
Look to which corp can use (so pre and post
merger corps treated as same entity.) SPECIAL
RULES Public treated as one 5 sholder but
can be different publics. Look all the way
up to individual level. Modified 318 applies
to determine ownership. (Options if cause CIO)
Gift, death and divorce dont count.
38

CHANGE IN OWNERSHIPEXAMPLE
V-2K
200 S 400
400 S
V - 400
V - 600
T assets V 1000 NOL 300
Long term T-E Rate 5
Consequences? COI Ps S/Hs are a 5 sholder
and ownership has increased from 0 to 54.5.
(602/2.2) NOLs limited to 50/yr.
COI (Equity Shift) Ps S/Hs increase from 0 to
77 (2/2.6). NOLs limited to 50/yr, same as
before.
39
BUILT-IN GAIN AND LOSSAND OTHER RULES 382
Built-in loss (BIL) is total basis in excess of
total FMV. If it exceeds lesser of 10M or 15
of value of corp, then treated as NOL if
recognized w/in 5 yrs of COI. Reduced
depreciation, also.
OTHER RULES If COBE is lost w/in 2 yrs of COI
then limit equals zero. Value At time of
COI Anti-stuffing contributions (COD) w/in 2
yrs. If over 1/3 non-business assets, then just
net business assets. Corp contraction after
COI counted. Any unused NOL limit carried over
until NOLs expires. Once COI, then 3 yrs starts
over.
Built-in gain (BIG) is FMV in excess of basis.
If it exceeds same lesser of 10M or 15 of
value of corp, then can use NOLs against.
40
OTHER TAX ATTRIBUTES ACQUIRING BIG CORP 383,
384 SRLY
383 applies the same rules as 382, but limits
capital loss and tax credit carry-overs using
economic equivalence.
384 applies to a Loss Corporations acquisition
of a corporation with BIG. Use of BIL also
limited BIG and BIL same size limits as in
382. Applies to acquisition of stock or tax-free
asset acquisition. Recognized BIG w/in 5 years
cant be off set with pre-acquisition
NOLs. Income items can be BIG items, such as
unrealized receivables.
Separate Return Limitation Year (SRLY) rules
apply only if 382 doesnt. It limits
pre-acquisition NOLs in an acquired subsidiary
being used by other members of a consolidated
group against their income. For example, held 60
of T, then acquired 20 when T had NOLs.
41
OTHER TAX ATTRIBUTES ACQUIRING BIG PROPERTY
383, 384 SRLY
383 applies the same rules as 382, but limits
capital loss and tax credit carry-overs using
economic equivalence.
384 applies to a Loss Corporations acquisition
of a corporation with BIG. Use of BIL also
limited BIG and BIL same size limits as in
382. Applies to acquisition of stock or tax-free
asset acquisition. Recognized BIG w/in 5 years
cant be off set with pre-acquisition
NOLs. Income items can be BIG items, such as
unrealized receivables.
Separate Return Limitation Year (SRLY) rules
apply only if 382 doesnt. It limits
pre-acquisition NOLs in an acquired subsidiary
being used by other members of a consolidated
group against their income. For example, held 60
of T, then acquired 20 when T had NOLs.
42
ANTI-AVOIDANCE ANDANTI-ABUSE PROVISIONS269,
482 AND JUDICIAL
269 THE principal purpose is the avoidance or
evasion of tax by acquiring the benefit of a
deduction, credit or other allowance As a result
of acquiring control (50 of V or V) of a
corp, acquiring property of a corp (not
previously controlled) where the basis of
the property carries over Or acquire stock in a
QSP, no 338 election made, but T liquidated
w/in 2 years. Not believed it applies if 382
applies, but regs to the contrary. Rarely applied
and most devices specifically prohibited.
482 IRS can reallocate income, deductions,
credits, etc. Requires arms length
pricing! Elements Two or more businesses or
entities Owned or controlled by same interests
(very broad) Reallocation to collect taxes or
clearly reflect income. Types of transactions
loans, rents, salaries, sales. For intangibles
royalties commensurate with income Most
frequent Cross Border, t/p whipsawed between
countries Advance pricing, Competent
Authority Penalties and Reporting.
JUDICIAL DOCTRINES Business purpose profit
motive, risk of loss done just for
taxes Economic substance not clear separate
change in economics Substance over form
Wrong name lease is loan. Step transaction
doctrine Esmark, more direct route.
43
ANTI-AVOIDANCE PROVISIONS532, 541
Both of these were more important when dividends
taxed as O/I and individual rates higher than
corporate rates.
532 Accumulated Earnings Tax Accumulation of
EP beyond the reasonable needs of
the corporation, with a purpose of avoiding tax
on dividends. Working capital and expansion
business cycle calculation. EP plus 250,000
tax at dividend rates. Applied in conjunction
with unreasonable comp rules and 482, but with
high employment taxes not much of a problem. Use
of LLCs and S corporations avoid the problem and
equality of corporate and individual rates not
induce use of C corp.
541 Personal Holding Companies Incorporated
pocket books. To avoid high individual rates,
historically, t/ps would incorporate their
investments, talent or personal assets and pay
lower corp rates Then liquidate w/out corp tax
and pay c/g rates on liquidation. Now, with the
repeal of GU and relatively equal rates only
after sale of assets or inadvertently.
Definition of PHC 5 or few individuals own more
than 50 of stock by value during second half of
year. Its own attribution rules apply. Plus
Income Test 60 of Adjusted Ordinary Gross
Income (AOIG) is Personal Holding Company Income
(PHCI) AOIG gross ordinary income with some
adjustments (some dep.) PHCI interest,
dividends, rents, royalties (but rents o.k. if
over 50 and no more than 10 other PHCI). Dumb
to put rentals in C corp. Personal service income
by 25 sholder and corp not designate. Consequenc
es Dividend tax imposed on PHCI, reduce by
actual, Consent and deficiency dividends. Rarely
imposed if know dividends induced.
44
S CORPORATIONSINTRO, DEFINED1361
Pass through of income and loss most of the
time Similar to, but definitely not the same as,
partnerships. Subject to repeal of G.U. (unlike
pships) tax on distros. Can participate in
tax-free reorgs, 355 and (h)(10) trans.
Eligibility Domestic corporation No more
than 100 U.S. or resident individual sholders
Count spouses, 7 lineals from common ancestor
as one Estates and certain exempts (ESOPs)
o.k., but NOT partnerships, corps (but
QSSS o.k.) or non-resident aliens.

ONE class of stock not a flexible capital
structure! Voting differences o.k.
Redemption rights, buy-sells etc. o.k. if not
avoidance Straight debt safe harbor term
or demand, not contingent interest,
sholder or in the business of lending,
non-convertible. Certain warrants o.k.
Large corporations (Cargill, Parsons) o.k., but
not banks or insurance companies. 100 owned
subs QSSS becomes a disregarded entity. No more
than 25 of income is investment (PHC) income
for three years if former C corp with EP.
45
S CORPORATIONSELECT, REVOKE, TERMINATE1362
Must elect S status w/in 2-½ months of
beginning of year or in prior year. Effective day
one. All consent. Waive for reasonable
cause. Revocation ½ of stock, effective
prospectively unless w/in 2-½ months, then
beginning of year. Termination disqualify (can
do it to revoke too). Split year
Non-qualified holder or too many or second class
of S. 25 of gross inc. in 3 years with EP.
Inadvertent can be excused. Cant re-elect for
5 years Taxable year calendar unless 25 of
gross in last two months or pay deferral
charge up to 3 months. Can be cash basis, if
personal service or small income.
46
S CORPORATIONSTREATMENT OF SHOLDERS1366,
1367
No tax, generally, imposed on corp, passes-thru
to sholders and retains its character (c/g,
invest, etc.) Exception 1374, BIG when C
elects S status. Passes through at year
end. Losses pass-thru, subject to limit? Basis
and sholder debt. Differs from pship.
Unlimited carryover. Beware of 362(e)(2) BIL
limit loss disappear. Stock basis adjustment
See Consolidated and Pships ? capital
contribution income distro -loss. InOut
often Sale of stock character capital, but rate
look thru COD rules now clarified limited loss
is attributed.
47
S CORPORATIONSDISTROS, TAX ON S, C
RULES311(b),1368, 1374
If no EP (never was a C) then reduce basis,
then C/G. If EP (was C or acquired C) then
dividend if over Accumulated Adjustments
Account, (AAA) AAA S period earnings,
which can take out first. Typical up by
earnings, down by distros. Distributions of
appreciated property always triggers income
(just like C) but flows through unless 1374
gain (appreciation while in a C corp). (Tax is
loss)
No S level tax other than 1374 BIG or on PHC
if over 1/3 EP (same as disqualification
rules). BIG is net overall built-in gain at
con/acq. BIG recognized w/in 10 yrs is taxed
GET APPRAISAL Installment sales A/R for cash
LKE- it carries over Generally other C rules
apply e.g. 351, 311 Can participate in
tax-free reorgs 338(h)(10) On death, step up
stock, sell assets, liq. tax? But if not
complete liquidation then asset distro taxed
48
CHOICE OF ENTITY
S Corporation Advantages and Disadvantages?
Single layer of tax (v. C Corp)
Can do reorgs (v. partnerships) - Hard to
remove assets (v. partnerships) - New
holders come in with tax - Inflexible
capital structure, sholder type.
Partnerships Advantages and Disadvantages?
Single layer of tax (v. C Corp)
Flexible structure (v. S corp) Easy
entrance and exit (v. Corp) - Cant do
reorgs (v. Corp)
C Corporations Advantages and Disadvantages?
Publicly traded
49
REVIEW TAXABLE ACQUISITIONS
TYPES AND CONSEQUENCES Stock Asset two
layers of tax on stock STOCK TREATED AS ASSET
338 election REQUIREMENTS Corporate
acquiror QSP 80 value w/in 12 months in
taxable. WHEN USE? Only when T has losses
or can make (h)(10) (h)(10) REQUIREMENTS
Same as above out of affiliated group or S
50
REVIEW TAX-FREE ACQUISITIVE REORG
A and JUDICIAL REQUIREMENTS Merger and
COI 40 COBE 33 B REQUIREMENTS SOLELY!
voting stock end with control Judicial C
REQUIREMENTS Voting stock for 80 sub all
assets (90 net/70 gross) Liquidate T
Judicial. TYPES OF TRIANGULAR AND REQS?
(a)(2)(D) Forward Merger sub all assets
Judicial (a)(2)(E) Reverse Merger sub all
assets and acquire control for
voting stock Jud. WHATS A TRIANGULAR B?
Reverse that B
51
REVIEW CONSEQUENCES OF T-F REORG
Tax consequences and basis to sholders w/boot?
? Tax to lesser of gain and boot (356)
Basis in stock old basisgain-boot (358)
Boot basis FMV (358) Tax consequences to Ts
securities holders? ? Tax FMV of
increased principal amount. (354) Tax
consequences to T, if survives? None, carry
over attributes Tax consequences and basis to S,
if S? No tax, Ts attributes carry over,
basis Ts gain Tax consequences and basis to
P? ? No tax, Ts attributes carry over,
basis Ts gain
1032 362
52
REVIEW DIVISIVE REORGS
Three types of divisive reorgs names
character? Spin-off pro rata, like a
dividend Split-off non-pro rata, like a
redemption Split-up non-pro rata, like a
liquidation Requirements for tax-free status?
Business purpose Both D C have a TorB for 5
years Not acquire stock in taxable w/in 5
years (TorB) COI ( probably COBE) Not a
device Have control (368(c)) and distribute all
53
REVIEW DIVISIVE REORGS CONSEQUENCE AND
ANTI-ABUSE
Consequences to stock securities holders
basis? Tax on boot. In split Old basis
gain boot. Then, in spin split existing stock
basis between D C stock based on relative
FMV. Consequences to D C, absent
anti-abuse No tax, divide EP, else
attributes only if C pre-exists. Two anti-abuse
transactions involving C D conseq?
355(d) 50 or of C or D by a person as result
of taxable acquisition of C or D stock w/in 5
years. 355(e) 50 or of C or D in any
transaction per plan generally w/in 2
years. Consequences of both D taxed on BIG
in C stock.
54
REVIEW OTHER REORGS
Recapitalization 4 types Requires, Conseq.
? 368(a)(1)(E) E One corp, no COI or
COBE Stock for stock o.k. unless NQP Stock
for debt o.k., but might have discharge of
debt. Debt for stock fully taxable Debt for
debt more principal boot, less
discharge Change in identity or location
Requires, conseq. ? F Super continuity,
but ever integrated No conseq. Liquidation-Reinco
rporation 2 types, reqs. conseq ?. D
assets for control distribute divisive not
357(c) if divisive. Bankruptcy ?
G
55
REVIEW LIMITS ON ATTRIBUTE TRANSFERS
What section limits NOLs and when does it apply?
382 COI ownershift, equity shift 50
change in 5 sholders over 3 year test
period. How are less than 5 sholders measured
and treated? By value and as a single 5
holder and can be multiple. What are
consequences? NOLs limited in each year to
value of corp when COI times tax-exempt rate,
unless no COBE then zero. How are BIGs BILs
measured and treated? BIL if overall asset
basis exceeds value by more than lesser of 10M
15. Is NOL if triggered w/in 5 yrs. BIG is
inverse and ups NOL limit if triggered w/in 5 yrs.
56
REVIEW LIMITS ON ATTRIBUTE TRANSFERS
(cont.)
What section limits other good attributes?
383 What are limits on corp with NOLs acquiring
BIG Co, ? 384 limits use of NOLs against
BIG (10M or 15) if acquire stock or assets
in tax-free of BIG Co and trigger BIGs w/in
5 years.
57
REVIEW S CORPORATIONS
What are the requirements for being an S
Corporation? 100 or less individual (or
non-profit) sholders U.S. corporation, not
bank or insurance company One class of stock
Elect by all sholders If EP not 25
passive in each of next 3 years How are sholders
counted? Spouse and lineals treated as one
sholder What are consequences to sholders
their stock? Gain and loss in corp. flows thru,
with character, and stock basis up for contrib
inc. down for loss distributions.
Distributions only taxed if over basis
58
REVIEW S CORPS(cont.)
When can an S be subject to tax? s? When it
was once a C or acquires a C 1374 built in
gain for 10 yrs. Passive earnings if EP
(gt25) What is the AAA and how does it work? AAA
keeps track of previously taxed income if corp
has EP. S earnings increase, distros
decrease. Distro in excess of AAA are
dividends and then return of basis and gain.