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What are Reorganizations?

Reorganizations provide ways for corporate entities to restructure without triggering substantial tax consequences. With any reorganization, it is essential to remember that the strategy is rooted in tax deferral rather than tax elimination. The consideration used by the acquiring corporation, or subsidiary of an acquiring corporation, can also significantly impact whether or not a transaction qualifies as a reorganization under §368. This article has been prepared by a Denver business attorney and tax attorney to discuss a B Reorganization.

What is a B reorganization?

One technique is known as a stock for stock acquisition, or in other words, a “B reorganization” under § 368(a)(1)(B) of the Internal Revenue Code. In this type of reorganization, the acquiring company transfers its stock in exchange for stock held by the target corporation’s shareholders. Rather than dealing with the target corporation, the transaction is conducted between the acquiring corporation and the target’s shareholders. This is important for basis purposes because the acquiring corporation takes over the basis that the target shareholders held in the stock, according to §362(b). In other words, the basis is calculated from the hands of the transferor. Generally, this is a corporation, but the transferor is considered the individual shareholder in a B reorganization. 

While B reorganizations may seem like a simple transaction, they have strict requirements regarding control and consideration.

What is the control requirement for a B reorganization?

First, consider control requirements. In a “B Reorganization,” the control requirement is satisfied under §368(c) of the tax code. This requires that the acquiring corporation possess 80% of the value of all voting stock in the target, along with 80% of all other classes of stock that are not considered voting stock. For instance, consider five types of stock – Class A, Class B, Class C, Class D, and Class E, where Class A and Class B are the only ones with voting stock. The acquiring corporation would need to acquire 80% of A and B since they contain voting stock and 80% of each Class C, Class D, and Class E because these are the nonvoting stock classes. 

What Type of Consideration May Be Used In B reorganizations?

B reorganizations are challenging to satisfy for the consideration required since only voting stock may be used. B reorganizations may not be accomplished using other property, such as nonvoting stock or cash. Therefore, the company cannot acquire a target’s stock valued at $200,000 for $160,000 worth of voting stock, $20,000 of cash, and $20,000 of nonvoting stock. The consideration’s cash and nonvoting stock components will ruin the transaction by violating the requirements of a B reorganization, and immediate tax consequences will follow.  

Can B reorganizations occur over a series of transactions?

B reorganizations can also be achieved through several transactions rather than just one. However, one must consider if, in the past, the stock acquired was done so by using cash or other property aside from voting stock. This is commonly known as “boot.” If the boot was used in the past, you would need to consider the time that has passed from the initial transaction to the subsequent trade to satisfy the consideration requirements.

Will there still be minority shareholders?

If the reorganization’s objective is to eliminate minority shareholders, then a B reorganization is likely not the right fit. B reorganizations only require 80% control to be effective. This leaves 20% of the shareholders that may or may not release control. For some transactions, retaining minority shareholders may not be an issue in accomplishing the tax deferral through a reorganization, but it may create other corporate matters outside tax consequences.

You can contact The McGuire Law Firm to speak with a Denver Business Attorney and learn if your transaction qualifies as a B reorganization for tax deferral purposes.

 

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