During negotiations, the purchase price of the deal is established as well as a general idea of what assets are to be exchanged.  The major objective of structuring a transaction is the ability to transfer the expected value of the deal to the seller while operating within constraints that are suitable to the buyer.  The type of structure depends on the law, the tax code and the creativity of the professionals involved in the deal.  There are a number of different ways to structure a transaction so that the benefits to the buyer and seller can be maximized.  This article will provide an introduction to a variety of tax-free strategies, that used properly, will maximize the value to both the buyer and seller.

Generally, stockholders who sell or exchange their stock, and corporations that sell or exchange their assets must recognize gains and losses for tax purposes.  However, the Internal Revenue Code (IRC) contains various rules that provide for tax-free treatment.  IRC Sections 354-368 provide the basic rules pertaining to tax-free reorganizations.  In particular, IRC Section 368 specifically identifies the various types of corporate reorganizations that can qualify for tax-free treatment.

A business that is owned by a corporation can be transferred other than by a direct sale of assets.  In a taxable sale, the selling stockholders can dispose of their stock in a taxable sale.  In a taxable stock transaction, the selling stockholders recognize gain or loss on the sale of their stock, and the buyer of the stock receives a basis in the stock equal to the purchase price.  The tax basis of the assets and liabilities acquired and the tax attributes such as net operating loss carry forwards, capital loss carry forwards and tax credit carry forwards are unaffected.  However, the use of these tax attributes after an ownership change may be limited.

The selling stockholders can dispose of their stock in a tax-free reorganization by exchanging their shares for those of the acquiring corporation.  The selling stockholders generally recognize no gain or loss and obtain a basis in the acquiring corporation’s stock equal to their basis in the selling corporation’s shares.  The tax basis of the acquired corporation’s assets and liabilities are unaffected.  The acquiring corporation succeeds to the acquired corporation’s tax attributes directly either because the acquired corporation disappears or indirectly because of the stock owned in the acquired entity.  Similar to the taxable sale, the use of any tax attributes may be limited.

A tax-free reorganization essentially involves the rearranging of the corporate ownership structure.  However, be aware that there must be a valid business reason for such a re-organization.  For example, an individual may sell the shares of his company in exchange for shares in a much larger company to remain involved with the management or ownership of a much larger business entity.  Tax-free reorganizations are generally classified into three categories as follows:

• Mergers, consolidations and stock exchanges that lead to the acquisition or combination of corporations.  In acquisition reorganization, the acquiring corporation ultimately ends up in control of the target corporation’s assets or stock.  These types of reorganizations are typically known as Type A, B and C reorganizations.

• Divisive reorganizations that are otherwise known as spin-offs, split-offs, and split-ups are designed to divest a corporate business segment or divide the ownership of a corporation.  These typically are known as Type D reorganizations.  However, a Type D reorganization can also be acquisitive.

• Restructuring reorganizations that involve the change of form, place of organization or identity are typically referred to Type E, F and G reorganizations.