Editor: Annette B. Smith, CPA
Corporations & Shareholders
If a reorganization spans different tax years, what is the proper time to report the transaction?
Example: X Corp. wholly owns Y Corp. and Z Corp. Under a plan of reorganization, on December 31 of year 1, X contributes the Z stock to Y in exchange for additional Y stock (the exchange). Under the same plan, in year 2, Z liquidates (the liquidation).
The characterization of the transaction in the example (the liquidation together with the exchange) is critical to determining when to report it. For purposes of this item, two characterizations are analyzed:
- A Sec. 351 exchange followed by a Sec. 332 liquidation; or
- A reorganization as defined in Sec. 368(a)(1)(D) (a D reorganization).
If each step of the transaction is viewed in isolation at the end of each tax year, the exchange in year 1 should qualify for nonrecognition under Sec. 351 and the liquidation in year 2 should qualify for nonrecognition under Sec. 332, each being reported as separate transactions on the respective tax returns. However, Regs. Sec. 1.368-1(a) provides that “[i]n determining whether a transaction qualifies as a reorganization under section 368(a), the transaction must be evaluated under relevant provisions of law, including the step transaction doctrine.” The step-transaction doctrine “treats a series of formally separate ‘steps’ as a single transaction if such steps are in substance integrated, interdependent, and focused toward a particular result” (Penrod, 88 T.C. 1415 (1987)). Therefore, in determining the proper tax characterization of the transaction, the step-transaction doctrine must be applied, if appropriate.
This approach is in accord with Rev. Rul. 2004-83. In that ruling, corporation P owned all the stock of corporations S and T. As part of an integrated plan, S purchased all the T stock from P for cash, and T completely liquidated into S. The IRS applied step-transaction principles to treat the stock sale, which otherwise would have been subject to Sec. 304, and liquidation as a D reorganization.
Similar to the IRS’s application of the step-transaction doctrine in that ruling to treat the stock sale and liquidation as a D reorganization, the step-transaction doctrine should apply to treat the exchange and liquidation in the example above as a D reorganization, regardless of whether each step occurred in different tax years.
If the transaction is treated as a D reorganization, the question arises as to when it should be reported: (1) in year 1, when the first step of the reorganization occurred; (2) in year 2, when the reorganization was completed; or (3) through an indication in year 1 that certain transactions have been undertaken that are under a plan of reorganization that has not yet been completed, followed in year 2 with full reporting of the reorganization on its completion.
Neither the statute nor the regulations provide explicit guidance. For example, Regs. Sec. 1.368-3(a) requires that all corporate parties to a reorganization attach to their returns “for the taxable year of the exchange” all the pertinent facts relating to the reorganization. However, it is unclear how this requirement applies if there are two exchanges in two different tax years, as posed by the example above, which would be classified differently depending on when the transaction is reported.
Sec. 381 and the regulations thereunder provide some guidance on when to report a reorganization that spans different tax years. Sec. 381 sets forth the general rules relating to carryovers in certain corporate acquisitions. Under Sec. 381(a), a corporation that acquires the assets of another corporation in certain liquidations and reorganizations should succeed to, and take into account, as of the close of the date of distribution or transfer, the items described in Sec. 381(c) of the distributor or transferor corporation. Generally, Regs. Sec. 1.381(b)-1(b)(1) provides that if the distribution or transfer is not made on one day, the date of distribution or transfer is the day on which the distribution or transfer of all such properties is completed. Further, Sec. 381(b) and Regs. Sec. 1.381(b)-1(b)(2) generally provide that, except in the case of a reorganization under Sec. 368(a)(1)(F), if an election is filed, the date of distribution or transfer should be the day that (1) substantially all the properties have been distributed or transferred, and (2) the distributor or transferor corporation has ceased all operations (other than liquidating activities).
Therefore, if the rules relating to carryovers in certain corporate acquisitions can be referred to as guidance here, the transaction would be reported in year 2, the date on which the transfer of all such properties is completed. This would appear appropriate because, until the liquidation actually takes place, the reorganization is not certain to occur. For example, if Z becomes insolvent, the liquidation cannot occur until it becomes solvent. Therefore, reporting the reorganization should be required only after all events that fix the characterization of the transactions as a reorganization have occurred.
Additional support for such an approach may be found in the consolidated return context. For example, in Rev. Rul. 57-53 and Technical Advice Memorandum (TAM) 8837003, the IRS held that if a member of an affiliated group of corporations, which files a consolidated tax return, acquires the stock of another corporation for the purpose of acquiring all its assets and subsequently liquidates the acquired corporation, the acquired corporation does not become a member of the affiliated group, because the acquiring corporation’s intention and business purpose at the time of obtaining control of the acquired corporation’s stock was to acquire all the acquired corporation’s assets.
In TAM 8837003, corporation P wanted to acquire the assets of corporation T. However, the seller would not sell the T assets. Accordingly, P formed corporation S for the purpose of acquiring T. After the stock purchase agreement was signed, but before the actual purchase of the stock (the stock purchase agreement was signed three weeks prior to the actual closing), P and S decided to liquidate T into S after the stock purchase to step up the bases of the T assets. Subsequently, S purchased all the outstanding T stock. The next day, T was liquidated into S under a plan of liquidation adopted by the directors and sole shareholder of T.
The IRS held that the facts and circumstances surrounding S’s purchase and liquidation of T evidenced an intent by S to acquire T’s assets by purchasing T’s stock to be followed by a liquidation. Because S’s stock ownership of T was transitory and for the end purpose of acquiring T’s assets, T could not be deemed to be affiliated with P and S under Sec. 1504(a). Accordingly, T could not join in the making of a consolidated return with P and S and had to file a final short-period return for the period ending on the date of its liquidation. Rather than viewing the stock purchase in isolation as enough to permit T to join the consolidated group, the IRS viewed the transactions as a whole. While it is unclear from the facts of this TAM whether the transactions crossed tax years, there does not appear to be any policy that would require a different treatment under step-transaction principles for a transaction that takes place across different tax years. See also Letter Ruling 201002027.
In light of the authorities discussed, it appears that technically, as a practical solution, the transaction should be reported at the end of year 2, the year during which the transaction is considered completed. However, as a matter of good practice, it would be prudent for the taxpayer to attach a statement to its return for year 1 providing enough information to notify the IRS that the taxpayer has undertaken transactions that are part of a plan of reorganization under which the reorganization will be completed and reported in a subsequent tax year.
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
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