Types of Corporate Reorganizations and When They are Useful

In the world of business, corporate reorganizations are a common occurrence. They can help companies streamline operations, improve efficiency, and achieve strategic goals. However, not all reorganizations are created equal. The Internal Revenue Code (IRC) Section 368 defines seven types of corporate reorganizations that qualify for tax-free treatment.

These seven types of reorganizations are further divided between acquisitive reorganization, divisive reorganizations, corporate restructuring reorganizations and bankruptcy reorganizations. Understanding these different types and structures and when they are useful is crucial for successful corporate restructuring.

The 7 Types of Reorganizations under IRC §368:

Type A – Statutory Merger or Consolidation

A company merges into another, or two companies consolidate into a new entity. This type of reorganization must follow state law merger statutes. Consideration can include stock, cash, or other property. In a Type A reorganization, the target corporation is dissolved following the merger. This process involves acquiring parent company absorbing all of the target corporation's balance sheet according to IRC § 368(a)(1)(A).

Type B – Stock-for-Stock Acquisition

In this type of reorganization, the acquiree exchanges its stock for voting stock in the acquirer’s corporation where the acquiring requiring entities exchanges around 75-85% of another’s stock solely in exchange for voting stock. No cash or other property (boot) is allowed, as it may disqualify the reorganization. Codified under IRC § 368(a)(1)(B).

Type C – Stock-for-Assets Acquisition

One corporation acquires substantially all assets of another in exchange for voting stock. Some cash or property (boot) is allowed, but it must be limited to maintain the tax-deferred treatment. The target company then liquidates in accordance to IRC § 368(a)(1)(C).

Type D – Acquisitive Reorganization

A corporate acquisition, when "substantially all" of a target corporation's assets are transferred to an acquiring corporation, it is required that the target corporation or its stockholders (or a combination of both) retain "control" of the acquiring corporation, typically through at least 80% ownership immediately after the transfer. This ensures that the original entity maintains influence over the newly acquired assets and operations.

The target corporation must distribute the acquiring corporation stock and any other consideration received to its stockholders, as well as its other properties if any, in a transaction that qualifies under IRC § 354 (IRC § 368(a)(1)(D)). Additionally, there is a type D divisive reorganization, as explained below.

Type D – Divisive Reorganization

A divisive reorganization involves a corporation splitting into smaller entities, creating two or more separate companies. This reorganization must meet the requirements outlined in the divisive Type D reorganization under IRC 368(a)(1)(D). The forms of a divisive reorganization are as follows:

• Spin-off: Parent company distributes subsidiary stock to shareholders, who keep both.

• Split-off: Shareholders exchange some of their parent company stock for subsidiary stock.

• Split-up: Parent company dissolves, splitting into two or more separate companies.

Type E – Recapitalization

A recapitalization is a restructuring that involves changing a corporation's capital structure, rather than its organizational structure. This type of restructuring is classified as a recapitalization under IRC § 368(a)(1)(E). It occurs when a corporation issues a new class of stock in exchange for existing common or preferred stock.

Type F – Mere Change in Identity, Form, or Place of IncorporationA Type F reorganization under IRC § 368(a)(1)(F) is a simple formality change to a corporation, such as a change in identity, form, or location. This can include changes in the state or jurisdiction of incorporation, which qualify as Type F reorganizations. These changes do not involve a change in ownership or control of the corporation, but rather are considered a restructuring of the corporation for legal or administrative purposes.

Type G – Bankruptcy Reorganization

Bankruptcy reorganizations involve transferring assets from one corporation to another in a bankruptcy or similar situation, meeting the criteria for Type G reorganizations under IRC 368(a)(1)(G).

When are These Reorganizations Useful?

• Type A: Useful when two companies want to join forces and create a stronger entity.

• Type B: Ideal for companies looking to expand their presence by acquiring another company without using cash.

• Type C: Beneficial when a company wants to acquire another company's assets using stock as consideration.

• Type D: Helpful when a parent company wants to separate its business into distinct entities.

• Type E: Effective for companies looking to restructure their financial obligations.

• Type F: Useful for companies looking to rebrand or change their legal structure.

• Type G: Valuable for companies facing financial distress and seeking to reorganize under bankruptcy protection.

Understanding the different types of corporate reorganizations and when they are useful can help companies navigate the complex world of business restructuring. By leveraging the tax advantages provided by the IRC Section 368, companies can strategically plan their reorganizations for maximum benefit. Whether it's a merger, acquisition, or spin-off, each type of reorganization serves a specific purpose in helping companies achieve their goals while minimizing tax consequences for shareholders and the corporation.