Category: Corporations
Subject: Reorganization
Title: Boot in Tax-Free Reorganizations
IRC Sections: 368(a)(2)(B), 361(b), 302(b)(2)
Filename: 1182.html
Date Produced: 10/96

Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com

This memo is in response to several points raised in our telephone conversation this morning.

C Reorganization
First, I want to correct and clarify something I said. I stated that boot is permissible in a C reorganization (the transaction in which the acquiring corporation takes substantially all the assets of the target company in exchange for voting stock). Boot is indeed permissible, but the amount is limited to 20% of the total consideration. In addition, for purposes of counting the 20% rule, target debt assumed by the acquiring corporation is treated as boot. That is not to say the assumed liabilities are taxed to the shareholders as additional boot; rather, assumed liabilities count only for purposes of determining whether more than 20% of the consideration in the transaction is boot. IRC Section 368(a)(2)(B).

Taxation of Boot
If there is boot in a reorganization that allows boot, then someone is taxed up to the lesser of the gain realized on the transaction or the amount of the boot. The issue is whether boot is taxed once (i.e., only at the shareholder level) or twice, at the target corporation level and at the shareholder level. In general, the answer is boot is taxed only once.

IRC Section 361(b) provides that boot received by a target corporation is not taxed at the corporate level if the boot is distributed to the shareholder pursuant to the plan of reorganization.

In the transactions we have discussed that allow boot, there is no opportunity for the target corporation to retain any of the boot it might receive. Accordingly, the issue is moot. Any boot will be taxed only once and at the shareholder level.

Having determined where the boot is taxed, the issue becomes what is the character of the gain at the shareholder level. This must be handled on a case-by-case basis. It is possible for the boot to be taxed as capital gain, as an ordinary dividend, or a combination of the two. The shareholder is viewed as having received consideration consisting of 100% stock. Thereafter, there is a hypothetical cash redemption such that the shareholder gives up a sufficient amount of stock for cash in order to net the amount of stock and cash he actually got in the reorganization transaction. If the hypothetical redemption is treated as a qualifying redemption under the rules of Section 302(b)(2), then the boot is treated as capital gain. Otherwise, the boot is treated as a corporate distribution taxable as a dividend to the extent of the stockholder's share of current or accumulated earnings and profits.