A Type D reorganization is a tax-free corporate restructuring under Section 368(a)(1)(D) of the Internal Revenue Code in which a corporation transfers all or part of its assets to another corporation, the same shareholders end up in control of the receiving corporation, and stock of that receiving corporation is distributed back to the transferor’s shareholders in a transaction qualifying under Section 354, 355, or 356.1Office of the Law Revision Counsel. 26 U.S. Code 368 – Definitions Relating to Corporate Reorganizations Done correctly, no gain or loss is recognized on the transfer. Done incorrectly, the same steps collapse into a taxable asset sale at the corporate level and a taxable liquidation at the shareholder level.
Acquisitive vs. Divisive: Two Different Transactions Under One Label
The single most important thing to know before planning a Type D reorganization is which of two variants you are actually doing. They share a statutory home but operate under different rules.
An acquisitive D reorganization consolidates. One corporation moves substantially all of its assets into another, then liquidates. The classic use is a reincorporation, where a business shifts its assets into a new corporate shell (a different state, a different structure) and the old corporation goes away.
A divisive D reorganization separates. One corporation splits its business activities into two or more entities, and shareholders end up holding stock in the resulting pieces. Spin-offs, split-offs, and split-ups all live here.
The control test is different for each, and confusing the two is a common planning error.
The Control Threshold for Acquisitive Deals: 50%
For a nondivisive (acquisitive) D reorganization, Section 368(a)(2)(H) borrows the control definition from Section 304(c).2Office of the Law Revision Counsel. 26 U.S. Code 368 – Definitions Relating to Corporate Reorganizations – Section: Special Rules for Determining Whether Certain Transactions Are Qualified Under Paragraph (1)(D) Control means owning stock representing at least 50% of the total combined voting power of all voting classes, or at least 50% of the total value of all classes.3GovInfo. 26 U.S.C. 304 – Redemption Through Use of Related Corporations
The Control Threshold for Divisive Deals: 80%
A divisive D reorganization uses the stricter Section 368(c) standard: at least 80% of the total combined voting power of all voting classes, and at least 80% of the total number of shares of every other class.4Internal Revenue Service. Revenue Ruling 2015-10 Control is measured immediately after the asset transfer and can be held by the transferor, its shareholders, or both together.
What an Acquisitive D Reorganization Requires
An acquisitive D has to satisfy Section 354, which imposes two conditions beyond the basic framework: the acquiring corporation must receive substantially all of the transferor’s assets, and the transferor must distribute everything it received (along with any remaining property) under the plan of reorganization.5Office of the Law Revision Counsel. 26 U.S. Code 354 – Exchanges of Stock and Securities in Certain Reorganizations – Section: Exception
“Substantially all” is not defined in the Code. The IRS has historically used an administrative guideline (Revenue Procedure 77-37) that looks for at least 90% of the fair market value of net assets and 70% of the fair market value of gross assets. Those percentages are not binding law, and the IRS evaluates surrounding facts, especially any assets distributed to shareholders or used to pay off liabilities shortly before closing.
What a Divisive D Reorganization Requires
A divisive D has to satisfy Section 355, which layers several requirements on top of the basic reorganization framework. These exist because Congress worried that corporate divisions could be used to extract earnings at capital gains rates rather than as ordinary dividends.
Active Trade or Business
Both the distributing and the controlled corporation must be engaged in an active trade or business immediately after the distribution. Each business must have been actively conducted for the five-year period ending on the distribution date, and neither can have been acquired in a taxable transaction during that window.6Office of the Law Revision Counsel. 26 U.S. Code 355 – Distribution of Stock and Securities of a Controlled Corporation – Section: Requirements as to Active Business
Not a Device for Distributing Earnings
The transaction cannot be used principally as a device for distributing the earnings and profits of either corporation.7Office of the Law Revision Counsel. 26 U.S. Code 355 – Distribution of Stock and Securities of a Controlled Corporation A later shareholder sale does not automatically make the transaction a device unless it was arranged beforehand. Regulatory factors that suggest device status include pro rata distributions, significant non-business assets in either corporation, and distributions to related shareholders.
Corporate Business Purpose
The distribution must be motivated in whole or substantial part by a real and substantial non-federal-tax purpose related to the business of one of the corporations.8eCFR. 26 CFR 1.355-2 – Limitations Resolving shareholder disputes, regulatory compliance, and isolating business risks are common qualifying purposes. Shareholder-level purposes like estate planning generally do not qualify unless they are also germane to a corporation’s business.
Distribution of All Controlled Stock
The distributing corporation must distribute all the stock and securities of the controlled corporation it holds, or distribute enough to constitute 80% control and prove that any retention was not intended to avoid federal income tax.7Office of the Law Revision Counsel. 26 U.S. Code 355 – Distribution of Stock and Securities of a Controlled Corporation Most distributing corporations distribute everything to avoid the burden of proving that motive.
Spin-Off, Split-Off, or Split-Up
How the controlled corporation’s stock is distributed determines the form of the transaction:
- In a spin-off, the distributing corporation makes a pro rata distribution of the controlled corporation’s stock to all shareholders. No one surrenders any existing stock. This is the most common form.
- In a split-off, shareholders exchange some or all of their distributing corporation stock for controlled corporation stock. Because the exchange is typically not pro rata, split-offs are often used to separate shareholders who disagree about direction.
- In a split-up, the distributing corporation transfers all its assets to two or more controlled corporations, distributes all their stock, and dissolves. Every shareholder exchanges old stock for new stock in one or more of the successor entities.
Two Judicial Requirements Layered on Top
Beyond the statute, two long-standing judicial doctrines apply, both now embedded in Treasury regulations.
Continuity of interest requires that a substantial part of the value of the target shareholders’ proprietary interests be preserved through receipt of stock in the acquiring corporation.9Federal Register. Corporate Reorganizations; Guidance on the Measurement of Continuity of Interest To the extent shareholders receive cash or other non-stock property instead, those interests are not preserved. In acquisitive D reorganizations among related parties this is usually easy to meet, because the same shareholders own both sides.
Continuity of business enterprise requires the acquiring corporation to either continue the target’s historic business or use a significant portion of the target’s historic business assets in a business.10eCFR. 26 CFR 1.368-1 – Purpose and Scope of Exception of Reorganization Exchanges If the target ran multiple lines, only a significant one has to be continued. A business entered into as part of the reorganization plan does not count as the historic business.
Tax Treatment at the Corporate Level
No Gain or Loss on the Asset Transfer
Under Section 361, the transferor corporation recognizes no gain or loss on the transfer of assets solely for stock or securities of the acquiring corporation. If the transferor also receives non-stock property (boot), it still avoids gain recognition so long as it distributes all the boot to shareholders under the plan. Gain is recognized only to the extent boot is retained.11Office of the Law Revision Counsel. 26 U.S. Code 361 – Nonrecognition of Gain or Loss to Corporations; Treatment of Distributions
The Section 357(c) Liability Trap in Divisive Deals
Section 357(c) creates an important exception for divisive D reorganizations qualifying under Section 355. If total liabilities assumed by the acquiring corporation, plus liabilities to which the transferred property is subject, exceed the aggregate adjusted basis of the transferred assets, the excess is treated as gain from a sale or exchange.12Office of the Law Revision Counsel. 26 USC 357 – Assumption of Liability Character depends on the underlying assets. This most often bites when a business with significant debt is transferred alongside low-basis assets, like fully depreciated equipment or mortgaged real estate.
Carryover Basis for the Acquirer
The acquiring corporation takes the transferor’s basis in the assets, increased by any gain the transferor recognized on the transfer.13Office of the Law Revision Counsel. 26 U.S. Code 362 – Basis to Corporations Built-in gain or loss carries forward for recognition when the acquirer eventually sells.
Tax Attributes and the Section 382 Cap
In an acquisitive D reorganization, the acquiring corporation succeeds to the transferor’s tax attributes under Section 381, including net operating loss carryforwards, earnings and profits, and accounting methods.14Office of the Law Revision Counsel. 26 U.S. Code 381 – Carryovers in Certain Corporate Acquisitions But Section 382 caps the annual use of pre-change NOLs after an ownership change. The limit equals the value of the old loss corporation multiplied by the long-term tax-exempt rate.15Office of the Law Revision Counsel. 26 U.S. Code 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses The NOLs carry over on paper; their usable annual amount can shrink to a fraction of face value.
In a divisive D reorganization, earnings and profits are allocated between the distributing and controlled corporations under Section 312(h), based on the relative values of the separated businesses.16Office of the Law Revision Counsel. 26 U.S. Code 312 – Effect on Earnings and Profits Section 381 does not apply because the transferor continues to exist.
Tax Treatment at the Shareholder Level
Shareholders receiving only stock or securities of the acquiring corporation in exchange for their stock in the transferor recognize no gain or loss. In acquisitive deals this comes from Section 354; in divisive deals, from Section 355.17Office of the Law Revision Counsel. 26 U.S. Code 354 – Exchanges of Stock and Securities in Certain Reorganizations
When Shareholders Receive Boot
When shareholders receive cash or other non-stock property alongside the qualifying stock, Section 356 requires gain recognition up to the value of the boot. Character depends on the type of reorganization. In an acquisitive D, if the exchange has the effect of a dividend distribution, the gain is treated as a dividend to the extent of the shareholder’s ratable share of accumulated earnings and profits, with any remainder as capital gain.18Office of the Law Revision Counsel. 26 U.S. Code 356 – Receipt of Additional Consideration This is how the D reorganization prevents shareholders from pulling cash out at capital gains rates through a disguised reincorporation.
In a divisive D, Section 356(b) turns off the dividend-treatment rule. Boot in a Section 355 distribution is generally capital gain.
Basis in the Stock Received
Section 358 governs the shareholder’s basis. Start with the basis of the stock surrendered, subtract any boot received, and add any gain recognized.19Office of the Law Revision Counsel. 26 U.S. Code 358 – Basis to Distributees In a spin-off no stock is surrendered, and in a split-off only some may be. The original basis is allocated between the distributing and controlled corporation stock based on their relative fair market values on the distribution date.20eCFR. 26 CFR 1.358-2 – Allocation of Basis Among Nonrecognition Property Total basis is preserved across both entities.
Anti-Abuse Rules That Can Undo a Divisive D
Two statutory rules can override the tax-free treatment of an otherwise qualifying divisive D reorganization. Both target divisions tied to acquisitions.
Section 355(d) makes the distribution taxable at the corporate level if, immediately after it, any person holds “disqualified stock” representing a 50% or greater interest in either the distributing or controlled corporation. Disqualified stock is generally distributing-corporation stock acquired by purchase within the five-year period ending on the distribution date, or controlled-corporation stock attributable to such purchased stock.21Office of the Law Revision Counsel. 26 U.S. Code 355 – Distribution of Stock and Securities of a Controlled Corporation – Section: Recognition of Gain on Certain Distributions of Stock or Securities in Controlled Corporation The provision targets leveraged buyouts followed by spin-offs.
Section 355(e) applies when the distribution is part of a plan or series of related transactions in which one or more persons acquire a 50% or greater interest in either corporation. The controlled-corporation stock stops being treated as qualified property, and the distributing corporation recognizes gain on the distribution.22Office of the Law Revision Counsel. 26 U.S. Code 355 – Distribution of Stock and Securities of a Controlled Corporation – Section: Recognition of Gain on Certain Distributions of Stock or Securities in Connection With Acquisitions Any 50% acquisition within a four-year window (two years before through two years after the distribution) is presumed to be part of such a plan, subject to rebuttal.
Reporting the Transaction
Every corporate party to a D reorganization must attach a statement to its tax return for the year of the exchange. Under Treasury Regulation 1.368-3, the statement includes the names and EINs of all parties, the date of the reorganization, and the value and basis of assets transferred, broken into categories including loss importation property, loss duplication property, and gain-recognition property.23eCFR. 26 CFR 1.368-3 – Records to Be Kept and Information to Be Filed With Returns Each significant holder of stock in the transferor must also file a statement.
If an acquisitive D reorganization involves the complete liquidation of the transferor, that corporation must file Form 966 (Corporate Dissolution or Liquidation) within 30 days of adopting the plan of liquidation, with a certified copy of the resolution or plan.24Internal Revenue Service. About Form 966, Corporate Dissolution or Liquidation State-level dissolution filings apply separately. Missing these filings does not undo the reorganization, but it can trigger penalties and extend the statute of limitations for an IRS challenge.