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Tax Free Mergers


Shareholders (SH) of a corporation may have an option to enter into a non taxable reorganization with an Acquirer (A), assuming both SH and A have proper purpose, and both decide on this type of deal. Tax free mergers are considered “reorganizations” under the tax code. In such a deal, A would use its stock as a significant portion of the consideration paid to SH rather than cash or debt, requiring SH taking equity, and thus risk in an investment stake in A.

The buyer, A, may prefer a merger, where neither party pays tax, tax is effectively deferred, except for cash or boot taken in the transaction, and A is able to pay for a significant part of the acquisition price with its equity. Since taxes are only deferred, not avoided, the motivation for such a deal may be that A cannot offer consideration other than equity, may have little cash, and may have trouble financing the acquisition with debt.

Here A and SH could pursue a non-taxable exchange of stock under a Section 368 statutory merger transaction. If the continuity and non-tax avoidance criteria are met, A and SH can pursue a reorganization such that A will be required to continue with target (T) business for a minimum of 2 years, A will defer taxes on the asset acquisition of T, SH will defer taxes until it sells its stock and will pay taxes on the amount of boot taken in the deal. A will assume the tax structure of the assets of T, take all carryover bases in those assets, and thus if and when A sells those assets it will realize taxable gain inherent in those assets bases. Up to 60% of the aggregate deemed asset disposition price (ADADP) can be money or other property received by SH.

SH may in such a deal take on what could be an undue risk with equity in A, deferring taxes, and limit and defer cash flows for A. If acquirer is a large solid firm, with a market for its shares, the risk to SH would be much lower, but if that stock received in the transaction is higher risk, that stock could become worthless in a worst case scenario.

Worldview Consulting & Accounting, Inc. is an Oregon registered CPA accounting firm. William Burwell, CPA, CFF, MBA, CPIM, is a business consultant and financial forensic accounting services professional with over twenty years of high technology industry experience. Licensed in Oregon and Massachusetts.

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