1. Tax Free Reorganization
2. Criteria
3. Considerations
4. When It Makes the Most Sense
5. Restructuring

Tax Free Reorganization

Tax free reorganization is a way for companies to cut expenses (thus, potentially increasing profits) or operate more effectively. Generally, events such as the company being taken over or bought out by another company (typically referred to as an acquisition, in the business world) are examples of why a company may want to look into tax free reorganization. Additionally, fear of bankruptcy, also known as filing for chapter 11, serves as a motivating factor.

By going through a tax free reorganization, the seller of the company that is potentially being bought or acquired, can avoid having to pay taxes on the money garnered from the sale. However, while taxes may not be due at the company level, shareholders who are selling their shares may still be required to pay taxes on those sales, as reported on their personal tax returns.

Criteria

There are four criteria to qualify for tax free reorganization, as far as the Internal Revenue Service is concerned. After all, the IRS does not want people or businesses getting away with not paying appropriate taxes! Some of the criteria include:

  • At least 50 percent of the purchase is acquirer stock. This is also known as continuity of ownership interest.
  • For a minimum of two years after the acquisition or sale of the original company, the purchaser (or, acquirer) must continue with the company’s intent, or use the majority of that company’s assets in a business that is already in existence. For example, if Amazon were to acquire Estee Lauder, Amazon would need to continue to the production of cosmetics for a minimum of two years after the acquisition. This is also known as continuity of business enterprise.
  • Beyond the reasons of avoiding taxes, the sale or purchase of a company needs to demonstrate a valid business purpose.
  • The buying or selling of a company cannot shown to be part of a larger sale or purchase that would be taxable. This is also known as a step-transaction doctrine.

Considerations

As with pretty much anything that involves taxes and the Internal Revenue Service, there a couple of things to take into consideration when looking into a tax free reorganization. These considerations include:

  • The phrase tax free in not entirely accurate. It really means that the taxes may be deferred, transferred or minimized; the terminology does not necessarily mean that the obligation of taxes is completely alleviated.
  • No taxes will be incurred during the reorganization or restructuring process.
  • Any taxable profits that do incur for the transferee (the company that is being bought or acquired) are ultimately rolled over into the profits, etc., of the company doing the acquiring.

When It Makes the Most Sense

There are definitely times in which pursuing tax free reorganization makes more sense than other times. Among those times in which it does make good business sense include:

  • The acquiring company is able to offer the shareholders of the target company a sale price for their shares that makes it advantageous for them, thus offsetting the problem of being taxed twice on the sale of their shares.
  • The acquiring company is offering the shareholders of the target company shares in the soon-to-be parent company, rather than cash in exchange for their original stocks.
  • If the selling company is operating with a net loss, it provides tax benefits for the acquiring company.

Restructuring

While the terms reorganizing and restructuring can often be used interchangeably, restructuring of an organization can also have a different meaning. The restructuring of an organization will often involve keeping the bones of the company, as is, meaning that the mission remains the same, but there may be an internal overhaul of board members and staff. It often also includes reevaluating the internal organizational structure of the organization.

Currently, we are seeing this a lot within the world of retail, as more and more people are shopping online, and it is forcing brick and mortar stores to reexamine their websites and online shopping experiences for their shoppers. Recent examples of retail stores that have undergone a great deal of restructuring include Ralph Lauren, Estee Lauder, and Saks Fifth Avenue.

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