Quick Answer
The exam names four tax topics for the buy-side banker: tax-free reorganizations (the named types A through E plus forward and reverse triangular structures), the stock-purchase-treated-as-asset-purchase election available to S-corp and consolidated-group targets, recapitalizations, and the stock-versus-cash consideration matrix. The reverse triangular merger is the most common modern structure because the target survives, preserving contracts and licenses.
Tax structure is a separate design layer from valuation. Two deals at the same price can produce very different after-tax outcomes for the buyer, the seller, and the combined entity depending on the structure chosen. The buy-side banker coordinates with the acquirer's tax advisors throughout to flag structural options and issues; the tax advisors make the final determination.
Which Reorganization Structures Defer Tax to Target Shareholders?
The Internal Revenue Code recognizes several reorganization structures that defer tax to the target shareholders.
- Tax deferral applies only to the stock portion of consideration: target shareholders defer gain to the extent they receive acquirer stock
- Boot is taxable: cash and other "boot" (non-stock consideration) remain immediately taxable to the seller
- Acquirer takes carryover basis: in a tax-free deal, the acquirer does not get a step-up in tax basis in the target's assets
- Tax cost of going tax-free: the buyer gives up future depreciation and amortization deductions in exchange for the target shareholders' tax deferral
The four general continuity tests for a reorganization to qualify as tax-free:
- Continuity of ownership interest: target shareholders retain a continuing equity interest in the acquirer; the required continuing equity interest depends on the applicable reorganization form and the facts, so do not apply one universal stock-percentage floor across every type
- Continuity of business enterprise: acquirer continues the historic business or uses a significant portion of the historic business assets
- Valid business purpose: the transaction must have a real corporate-business reason beyond tax avoidance
- Step-transaction compliance: a series of integrated steps cannot be used to manufacture tax-free treatment that the end-state structure would not qualify for
How Do the Named Reorganization Types Compare?
| Type | Structure | Consideration Rules | Notes |
|---|---|---|---|
| Type A | Statutory merger or consolidation | Flexible consideration subject to the applicable qualification requirements | Target dissolves into acquirer |
| Type B | Stock-for-stock exchange | ONLY voting stock of acquirer; NO cash or other boot allowed | Acquirer must hold 80% or more control of target after the deal |
| Type C | Stock-for-assets exchange | Substantially all target assets; up to 20% non-voting consideration permitted ("boot relaxation") | Target distributes acquirer stock to its shareholders and dissolves |
| Type D | Transfer of assets to a controlled corporation, then distribution of its stock | The transferor or its shareholders control the recipient corporation, and its stock is distributed to the transferor's shareholders; cash or other property received can be taxed as boot | Most commonly the divisive spin-off, split-off, or split-up of a subsidiary to the parent's shareholders |
| Type E | Recapitalization | Restructuring of target's capital structure (debt-for-equity, equity-for-debt, leveraged-recap dividend) | Can be used as an alternative or precursor to a full sale |
| Forward triangular merger | Target merges INTO acquirer's subsidiary | Subsidiary survives; target dissolves | Isolates target liabilities inside the subsidiary |
| Reverse triangular merger | Acquirer's subsidiary merges INTO target | Target SURVIVES as wholly owned subsidiary of acquirer; 80% or more acquirer voting stock required | Most common modern structure; preserves target's contracts and licenses |
Exam Tip: Gotchas
- Type B is strict: only voting stock of the acquirer, no cash boot at all. Even one dollar of cash disqualifies Type B treatment. Type C is more forgiving (its boot relaxation allows up to 20% non-voting consideration). Type A is more flexible, but it does not have one universal stock-percentage floor for every fact pattern.
- The reverse triangular merger is the most common modern M&A structure. The target survives the merger, preserving its contracts, licenses, and regulatory permits without the asset-by-asset assignment process an asset sale would require.
- Survival does not erase every consent issue. A change-of-control clause in a specific contract can still require consent even though the target survives; the forward triangular merger dissolves the target into the acquirer's subsidiary, which more broadly can trigger consent requirements.
How Does the Stock-Sale-Treated-as-Asset-Sale Election Work?
There is a federal-tax election that lets a buyer and seller jointly recharacterize a stock purchase as an asset purchase for federal tax purposes while leaving the transaction a stock sale for legal and contractual purposes.
The election is the buy-side banker's tool for getting a stepped-up tax basis in the target's assets, and thus enhanced depreciation and amortization deductions over time, without forcing an asset purchase deal structure.
- Joint election: required by both buyer and seller; one party cannot make it unilaterally
- Buyer benefit: stepped-up tax basis in target assets → increased depreciation and amortization deductions over time, lowering future taxable income
- Eligibility: available ONLY when the target is an S corporation OR a C corporation subsidiary of a consolidated group
- Why eligibility is restricted: the deemed asset sale would normally trigger double taxation at the target corporate level for a freestanding C corp; the S corp and consolidated-group structures avoid that corporate-level layer
- Irrevocable: once made, the election cannot be undone
- Legal effect remains a stock sale: the buyer inherits all target liabilities, contracts, and licenses (no asset-by-asset assignment)
Think of it this way: the election lets the buyer get the tax economics of an asset purchase (the basis step-up) without the legal burden of an asset purchase (assigning every contract, license, and lease). The trade-off is that the eligibility universe is narrow.
Exam Tip: Gotchas
- The joint §338(h)(10) election is NOT available for a standalone C corporation target. Filing it for a freestanding C corp would trigger double taxation (corporate-level gain on the deemed asset sale PLUS shareholder-level gain on the deemed liquidation). The joint election is restricted to S corps and consolidated-group subsidiaries precisely because those structures avoid the corporate-level layer.
- The §338(h)(10) election preserves the LEGAL stock-sale character. Contracts and licenses need no assignment, though a specific change-of-control clause can still require consent. The buyer inherits liabilities the same way a stock purchaser would.
How Does a Recapitalization Restructure the Target's Capital?
A recapitalization restructures the target's capital structure pre- or post-deal. Recaps are useful when the goal is to extract value or change the mix of debt and equity without selling the operating business.
- Debt-for-equity swap: existing debt holders accept new equity in exchange for canceling the debt
- Leveraged recap dividend: target borrows new debt and pays a special dividend to existing shareholders, increasing leverage and distributing value
- Equity-for-debt exchange: existing equity holders accept new debt in exchange for retiring shares
- Tax treatment: depends on structure; some recaps qualify as a Type E reorganization, deferring tax to the participating holders to the extent the exchange is stock-for-stock
How Do Stock and Cash Consideration Compare on Tax and Deal Terms?
The consideration mix is the highest-stakes tax design choice in the deal. The matrix below captures the full set of trade-offs.
| Dimension | All-Cash | All-Stock | Mixed |
|---|---|---|---|
| Seller tax | Immediately taxable | Tax-deferred if a tax-free reorganization qualifies | Boot is taxable; stock portion deferred |
| Value certainty (to seller) | Fixed at signing | Floats with acquirer share price (fixed exchange ratio) or fixes value (floating exchange ratio) | Hybrid |
| Acquirer cash impact | Depletes cash or adds debt | Preserves cash; dilutes existing acquirer shareholders | Hybrid |
| Acquirer debt capacity | Consumes capacity (or uses acquisition debt) | Preserves capacity | Hybrid |
| Accretion / dilution direction | Depends on target earnings relative to after-tax financing cost and other deal effects | Relative earnings yield (the inverse of price-to-earnings) is a shortcut only in a simplified no-premium, no-synergy case | Depends on mix and other deal effects |
| Seller participation in upside | None (cash out) | Full (stays exposed to combined entity) | Partial |
| Speed and certainty of close | Higher | Lower (acquirer-shareholder vote and merger-registration statement often required) | Depends |
| Continuity-of-interest test (tax-free reorganization) | Fails because no continuing equity interest remains | May pass if the applicable reorganization requirements are satisfied | Depends on the stock portion and the applicable reorganization requirements |
Exam Tip: Gotchas
- Tax-deferral on stock consideration is conditional on a qualifying reorganization structure. Stock is not automatically tax-free; it has to be issued under a structure that meets the continuity-of-interest, continuity-of-business-enterprise, business-purpose, and step-transaction tests. A stock deal structured outside the reorganization framework is fully taxable to the seller.
What Should You Check on Exam Day?
- Can you match each named reorganization type (A through E, plus forward and reverse triangular) to its consideration rule and which entity survives?
- Do you know the §338(h)(10) election is available only for S-corp targets and consolidated-group C-corp subsidiaries, not a standalone C corporation?
- Can you fill in the stock-versus-cash matrix from memory: seller tax, value certainty, acquirer cash and debt impact, and speed to close?