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 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
- Filing window: the election must be filed by the 15th day of the 9th month after the acquisition month
- 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.
- A standalone C-corp target is not entirely locked out of a basis step-up. After a qualified stock purchase, the corporate buyer alone (without the seller) may be able to make the general §338(g) election. That route treats the target as having sold its assets and can produce target-level gain in addition to the selling shareholders' gain on their actual stock sale, so it is used selectively.
- The §338(h)(10) election preserves the LEGAL stock-sale character. Contracts and licenses do not require assignment consents. 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?