Question

When a corporation is sold, sellers often wish to defer the taxable gain on a sale of shares. Under the US tax code, such gain deferral may be accomplished through a tax-free reorganization pursuant to IRC Sec. 368(a)(1). Please consider the common requirements (listed below) that each one of these reorganization types must meet to qualify for tax-free treatment. Please select one requirement and discuss how failure to meet the requirement may preclude qualifying for a tax-free reorganization. Pursuant to plan of reorganization Continuity of interest Continuity of business enterprise Business purpose test

Answer 1

Continuity of Interest :

Under Sec. 368, continuity of interest requirement, the shareholders of the target organization must have a continuing interest in the target assets and target business through acquisition of the stocks of the acquiring organization.

The continuity of interest requirement is satisfied when shareholders of the target organization hold stocks of the acquiring corporation ( as a result of prior ownership of target stock) representing at least 50% of the value of the stock of the target organization. Failure to meet such requirement may preclude qualifying for a tax free reorganization.

However, there are some cases where reorganizations have been approved with significantly lower percentages of stock considerations.