26 USC 368: Seven Reorganization Types and Tax Treatment

Section 368 of the Internal Revenue Code defines seven categories of corporate reorganization that let companies merge, acquire, divide, or restructure without triggering immediate tax on the gains built into their stock or assets. Section 368 tax-free reorganizations defer tax at both the corporate and shareholder level, but only when the deal fits one of the statutory types and clears a set of judicially developed doctrines that look past form to substance. Miss a requirement, and what the parties planned as a tax-free exchange becomes a fully taxable sale.¹

The underlying logic is that when a business merely changes its corporate form or combines with another company and the same economic interests continue, there is no appropriate moment to tax the embedded gain. Deferral is not automatic. The transaction has to fit one of the seven categories in Section 368(a)(1), and it has to serve a legitimate business purpose beyond saving tax. The Supreme Court made that clear in Gregory v. Helvering, denying tax-free treatment to a transaction that met the statute’s letter but existed solely to let a shareholder pull assets out at a lower rate.²

The Seven Reorganization Types

Each type has its own rules about what consideration the acquirer can use, how assets or stock move, and what structure survives. Picking the wrong type, or failing one of its specific requirements, collapses the whole deal into a taxable event.

Type A: Statutory Mergers and Consolidations

A Type A reorganization is a merger or consolidation carried out under state or federal corporate law.³ In a merger, one corporation absorbs another and the target ceases to exist. In a consolidation, both predecessors dissolve into a newly formed entity that holds the combined assets and liabilities.

Type A is the most flexible on consideration. There is no requirement that the acquirer use voting stock, or even common stock. Any class of stock works, and cash or other property can round out the deal, as long as enough of the total consideration is equity to satisfy the continuity of interest test. That flexibility is why Type A dominates large acquisitions. The trade-off: any non-stock consideration received by target shareholders (called “boot”) can trigger taxable gain for those shareholders individually, even though the reorganization itself remains tax-free.

Triangular Variants

Two variants let the acquirer use a subsidiary as the merger vehicle rather than merging the target in directly. They insulate the parent from the target’s liabilities, which is why they are so common.

In a forward triangular merger under Section 368(a)(2)(D), the target merges into the acquirer’s subsidiary and the target’s shareholders receive the parent’s stock. The subsidiary has to acquire substantially all of the target’s properties, and no stock of the subsidiary itself can be used as consideration.³

In a reverse triangular merger under Section 368(a)(2)(E), the subsidiary merges into the target and the target survives as a subsidiary of the acquiring parent. Two conditions have to be met: the surviving corporation must hold substantially all of its own and the merged subsidiary’s properties afterward, and the former target shareholders must exchange enough stock that the parent ends up with a controlling interest in the surviving entity.³ This structure is useful when the target holds contracts, licenses, or permits that cannot easily be transferred to a different legal entity.

Type B: Stock-for-Stock Acquisitions

A Type B reorganization is the most restrictive. The acquirer exchanges solely its voting stock (or the voting stock of its parent) for stock of the target, and immediately after the acquisition must have control of the target. Section 368(c) defines control as at least 80% of the total combined voting power plus at least 80% of each class of nonvoting stock.³

The word “solely” is what makes Type B unforgiving. Any cash, debt assumption, or other non-stock consideration contaminates the whole transaction. The Supreme Court drew the line firmly in Helvering v. Southwest Consolidated Corp., holding that “voting stock plus some other consideration does not meet the statutory requirement.”⁴ Even paying target shareholders’ transaction expenses in cash has been enough to disqualify a Type B in some rulings. The payoff is that the target survives as a separate subsidiary, keeping its contracts, legal identity, and entity-level tax attributes intact.

Type C: Asset Acquisitions

A Type C reorganization involves one corporation acquiring substantially all of another corporation’s assets in exchange for voting stock.³ The target typically liquidates after transferring its properties. The IRS treats “substantially all” as at least 70% of the target’s gross assets and 90% of its net assets, a safe harbor from Revenue Procedure 77-37 that it uses when evaluating private letter ruling requests.

A limited amount of boot is permitted. The acquirer can use up to 20% of the total value in cash or other property, but only if at least 80% of the target’s property is acquired solely for voting stock.³ For that 80% test, any liabilities the acquirer assumes count as cash, which can eat into the allowance fast.

Types D Through G

The remaining four types handle more specialized situations:

Type D covers corporate divisions. A corporation transfers assets to a new or existing entity and distributes that entity’s stock to its shareholders, which captures spin-offs, split-offs, and split-ups. For divisive Type D reorganizations, the transferor or its shareholders must have 80% control of the new entity under Section 368(c). For nondivisive Type D reorganizations (often overlapping with Type A or C), the threshold drops to 50% of voting power or total value under Section 304(c).⁵
Type E is a recapitalization: a reshuffle of capital structure without a change in business. Swapping debt for equity, exchanging preferred for common, or modifying rights on existing share classes all qualify.
Type F is a mere change in identity, form, or state of incorporation. Reincorporating from Delaware to Nevada is the classic example.
Type G covers bankruptcy reorganizations. A corporation in a Title 11 case transfers assets under a court-approved plan, and special rules relax some of the normal requirements to fit insolvency practice.

Continuity of Interest and Continuity of Business Enterprise

Two judge-made doctrines, now codified in Treasury Regulations, gate every reorganization type. Fail either and the transaction is disqualified no matter how neatly it fits the statutory definition.

Continuity of interest requires that target shareholders receive a meaningful equity stake in the acquirer, not just cash. The Supreme Court said in Helvering v. Minnesota Tea Co. that the interest acquired “must represent a substantial part of the value of the thing transferred.”⁶ Treasury Regulations illustrate through examples that a transaction preserves a substantial proprietary interest when at least 40% of the total consideration is acquirer stock.¹ The IRS, however, wants at least 50% stock consideration before it will issue a favorable private letter ruling. For planning purposes, 50% equity is the safe target.

Continuity of business enterprise requires the acquirer to either continue a significant portion of the target’s historic business or use a significant portion of the target’s historic business assets in a business. The IRS evaluates this on facts and circumstances, with no bright-line asset percentage, though the 70%/90% safe harbor from Revenue Procedure 77-37 gives a practical guide. A related, stricter penalty sits in Section 382: if the new loss corporation does not continue the old loss corporation’s business enterprise for two full years after an ownership change, the annual limitation on pre-change losses drops to zero.⁷

When Separate Steps Get Collapsed

When a reorganization unfolds in several transactions rather than a single event, the IRS and courts may collapse the steps and evaluate the end result. The step transaction doctrine cuts both ways. It can save a deal that looks like it fails an intermediate test, or kill one whose ultimate result does not match any qualifying type.

Courts apply three tests. The end-result test asks whether the separate transactions were always intended to produce the ultimate outcome. The interdependence test asks whether each step would have been pointless on its own. The binding-commitment test asks whether there was a binding obligation at the outset to complete all the steps. Revenue Ruling 2001-46 shows the mechanic in practice: when a newly formed subsidiary merges into a target and the target then merges into the parent, the IRS treats the two steps as a single statutory merger of the target into the parent.⁸

How Shareholders Are Taxed

If you exchange target stock solely for acquirer stock in a qualifying reorganization, you recognize no gain or loss.⁹ Your basis in the new shares equals your basis in the old, adjusted for any gain recognized and any boot received.¹⁰ Your holding period carries over, which matters if you later sell and want long-term capital gains treatment.

Boot changes the picture. If the deal includes cash or other non-stock property, you recognize gain up to the fair market value of the boot received. You never recognize loss in a reorganization exchange.¹¹ In some cases, the recognized gain is treated as a dividend rather than a capital gain, depending on whether the exchange has the effect of a distribution of earnings and profits. The distinction matters because dividend and capital gain income can be taxed at different rates and interact differently with loss deductions.

What Happens to the Target’s Tax Attributes

A big practical question in any reorganization is what happens to the target’s tax attributes after closing: net operating loss carryovers, capital loss carryovers, tax credit carryovers, accounting methods, and earnings and profits history. Section 381 provides that in qualifying acquisitive reorganizations, the acquirer inherits those attributes from the target.¹² Divisive Type D reorganizations and certain Type G transactions fall outside those carryover rules, so the attributes do not automatically follow the assets.

There is a major catch for net operating losses. Section 382 sharply limits how fast an acquirer can use the target’s pre-change losses after an ownership change. An ownership change happens when one or more 5-percent shareholders increase their aggregate ownership by more than 50 percentage points over a testing period, which most acquisitive reorganizations trigger.⁷

Once triggered, the annual amount of pre-change losses the acquirer can use is capped at the value of the old loss corporation multiplied by the long-term tax-exempt rate. As of early 2026, that rate is 3.51%.⁷ If the target was worth $10 million at the time of the change, the annual cap on using its pre-change losses would be roughly $351,000. Unused limitation carries forward, but the constraint is real: a company sitting on $50 million in net operating losses can find it takes decades to absorb them. And if the acquirer does not continue the target’s business for two years after the change date, the annual limitation drops to zero and those losses become permanently worthless.

What Has to Be Reported

Every corporation that is a party to a reorganization must attach a formal statement to its tax return for the year of the transaction. Treasury Regulation 1.368-3 specifies the contents: names and employer identification numbers of all parties, the date of the reorganization, and the value and basis of all assets, stock, or securities transferred, broken down by category.¹³ Any significant holder has to file a separate statement showing the value and basis of the stock they exchanged. For publicly traded corporations, a significant holder is anyone owning at least 5% by vote or value; for private companies, the threshold is 1%.¹⁴

The issuing corporation also has a separate obligation under Section 6045B to report any organizational action that affects the tax basis of its securities. That goes on Form 8937, which must be filed with the IRS within 45 days of the reorganization or by January 15 of the following year, whichever is earlier. The same form has to be furnished to affected shareholders by January 15 of the following year.¹⁵ As an alternative to filing with the IRS directly, the issuer can post the completed Form 8937 on its public website by the same deadline and keep it available for ten years. Missing these deadlines carries penalties, and if the original issuer fails to file, any acquiring or successor entity becomes jointly liable.

What Can Void Tax-Free Treatment After Closing

Qualifying at closing is only half the job. The IRS can retroactively recharacterize a reorganization as a taxable sale if post-closing conduct shows the deal was never what it appeared to be.

The most common problem is a prearranged disposal. If target shareholders have an implicit or explicit agreement to sell the stock they received shortly after closing, continuity of interest fails and the IRS treats the substance as a cash sale dressed up as a stock exchange. The same thing happens on the business side: if the acquirer sells off the target’s assets or shuts down the target’s business soon after the reorganization, continuity of business enterprise is no longer satisfied.

Redemptions can produce the same result. If the acquirer redeems a large block of the stock it issued to target shareholders, the deal starts to look like a purchase funded with borrowed money rather than a reorganization. Courts weigh the totality of the circumstances: was the redemption always part of the plan, or an independent decision made later for unrelated reasons?

The plan of reorganization is the documentary backbone that defends against all of this. Each participating corporation’s board must adopt a formal plan setting out the terms, structure, and parties. Without a clear plan, the IRS has an easy argument that the transaction was assembled after the fact to fit a tax-free mold. Shareholder approvals, regulatory filings, and corporate resolutions should line up with the plan’s timeline and terms.

1
eCFR. 26 CFR 1.368-1 – Purpose and Scope of Exception of Reorganization Exchanges
2
Legal Information Institute. Gregory v. Helvering
3
Office of the Law Revision Counsel. 26 USC 368 – Definitions Relating to Corporate Reorganizations
4
Justia U.S. Supreme Court Center. Helvering v. Southwest Consolidated Corp., 315 U.S. 194 (1942)
5
Internal Revenue Service. Revenue Ruling 2015-10
6
Justia U.S. Supreme Court Center. Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935)
7
Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change
8
Internal Revenue Service. Revenue Ruling 2001-46
9
Office of the Law Revision Counsel. 26 USC 354 – Exchanges of Stock and Securities in Certain Reorganizations
10
Office of the Law Revision Counsel. 26 USC 358 – Basis to Distributees
11
Office of the Law Revision Counsel. 26 USC 356 – Receipt of Additional Consideration
12
Office of the Law Revision Counsel. 26 USC 381 – Carryovers in Certain Corporate Acquisitions
13
eCFR. 26 CFR 1.368-3 – Records to Be Kept and Information to Be Filed With Returns
14
Internal Revenue Service. Notice 2009-4 – Determination of Basis in Property Acquired in Transferred Basis Transaction
15
Internal Revenue Service. Instructions for Form 8937