Divisive Merger: Filing, Federal Tax, and the Texas Two-Step

A divisive merger in Texas is a corporate reorganization that splits a single existing entity into two or more separate organizations, with each new entity taking a defined share of the original company’s assets and liabilities. Texas uses the word “merger” more broadly than most states, so the same statute that governs traditional combinations also governs divisions. The authority sits in Chapter 10 of the Texas Business Organizations Code, and the transaction is executed by filing a certificate of merger with the Secretary of State on Form 621.¹

Section 10.001 authorizes any domestic entity to carry out a merger under the code, and the Secretary of State’s Form 621 instructions expressly define a merger to include “the division of a domestic entity into two or more new domestic entities or other organizations.” Section 10.003 supplies the vocabulary you will see throughout the transaction documents. The “dividing entity” is the organization that exists before the split. A “resulting entity” is any organization that is created or survives because of it. Those labels drive who ends up with which rights, debts, and legal obligations.

Drafting the Plan of Merger

Every divisive merger begins with a written Plan of Merger. Under TBOC Section 10.002, this document is the blueprint for the entire transaction. It must name the dividing entity, list every resulting entity, and identify the jurisdiction of formation for each new organization.

The plan then has to describe how ownership interests in the original company convert into interests in the resulting entities. If shareholders receive stock in the new organizations, the plan states the ratio and allocation. If some owners receive cash or other property in place of equity, those terms go in the plan too. Ambiguity here becomes litigation later.

The heart of the document is the allocation section: exactly how every asset and every liability of the dividing entity is distributed among the resulting organizations. This is where careful drafting matters most, particularly when the point of the transaction is to separate operating assets from litigation exposure. The plan should also include any amendments to a surviving entity’s certificate of formation, along with a full certificate of formation for each newly created filing entity.

Owner Approval and Comptroller Clearance

A divisive merger cannot proceed on the board’s authority alone. Each domestic entity that is a party to the merger must approve the plan in the manner the TBOC prescribes for that entity type. For corporations, that generally means a board resolution followed by a shareholder vote. No owner or member can be subjected to personal liability for another entity’s obligations because of the merger without their consent.¹

There is also a franchise tax gate. The Secretary of State will not accept the certificate of merger without a certificate of account status from the Texas Comptroller of Public Accounts confirming that franchise taxes have been paid and that the non-surviving party may legally end its existence.¹ Filers who skip this step get their filings rejected and lose their timeline.

How Assets and Liabilities Move

The mechanics of the transfer sit in TBOC Section 10.008. When the merger takes effect, all rights, title, and interests in real estate and other property owned by the dividing entity are allocated to and vested in the resulting entities as the plan provides. No separate deed, bill of sale, or assignment is required.²

Liabilities move the same way. Each obligation of the dividing entity is allocated to one or more resulting entities according to the plan, and each resulting entity that takes a particular liability becomes the primary obligor for it. No other resulting entity is responsible unless the plan says so or unless another law or contract creates shared liability.²

Gaps are punished by the default rule. Under Section 10.008(b), if the plan fails to allocate a particular asset, that property is owned in undivided interest by all resulting entities; if it fails to allocate a liability, that obligation becomes joint and several among every resulting entity, split proportionally by the total number of resulting organizations.² The rule creates a strong incentive to draft comprehensively.

Pending litigation does not vanish. Any proceeding against the dividing entity may continue as if the merger had not occurred, or the resulting entity that inherited the associated liability can be substituted as a party.

What Creditors Keep

Section 10.901 states that the Business Organizations Code does not “abridge any right or rights of any creditor under existing laws.”³ A divisive merger cannot extinguish a creditor’s legal claim. What it can do is change the entity that holds the debt, which is a different question from whether the creditor can collect. A creditor whose debt gets assigned to a thinly capitalized resulting entity still has a claim on paper, and courts have started examining whether transactions that effectively strand creditors run afoul of fraudulent transfer principles or bankruptcy good-faith rules.

Filing the Certificate of Merger

Once the plan is approved and tax clearance is in hand, the company files a Certificate of Merger with the Texas Secretary of State on Form 621, which is the form built for transactions that divide a single domestic entity into multiple organizations.¹

The base filing fee is $300 for the certificate of merger, plus the standard formation fee for each newly created filing entity.⁴ Split one corporation into two new entities and you pay the $300 for the merger certificate plus a formation fee for each new entity. Credit card payments add a convenience fee of 2.7 percent of the total.¹

The certificate takes effect when the Secretary of State accepts and files it. The plan can delay effectiveness in two ways: to a specified future date within 90 days of the signing date, or upon a specific future event within that same 90-day window.⁵ The most common reasons for rejection are using an outdated form or omitting the comptroller’s certificate.

One last thing on the filing itself. Anyone who signs or directs the filing of a certificate they know to be materially false commits a Class A misdemeanor. If the false filing was intended to harm or defraud someone, the offense becomes a state jail felony.¹

Federal Tax Treatment

A divisive merger creates a corporate division for federal tax purposes, and whether that division is tax-free depends on Internal Revenue Code Sections 368 and 355. Under Section 368(a)(1)(D), a transfer of assets to a controlled corporation followed by a distribution of that corporation’s stock can qualify as a reorganization if the distribution meets Section 355’s requirements.⁶

Section 355 imposes several conditions. Both the distributing corporation and the controlled corporation must be engaged in the active conduct of a trade or business immediately after the distribution, and each business must have been actively operated for at least five years before the transaction. The division cannot be used primarily as a device to distribute corporate earnings in a way that avoids dividend treatment. A valid corporate business purpose must drive the transaction, and there must be continuity of shareholder interest in both resulting entities.

Sections 355(d) and 355(e) add further guardrails. If one or more persons acquire a 50-percent-or-greater interest in either the distributing or controlled corporation as part of a plan connected to the distribution, tax-free treatment can be disqualified. Bring in tax counsel early; missing any one of these requirements can produce a taxable event for both the corporation and its shareholders.

Corporations that issue securities affected by a divisive merger must also file IRS Form 8937 to report the transaction’s effect on shareholder basis. The filing is due within 45 days of the organizational action or by January 15 of the following year, whichever comes first, and a copy must be provided to each security holder of record by that same January 15 deadline. Public companies can satisfy both requirements by posting a completed, signed Form 8937 on their primary website in a readily accessible format and keeping it available for 10 years.⁷

SEC Reporting for Public Companies

Public companies undergoing a divisive merger must disclose the transaction on Form 8-K. The filing is due four business days after the merger takes effect, with the clock starting on the next business day if the effective date is a weekend or federal holiday.⁸

After the Filing

Once the Secretary of State processes the filing, each resulting entity is a legally independent organization and the dividing entity’s original structure is gone. Keep file-stamped copies of the certificate. Use them to update bank accounts, tax registrations, insurance policies, and operational permits for each new entity.

Intellectual property needs its own attention. Property transfers by operation of law under Section 10.008, but the United States Patent and Trademark Office still requires trademark owners to record ownership changes through its Assignment Center by submitting a cover sheet, uploading supporting documentation, and paying the recording fee.⁹ Trademarks filed under the Madrid Protocol are recorded through the World Intellectual Property Organization rather than directly with the USPTO. Patents follow a similar recording process. Skipping these updates creates chain-of-title problems that complicate enforcement and licensing later.

The Texas Two-Step and Its Current Limits

Divisive mergers drew national attention when large corporations began using them to isolate mass tort liabilities. The move has two steps: execute a divisive merger that assigns all litigation-related liabilities to one resulting entity while keeping the profitable operations in the other, then send the liability-burdened entity into Chapter 11 bankruptcy. The bankruptcy triggers an automatic stay of pending lawsuits, and the plan is to resolve the claims through a settlement trust while the operating company continues business as usual.

The best-known example is Johnson & Johnson’s consumer products subsidiary, which used a Texas divisive merger to create LTL Management LLC and assign it the company’s talc-related personal injury liabilities. LTL then filed for bankruptcy in New Jersey. The Third Circuit dismissed the petition, holding that a debtor must be in genuine financial distress at the time of filing. The court found that LTL had access to an indemnity from a corporate affiliate worth over $61 billion, which covered even aggressive projections of future talc liabilities. The mere possibility of future financial distress was not enough.

The ruling did not invalidate divisive mergers as a corporate tool. It did sharply narrow their use as a bankruptcy strategy. A company that uses a divisive merger to separate liabilities and then backs those liabilities with a well-capitalized indemnitor may find the resulting entity cannot demonstrate the financial distress Chapter 11 requires. Courts are examining whether these transactions serve a legitimate business purpose or exist primarily to disadvantage claimants, and companies considering the structure should plan for that scrutiny.

1
Office of the Texas Secretary of State. Form 621 – General Information (Certificate of Merger – Domestic Entity)
2
State of Texas. Texas Business Organizations Code BUS ORG 10.008
3
State of Texas. Texas Business Organizations Code Section 10.901 – Creditors; Antitrust
4
Secretary of State. Business Filings and Trademarks Fee Schedule
5
Office of the Texas Secretary of State. Mergers and Conversions FAQs
6
Office of the Law Revision Counsel. 26 USC 368 – Definitions Relating to Corporate Reorganizations
7
Internal Revenue Service. Instructions for Form 8937 Report of Organizational Actions Affecting Basis of Securities
8
Securities and Exchange Commission. Form 8-K Current Report
9
United States Patent and Trademark Office. Trademark Assignments: Transferring Ownership or Changing Your Name