Certain mergers involving disregarded entities qualify as a reorganizations.

• Author: Goldberg, Michael J.
• Position: Proposed IRS regulation

On Nov. 15, 2001, the IRS issued Prop. Regs. Sec. 1,368-2(b)(1), allowing certain mergers involving disregarded entities to qualify as A reorganizations and partially reversing its previous position that maintained that neither the merger of a disregarded entity into an acquiring corporation nor one of a target corporation into a disregarded entity could qualify as an A reorganization.

The term "disregarded entities" includes qualified real estate investment

trust subsidiaries, qualified subchapter S subsidiaries and entities disregarded as separate from their owners for Federal tax purposes under the "check-the-box" regulations.

The underlying premise of the proposed regulations is that an entity disregarded from its owner for Federal tax purposes is a division of that owner. As such, economic and business reality dictate that those divisions be able to acquire target corporations and qualify for nonrecognition treatment under Sec. 368 (a)(1)(A), as long as the transaction is pursuant to Federal or state law. Further, a division of a corporation may be transferred to an acquiring corporation; however, that transaction would have to rely on the divisive reorganization provisions to qualify for nonrecognition treatment.

The proposed regulations set two requirements for nonrecognition treatment for transactions involving disregarded entities:

1. All of the assets and liabilities of each member of a combining unit (the transferor unit) become the assets and liabilities of one or more members of another combining unit (the transferee unit) (Prop. Regs. Sec. 1.368-2(b)(1)(ii)(A)).

2. The combining entity of the transferor unit ceases its separate legal existence for all purposes (Prop. Regs. Sec. 1.368-2(b)(1)(ii)(B)).

For purposes of the above language, the regulations introduced the concepts of a "combining entity" defined as a corporation not classified as a disregarded entity (Prop. Regs. Sec...