One reorganization, two tax years, one practical solution.

• Author: Smith, Annette B.

If a reorganization spans different tax years, what is the proper time to report the transaction?

Example: X Corp. wholly owns Y Corp. and Z Corp. Under a plan of reorganization, on December 31 of year 1, X contributes the Z stock to Y in exchange for additional Y stock (the exchange). Under the same plan, in year 2, Z liquidates (the liquidation). Classification

The characterization of the transaction in the example (the liquidation together with the exchange) is critical to determining when to report it. For purposes of this item, two characterizations are analyzed:

* A Sec. 351 exchange followed by a Sec. 332 liquidation; or

* A reorganization as defined in Sec. 368(a)(1)(D) (a D reorganization).

If each step of the transaction is viewed in isolation at the end of each tax year, the exchange in year 1 should qualify for nonrecognition under Sec. 351 and the liquidation in year 2 should qualify for nonrecognition under Sec. 332, each being reported as separate transactions on the respective tax returns. However, Regs. Sec. 1.368-1(a) provides that "[i]n determining whether a transaction qualifies as a reorganization under section 368(a), the transaction must be evaluated under relevant provisions of law, including the step transaction doctrine." The step-transaction doctrine "treats a series of formally separate 'steps' as a single transaction if such steps are in substance integrated, interdependent, and focused toward a particular result" (Penrod, 88 T.C 1415 (1987)). Therefore, in determining the proper tax characterization of the transaction, the step-transaction doctrine must be applied, if appropriate.

This approach is in accord with Rev. Rul. 2004-83. In that ruling, corporation P owned all the stock of corporations S and T. As part of an integrated plan, S purchased all the T stock from P for cash, and T completely liquidated into S. The IRS applied step-transaction principles to treat the stock sale, which otherwise would have been subject to Sec. 304, and liquidation as a D reorganization.

Similar to the IRS's application of the step-transaction doctrine in that ruling to treat the stock sale and liquidation as a D reorganization, the step-transaction doctrine should apply to treat the exchange and liquidation in the example above as a D reorganization, regardless of whether each step occurred in different tax years.

Reporting Considerations

If the transaction is treated as a D reorganization, the question arises as to when it...