Sec. 351: an alternative to taxable asset acquisitions.

• Author: Boyer, Mark W.

In a business acquisition, the buyer will want to purchase assets so the amount being paid will be reflected in their bases and will be recovered through deductions related to those assets (depreciation, amortization, etc.). With the passage of the Revenue Reconciliation Act of 1993 (RRA), amounts paid for "Sec. 197 intangibles" may be amortized over a 15-year period. Although some might argue this will encourage taxable asset acquisitions, there are still many other unresolved issues that affect their tax consequences. The most significant is the treatment accorded contingent liabilities assumed as part of an acquisition. In many cases, restructuring the asset acquisition as a Sec. 351 transfer will avoid issues related to taxable asset purchases without significantly changing the economics of the transaction.

In order to convert a taxable asset acquisition to a Sec. 351 transfer, a new corporation ("Newco") is formed to which the Seller transfers the assets and the Buyer transfers the consideration that was to be paid for the assets Together, the Buyer and Seller ("Transferors") are the owners of Newco. In exchange for the assets, the Seller could receive some cash from Newco, even cash contributed by the Buyer, and Newco stock equal to the net value of the assets transferred. The Buyer would receive all of the Newco common stock. In addition, if the stock received by the Seller is preferred stock (as described in Sec. 1504(a)(4)), a corporate Buyer and Newco could join in filing a consolidated tax return.

Often, it is more advantageous to transfer the assets to a preexisting corporation ("Transferee"). The transfer of assets by the Seller in exchange for Transferee stock will be subject to Sec. 351, provided the preexisting Transferee shareholder(s) also transfer property for stock. In measuring whether the Transferors of property are in control of the Transferee, all stock owned in the Transferee immediately after the transfer is considered, even though some of the stock was held before the transfer. This structure is often referred to as an "accommodation transfer," since the preexisting shareholders are accommodating the Seller in order to satisfy the requirements of Sec. 35 1. In Rev. Proc. 77-37, the IRS has stated it will respect an accommodation transfer provided the amount of stock received equals or exceeds 10% of the value of the stock previously held.

Seller deferral

Taxable asset acquisition: In a taxable asset acquisition, the Seller can defer gain recognition by reporting the gain under the installment method. Under this method, gain from the sale is pro-rated and recognized in the year of payment in an amount equal to the payment multiplied by the gross profit ratio for the sale (Sec. 453). However, for deferred gain in excess of $5 million, interest will be charged in an amount equal to the underpayment rate in effect under Sec. 6621(a)(2) multiplied by the deferred tax liability (to the extent related to the deferral in excess of $5 million). The deferred tax liability is calculated without regard to the existence of any net...