[Federal Register Volume 65, Number 95 (Tuesday, May 16, 2000)]
[Proposed Rules]
[Pages 31115-31118]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-11902]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106186-98]
RIN 1545-AW36


Certain Corporate Reorganizations Involving Disregarded Entities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance to corporations and their shareholders about whether certain 
transactions qualify as corporate reorganizations. The proposed 
regulations apply to certain mergers under state or Federal law between 
two entities, one of which is a corporation and the other of which, for 
Federal tax purposes, is disregarded as an entity separate from its 
owner (for example, a qualified REIT subsidiary, a qualified subchapter 
S subsidiary, or a limited liability company with a single corporate 
owner that does not elect to be treated as a separate corporation). 
This document also provides a notice of public hearing on these 
proposed regulations.

DATES: Written or electronic comments must be received by August 14, 
2000. Requests to speak (with outlines of oral comments to be 
discussed) at the public hearing scheduled for August 8, 2000, must be 
received by July 18, 2000.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-106186-98), room 
5226, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 am and 5 pm to: CC:DOM:CORP:R (REG-
106186-98), Courier's desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC 20044. Alternatively, taxpayers may submit 
comments electronically via the Internet by selecting the ``Tax Regs'' 
option on the IRS Home Page, or by submitting comments directly to the 
IRS Internet site at http://www.irs.gov/tax__regs/reglist.html. The 
public hearing will be held in room 4718, Internal Revenue Building, 
1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Reginald Mombrun, (202) 622-7750, concerning submissions of comments,

[[Page 31116]]

the hearing, and/or to be placed on the building access list to attend 
the hearing, Guy Traynor, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) that provide guidance as to whether certain 
mergers under state or Federal law between two entities, one of which 
is a corporation and the other of which, for Federal tax purposes, is 
disregarded as an entity separate from its owner can be statutory 
mergers qualifying as reorganizations under section 368(a)(1)(A) of the 
Internal Revenue Code of 1986 (Code). The Code provides general 
nonrecognition treatment for reorganizations specifically described in 
section 368(a). Section 368(a)(1)(A) provides that the term 
reorganization means ``a statutory merger or consolidation.'' Section 
1.368-2(b)(1) provides that a statutory merger must be accomplished 
under the ``corporation laws of the United States or a State or 
territory or the District of Columbia.'' In addition to meeting the 
requirements of section 368(a), a merger transaction must meet other 
reorganization requirements such as the requirement that the persons 
engaged in the transaction each qualify as ``a party to a 
reorganization'' under section 368(b), the continuity of interest 
requirement of Sec. 1.368-1(e), and the continuity of business 
enterprise requirement of Sec. 1.368-1(d).
    Certain entities that are respected under state law are disregarded 
for Federal tax purposes. These entities include a qualified REIT 
subsidiary, a qualified subchapter S subsidiary (QSub), and an entity 
that is disregarded under Sec. 301.7701-3 as an entity separate from 
its owner. Section 856(i)(2) provides that a corporation that is wholly 
owned by a real estate investment trust (REIT) is a qualified REIT 
subsidiary. Section 1361(b)(3)(B) provides that a QSub is an eligible 
domestic corporation, wholly owned by an S corporation, for which the S 
corporation makes a QSub election. Under Sec. 301.7701-3, a business 
entity that is not classified as a corporation per se (see 
Sec. 301.7701-2(b)((1), (3), (4), (5), (6), (7) or (8); for example, a 
limited liability company) can elect to be treated as a corporation or, 
if it has a single owner, can choose to be disregarded. (These entities 
hereinafter are collectively referred to as Disregarded Entities, and 
the corporation that owns the Disregarded Entity is referred to as the 
Owner.) For Federal tax purposes, all of the assets, liabilities, and 
items of income, deduction, and credit of a Disregarded Entity are 
treated as those of its Owner.
    Because qualified REIT subsidiaries and QSubs are corporations 
under state law, state merger laws generally permit them to merge with 
other corporations. In addition, many state merger laws permit mergers 
between limited liability companies and corporations.
    Commentators have raised questions as to whether the merger under 
state or Federal law of a Disregarded Entity into an acquiring 
corporation or of a target corporation into a Disregarded Entity can 
qualify as a reorganization under section 368(a)(1)(A). These 
regulations address this issue.

Explanation of Provisions

    The proposed regulations provide guidance on the tax treatment of 
the following two transactions: (1) the merger of a Disregarded Entity 
into an acquiring corporation, and (2) the merger of a target 
corporation into a Disregarded Entity. Under the Federal tax laws, the 
merger under state or Federal law of a Disregarded Entity into an 
acquiring corporation in which the Owner exchanges its interest in the 
Disregarded Entity for stock in the acquiring corporation and the 
Disregarded Entity ceases to exist as a result of the transaction by 
operation of the state or Federal merger law (hereinafter, the merger 
of a Disregarded Entity into an acquiring corporation) is treated as if 
the Owner transferred the assets of the Disregarded Entity to the 
acquiring corporation. Conversely, the merger under state or Federal 
law of a target corporation into a Disregarded Entity in which the 
shareholders of the target corporation exchange their target 
corporation stock for stock in the Owner and the Disregarded Entity 
does not lose its status as a Disregarded Entity as a result of the 
transaction (hereinafter, the merger of a target corporation into a 
Disregarded Entity) is treated as if the Owner acquired all of the 
assets of the target corporation.
    The proposed regulations reflect Treasury's and the IRS' view that 
neither merger is a statutory merger qualifying as a reorganization 
under section 368(a)(1)(A). Compliance with a corporate law merger 
statute does not by itself qualify a transaction as a ``statutory 
merger'' for purposes of section 368(a)(1)(A). See Roebling v. 
Commissioner, 143 F.2d 810, 812 (3d Cir. 1944), cert. denied, 323 U.S. 
773 (1944). The proposed regulations contain the requirements that must 
be satisfied for a state or Federal law merger or consolidation to 
qualify as a reorganization under section 368(a)(1)(A). In addition, 
the proposed regulations remove the word ``corporation'' from the 
requirement that, in order to qualify as a reorganization under section 
368(a)(1)(A), a merger or consolidation must be effected pursuant to 
the corporation law of the relevant jurisdiction. This change is 
necessary to conform the regulations to the IRS' long-standing position 
that a merger or consolidation may qualify as a reorganization under 
section 368(a)(1)(A) even if it is undertaken pursuant to laws other 
than the corporation law of the relevant jurisdiction. See Rev. Rul. 
84-104 (1984-2 C.B. 94) (a ``consolidation'' pursuant to the National 
Banking Act, 12 U.S.C. 215, is treated as a merger for Federal tax 
purposes).

The Merger of a Disregarded Entity into an Acquiring Corporation

    Consistent with the views of all the commentators, Treasury and the 
IRS believe that the merger of a Disregarded Entity into an acquiring 
corporation is not a statutory merger qualifying as a reorganization 
under section 368(a)(1)(A) because the Owner's assets (other than those 
held in the Disregarded Entity) are not transferred to the acquiring 
corporation and the Owner does not cease to exist as a result of the 
state or Federal law merger transaction. ``A merger ordinarily is an 
absorption by one corporation of the properties and franchises of 
another whose stock it has acquired. The merged corporation ceases to 
exist, and the merging corporation alone survives.'' Cortland Specialty 
Co. v. Commissioner of Internal Revenue, 60 F. 2d 937, 939 (2d Cir. 
1932), cert. denied, 288 U.S. 599 (1933). The merger of a Disregarded 
Entity into an acquiring corporation, in which the Owner's assets and 
liabilities are divided between the Owner and the acquiring corporation 
after the transaction, is a divisive transaction, not a transaction in 
which the assets of the Owner and the acquiring corporation are 
combined. Congress intended that section 355 be the sole means under 
which divisive transactions will be afforded tax-free status and, thus, 
specifically required the liquidation of the acquired corporation in 
reorganizations under both sections 368(a)(1)(C) and 368(a)(1)(D) in 
order to prevent these reorganizations from being used in divisive 
transactions that did not satisfy section 355. See S. Rep. No. 1622, 
83rd Cong., 2d Sess. 274 (1954); S. Rpt. No. 169, 98th Cong., 2d

[[Page 31117]]

Sess. 204 (1984) and Rev. Rul. 2000-5 (2000-5 I.R.B. 436).
    Accordingly, consistent with existing law, the proposed regulations 
provide that for a merger to qualify as a reorganization under section 
368(a)(1)(A), it must, by operation of the merger statute of the 
relevant jurisdiction, result in one corporation acquiring the assets 
of the merging corporation and the merging corporation ceasing to 
exist. Thus, the merger of a Disregarded Entity into an acquiring 
corporation cannot qualify as a reorganization under section 
368(a)(1)(A). However, the transaction may be treated as a 
reorganization under section 368(a)(1)(C), (D), or (F) if all 
applicable requirements are met (including the liquidation of the 
Owner). The transaction also may be described in section 351.

The Merger of a Target Corporation into a Disregarded Entity

    There has been a split in views as to whether the merger of a 
target corporation into a Disregarded Entity is a statutory merger 
qualifying as a reorganization under section 368(a)(1)(A). Some 
commentators argue that, because the Disregarded Entity is disregarded 
for Federal tax purposes, the transaction should be treated for Federal 
tax purposes as a merger into the Owner. Thus, they argue, as long as 
the Owner is a corporation, all other relevant reorganization 
requirements are satisfied, and the target corporation could have 
merged into the Owner in a transaction that qualifies as a 
reorganization under section 368(a)(1)(A), the merger should qualify as 
a reorganization under section 368(a)(1)(A). According to these 
commentators, treating such a merger as a statutory merger into the 
Owner qualifying as a reorganization under section 368(a)(1)(A) does 
not inappropriately facilitate avoidance of any reorganization 
requirement under section 368. Accordingly, the commentators argue 
there is no sound policy for not permitting the merger of a target 
corporation into a Disregarded Entity to be treated as a statutory 
merger into the Owner qualifying as a reorganization under section 
368(a)(1)(A).
    Other commentators argue that, as a technical matter, the better 
interpretation of the applicable provisions of the Code and regulations 
is that the merger of a target corporation into a Disregarded Entity is 
not a statutory merger of the target corporation into the Owner 
qualifying as a reorganization under section 368(a)(1)(A). Congress 
added the word ``statutory'' in 1934 so that the definition ``will 
conform more closely to the general requirements of [state or Federal] 
corporation law.'' See H.R. Rep. No. 704, 73rd Cong., 2nd Sess. 14 
(1934). Treasury and the IRS believe that it is inappropriate to treat 
the state or Federal law merger of a target corporation into a 
Disregarded Entity instead as a statutory merger of the target 
corporation into the Owner, because the Owner, the only potential party 
to a reorganization under section 368(b), is not a party to the state 
or Federal law merger transaction. A reorganization under section 
368(a)(1)(A) is a combination of the assets and liabilities of two 
corporations through a merger under state or Federal law. A merger of a 
target corporation into a Disregarded Entity differs from a merger of a 
target corporation into the Owner because the target corporation and 
the Owner have combined their assets and liabilities only under the 
Federal tax rules concerning Disregarded Entities, and not under state 
or Federal merger law, the law on which Congress relied in enacting 
section 368(a)(1)(A).
    Accordingly, the proposed regulations provide that the merger of a 
target corporation into a Disregarded Entity is not a statutory merger 
of the target corporation into the Owner qualifying as a reorganization 
under section 368(a)(1)(A). Such a transaction may qualify as a 
reorganization under section 368(a)(1)(C), section 368(a)(1)(D), or 
section 368(a)(1)(F) if all relevant requirements are met. Such a 
transaction also may qualify for nonrecognition of gain under section 
351.

Proposed Effective Date

    These regulations as proposed apply to any transaction occurring on 
or after the date these regulations are published as final regulations 
in the Federal Register.

Comments Requested

    Several states permit the merger of a domestic corporation into a 
foreign corporation under state law. Treasury and the IRS are studying 
whether this transaction qualifies as a reorganization under section 
368(a)(1)(A) and request comments on this issue.

Special Analysis

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C chapter 5) does not apply to these regulations, and, because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight copies) that are submitted timely to the IRS. Alternatively, 
taxpayers may submit comments electronically via the Internet by 
selecting the ``Tax Regs'' option on the IRS Home Page, or by 
submitting comments directly to the IRS Internet site at http://
www.irs.gov/tax__regs/reglist.html. The IRS and Treasury Department 
request comments on the clarity of the proposed rules and how they can 
be made easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing has been scheduled for August 8, 2000, beginning 
at 10:00 AM in Room 4718, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures, 
visitors must enter at the 10th Street entrance, located between 
Constitution and Pennsylvania Avenues, NW. In addition, all visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 15 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see the FOR FURTHER INFORMATION CONTACT portion 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments must submit written comments and an 
outline of the topics to be discussed and the time to be devoted to 
each topic (a signed original and eight (8) copies) by July 18, 2000. A 
period of 10 minutes will be allotted to each person for making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for reviewing outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.
    Drafting Information: The principal author of these regulations is 
Reginald

[[Page 31118]]

Mombrun of the office of the Assistant Chief Counsel (Corporate), IRS. 
However, other personnel from the IRS and the Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR Part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *.

    Par. 2. Section 1.368-2 is amended by revising paragraph (b)(1) to 
read as follows:


Sec. 1.368-2  Definition of terms.

* * * * *
    (b)(1) In order to qualify as a reorganization under section 
368(a)(1)(A), the transaction must be a merger or consolidation 
involving two corporations effected pursuant to the laws of the United 
States or a State or territory, or the District of Columbia. In 
addition, by operation of such a merger law, the transaction must 
result in one corporation acquiring the assets of the merging 
corporation and the merging corporation ceasing to exist. Similarly, by 
operation of such a consolidation law, the transaction must result in 
one newly formed corporation acquiring the assets of both consolidating 
corporations, and both consolidating corporations ceasing to exist. 
Thus, the merger under state or Federal law of an entity that is 
disregarded as an entity separate from its owner for Federal tax 
purposes into an acquiring corporation in which the owner exchanges its 
interest in the disregarded entity for stock in the acquiring 
corporation and the disregarded entity ceases to exist as a result of 
the transaction by operation of the state or Federal merger law is not 
a statutory merger qualifying as a reorganization under section 
368(a)(1)(A). Moreover, the merger of a target corporation into an 
entity that is disregarded as an entity separate from its owner for 
Federal tax purposes that does not lose its status as a disregarded 
entity as a result of the transaction is not a statutory merger 
qualifying as a reorganization under section 368(a)(1)(A). Examples of 
entities that are disregarded as entities separate from their owners 
include a qualified REIT subsidiary (within the meaning of section 
856(i)(2)), a qualified subchapter S subsidiary (within the meaning of 
section 1361(b)(3)(B)), and a business entity that is not classified as 
a corporation and that has a single owner (as provided in 
Sec. 301.7701-2(c)(2) of this chapter). The preceding five sentences 
apply to any transaction occurring on or after [Date These Regulations 
Are Published As Final Regulations In The Federal Register].
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-11902 Filed 5-11-00; 2:30 pm]
BILLING CODE 4830-01-P