Discuss the advantages and disadvantages of a tax-free reorganization as compared with a taxable transaction.

Question

What will be an ideal response?

Answer 1

A number of advantages and disadvantages are connected with a tax-free reorganization. Some of these include:
• A tax-free reorganization permits a deferral of taxes by the shareholders unless boot is received. The reorganization alternative may permit a shareholder to retain a higher percentage of the capital after payment of any income tax liability.
• A reorganization requires the owner to retain a proprietary interest; thus, he or she must continue to own an equity interest. A taxable transaction permits the equity to be converted into more liquid assets (e.g., cash).
• Losses realized in a reorganization cannot be recognized as they can in a taxable transaction.
• A taxable transaction usually results in capital gain treatment for the shareholders, while in a reorganization, it may result in dividend income being recognized.
• In a taxable transaction, the basis in the assets is stepped up, while in a reorganization, usually the basis is a carryover basis from the target corporation's books.
• In a reorganization, the depreciation and ITC recapture rules do not usually apply, while they do apply in a taxable transaction.
• A reorganization requires less cash than a taxable transaction because large amounts of stock are generally used. The larger amount of stock, however, may dilute the ownership interests of the acquiring corporation's shareholder group.
• The reorganization permits the target corporation to avoid recognizing gain on an asset transfer or distribution of stock or securities as is typically required in a taxable transaction.
• A reorganization permits the preservation of tax attributes, which are lost in a taxable transaction.