IRS proposes new section 368 reorganization rules

On Jan. 13, 2025, Treasury and the IRS published proposed regulations (REG-112261-24) that apply to certain corporate spinoffs, incorporations, and reorganizations that companies intend to qualify for tax-free treatment. In part, the proposed regulations would require companies provide greater information for transactions they intend to treat as tax-free under section 368(a). The new rules would require corporations that are parties to a reorganization to provide these items through a more detailed “plan of reorganization.” A key aim of these rules is to better facilitate the IRS’s examination of intended tax-free reorganizations and, by extension, to identify potential taxpayer noncompliance.

If finalized, the proposed regulations would greatly increase the reporting and documentation requirements associated with corporate reorganizations and spinoffs. In the meantime, the proposed rules provide a framework for the documentation and description of the transaction the IRS likely expects companies to have developed as part of their plan of reorganization if examined. As such, it is possible that these proposals, though not final, could also become part of the framework for reviewing certain Merger & Acquisition (M&A) transactions in the tax due diligence process. 

The new rules would apply to both acquisitive and divisive reorganizations. Similar reporting rules would apply to a plan of distribution for straight spinoff that is not considered a reorganization. Companies should ensure that they tailor any documentation of a plan of reorganization (or plan of distribution) based upon the elements set forth in these proposed rules.

Generally, for a transaction to achieve tax-deferred treatment, it must meet certain requirements set out in section 368 and its associated Treasury Regulations.¹ One such requirement is that there must be a plan of reorganization, and therefore, each step of the transaction must be treated as occurring in pursuance of that plan. The plan of reorganization also serves to identify the beginning and end of a reorganization.

Plans of reorganization are often memorialized in the form of written documents. However, current regulations do not require taxpayers to formalize the plan of reorganization into a written document.² Rather, all of the facts and circumstances are relevant to determining if steps were taken as part of a plan of reorganization.³ Thus, the IRS has historically accepted, but by no means required or sought, documentation of the plan to support its conclusion as to the plan’s existence.

If finalized, the proposed regulations would require the parties to a reorganization to document a comprehensive plan of reorganization and report it with their timely filed return as part of the reorganization reporting rules under Reg. section 1.368-3. If a taxpayer fails to comply with these requirements or report its plan of reorganization, the IRS may be able to identify a plan of reorganization based on the facts and circumstances.⁴ However, it remains unclear what penalties or other consequences the IRS would or could impose for non-compliance with these new mandates. In all events, it is highly likely that the IRS would scrutinize failure to comply during audit. Buyers would likely apply similar scrutiny during any tax due diligence process.

“Plan of reorganization”

In the preamble to the proposed regulations, the IRS and Treasury characterize the current definition of “plan of reorganization” as flexible, vague and imprecise. The preamble describes how the current regulations lack detail and guidance on the “manner in which the plan of reorganization must be adopted” and lack procedures for reporting and documenting such plan.

In General

Prop. Reg. sections 1.368-4(a) through (d) would impose new requirements and procedures for the determination of a plan of reorganization. For there to be a plan of reorganization under the proposed regulations, taxpayers generally must (i) explain the transaction and identify various details about the plan of reorganization (as described below) in a single, comprehensive document filed with the IRS, (ii) adopt the plan and (iii) complete the transaction in accordance with the plan documentation.⁵ Further, they must amend a plan in direct response to an identifiable, unexpected and material change in market or business conditions or to achieve a business purpose.⁶

Notably, the IRS may correct a plan of reorganization filed by the taxpayer.⁷ If the taxpayer fails to file a plan of reorganization, the IRS also may determine that a transaction(s) is (or is not) included in a plan of reorganization based on all facts and circumstances and general Federal income tax principles, including the step transaction doctrine.⁸

Documentation requirements

To qualify as a plan of reorganization, Prop. Reg. section 1.368-4(d)(1) would require parties to a reorganization to include the following in a single, comprehensive document:

• All parties to the reorganization.
• All transactions that are part of the plan of reorganization.
• All liabilities, including debt, to be assumed by the acquiring corporation and the obliges of those liabilities.
• All the debt of the target corporation that will be satisfied with section 361 consideration.

This document would further describe the intended Federal income tax treatment of the transactions and the business purpose for each transaction. If there are readjustments to the transactions that are part of the plan, the document would need to establish that the adjustments are undertaken to facilitate the continuance of the business of a corporation that is a party to the reorganization.⁹

Formally adopting and completing a plan

Additionally, the proposed regulations would require corporations to formally adopt the plan of reorganization prior to the first step of the reorganization. Taxpayers would establish this formal plan through the acts of its officers and directors, as well as in its official records.¹⁰ “Official records” may include a contract or other written agreement to which the corporation is a party, as well as resolutions adopted by the corporation’s board of directors or other document filed with the Securities and Exchange Commission (SEC) or other Federal regulatory agency.¹¹ The taxpayer then needs to complete the plan of reorganization by actually carrying out each transaction step as expeditiously as possible.¹²

Multiple steps in a reorganization

For multi-step reorganizations, the proposed regulations state that each step of the plan of reorganization must satisfy additional requirements to be included in the plan of reorganization.¹³

• One or more of the parties must evidence a definite intent to carry out the transaction through the official records ¹⁴ of the party to substantiate the plan.¹⁵
• The step must have a proximate relationship to the plan, which means:
  • It must be necessary to satisfy the requirements of a valid 368 reorganization or integral as a part of a series of transactions to satisfy such requirements; and
  • The step must not take place close in time to one or more of the other transactions unless federal income tax principles would apply to determine that it was in substance part of the plan of reorganization.¹⁶
•   The step, on its own or as part of the series of steps, must be consistent with the business purpose of the reorganization.¹⁷

Conclusion

These proposed regulations suggest that the IRS is eager to more accurately identify intended acquisitive and divisive section 368 reorganizations (and non-reorganization spinoffs) and to streamline examinations in the future. If finalized, the regulations will require parties to a reorganization to proactively file the documentation outlined in the proposed regulations in order to have a valid plan of reorganization without further involvement by the IRS.

Even prior to finalization, the proposed rules provide a framework for the kind of information and factual development the IRS would want to see if examining a reorganization (or spinoff). As such, potential acquirors may begin inquiring whether companies involved in these transactions have properly maintained this information as part of the diligence process.

All told, these proposed regulations may mark a shift in how the IRS identifies 368 reorganizations on exam and in turn create a ripple effect of increased standardization of reporting documentation.

_{[1] Under Reg. sections 1.368-1 and -2, the transaction must meet the general reorganization requirements, which include continuity of interest, continuity of business enterprise, business purpose, party to the reorganization and plan of reorganization. There are additional requirements for each type of reorganization under sections 368(a)(1)(A) through (G).}

_{[2] Simon v. Commissioner, 644 F.2d 339 (5^th Cir. 1981); rev’g and rem’g 71 T.C. 516 (1978).}

_{[3] Atlas Tool Co. v. Commissioner, 614 F.2d 860 (3d Cir. 1980), aff’g 70 T.C. 86 (1978).}

_{[4] Prop. Reg. section 1.368-4(b)(2)(ii).}

_{[5] Prop. Reg. section 1.368-4(d).}

_{[6] Prop. Reg. sections 1.368-4(a)(2)(i) and 1.368-4(f).}

_{[7] Prop. Reg. sections 1.368-4(a)(2)(ii) and 1.368-4(b)(2)(i).}

_{[8] Prop. Reg. sections 1.368-4(a)(2)(iii) and 1.368-4(b)(2)(ii).}

_{[9] Prop. Reg. sections 1.368-4(d)(1)(i) through (vii).}

_{[10] Prop. Reg. section 1.368-4(d)(2).}

_{[11] Prop. Reg. section 1.368-4(d).}

_{[12] Prop. Reg. section 1.368-4(d)(3); Note: there is a presumption that the plan is completed by all parties within 24 months of the first step.}

_{[13] Prop. Reg. section 1.368-4(e).}

_{[14] “Official records” in the context of the definite intent requirement appears to be defined the same as in the context of the adoption of the plan, discussed above – i.e., a written agreement or resolution of a party’s board.}

_{[15] Prop. Reg. section 1.368-4(e)(1).}

_{[16] Prop. Reg. section 1.368-4(e)(2) but note that each step need not have an independent significance or separate business motive apart from the reorganization.}

_{[17] Prop. Reg. section 1.368-4(e)(3).}