1. Tax-free* Acquisitions of Freestanding C Corporations Basic types: IRC §368(a)(1)(A)— Statutory merger IRC §368(a)(1)(B)— Stock-for-stock acquisition IRC §368(a)(1)(C)— Stock-for-asset acquisition Other: Forward and reverse triangular mergers *These transactions are not actually “tax-free”—they only provide target shareholders with tax-deferral of the gain on the acquisition. Also, each of these “tax-free” reorganization structures requires shareholders to recognize a taxable gain to the extent they receive cash or other forms of boot. *

2. General Requirements for Tax- free Treatment Under IRC §368 Continuity of interest must be maintained by target shareholders in the assets of the target— target shareholders must receive stock of the acquirer. The principle of continuity of business interest requires the assets of the target to be used in a productive capacity post-acquisition. An acquirer cannot liquidate the target’s assets after purchase. The acquirer must have a valid business purpose, not just a desire to avoid taxes.

3. IRC §368 “A” Reorganization— Statutory Merger The acquirer exchanges its stock (and possibly some boot) for the assets and liabilities of the target. The target corporation must distribute to its shareholders in return for their target stock the consideration received from the acquirer. –This liquidating distribution is tax-free if target shareholders receive stock of the acquirer; cash received is taxable even if the transaction is tax-free. –Gain recognized by target shareholders is the lesser of the gain realized or the boot received. –Gain realized is equal to the purchase price (value of consideration received) less the selling shareholder’s tax basis in the stock. –Losses realized are not recognized.

4. Requirements to Qualify for Tax-free Treatment Under IRC §368(a)(1)(A) Reorganizations must qualify as statutory mergers under applicable state law— the merger must be approved by both the acquirer’s and the target’s shareholders. “A” reorganizations usually require that at least 50%* of the total consideration received by target shareholders in the acquisition is acquirer stock— acquirers can use either voting or non-voting stock and either common or preferred stock. *40% acquirer stock is sufficient in some transactions.

5. Tax Consequences of a §368 “A” Target shareholders take a substituted basis in the acquiring firm stock received in the transaction: Substituted basis = same basis as had in T stock + any gain recognized – boot received The acquirer takes a carryover basis in the assets of the target. The tax attributes of the target will carry over to the acquirer, but they will be limited by IRC §382.

6. Given Information for Examples

7. Tax Implications of a §368 “A” Reorganization Tax-free AcquisitionsTaxable Acquisitions Stock Sale w/o 368 "A" * a 338 Election Purchase Price:$1,370.00 Cash548.001,370.00 Stock822.000.00 Target Corporation Tax Liability0.00 Target Shareholder Gain Recognized548.001,370.00 Target Shareholder Tax Liability109.60234.00 Target Shareholder After-tax Wealth: Cash$438.40$1,136.00 Stock822.000.00 Total$1,260.40$1,136.00 Acquirer Net After-tax Cost: Pre-tax Cost$1,370.00 Less: Incremental Tax Savings0.00 Net After-tax Cost$1,370.00 * Assumes that the mix of consideration is 60% stock and 40% cash.

8. Tax-free Merger Under IRC §368(a)(1)(A)—Statutory Merger Target: Receives $1,370 of consideration from acquirer and distributes all of the consideration to shareholders in liquidation. Acquirer: Transfers $1,370 to target for its assets and liabilities. Target is merged into acquirer under state law. Target Shareholders: Basis in target stock = $200. Gain realized is $1,170 ($1,370 received - $200 stock basis). Gain recognized is $548 (lesser of gain realized or boot received). Acquirer Shareholders: No direct tax effect. All of Target’s Stock $548 Cash $822 Stock Assets and Liabilities of Target $548 Cash $822 Stock

9. Post-acquisition Structure: Statutory Merger Acquirer: Holds the assets and liabilities of the target. Has a carryover basis in the target’s assets. Target Shareholders: Now own acquirer stock and have some boot. Acquirer Shareholders: Remain owners of the acquirer.

10. Non-tax Issues Associated w/ the §368 “A” Structure The acquirer obtains all the liabilities (including contingent and unrecorded liabilities) of the target. Some of the target’s assets may be non-transferable based on laws and/or contracts. Qualifying as a statutory merger can involve significant non-tax costs for both the acquirer and target, i.e., shareholders of both the acquirer and target have to approve the transaction. The acquirer can use up to 60% cash in the transaction. Acquiring is not required to take all target’s assets.

11. Forward Triangular Merger Forward Triangular Merger--the acquirer establishes a subsidiary through which it acquires the target (and its assets and liabilities) for stock (voting and non-voting) of the acquiring firm. –The surviving entity is the subsidiary of the acquirer, i.e., target’s liabilities are isolated. –The acquirer must acquire “substantially all”* of the target’s assets. –Acquiring firm shareholders do not have to formally approve a triangular merger (unless required by the corporate charter). –Up to 50% of consideration may be in the form of cash. *90% of net fair market value of the target’s assets and 70% of gross fair market value of those assets.

12. Tax-free Forward Triangular Type-“A” Merger Target Shareholders: Basis in target stock = $200. Gain realized is $1,170 ($1,370 - $200). Gain recognized is $548 (lesser of gain realized or boot received). Acquirer Shareholders: No direct tax effect. Acquirer: Transfers $1,370 in consideration to subsidiary for all of subsidiary’s stock. Acquirer Subsidiary: Transfers $1,370 (cash and acquirer stock) for all of the assets and liabilities of the target. Target: Receives $1,370 of consideration from the acquirer and distributes all of the consideration to share- holders in liquidation. 100% of subsidiary’s stock $548 Cash $822 acquirer stock $548 Cash $822 acquirer stock All of target’s stock “Substantially All” of the target’s assets and liabilities. $548 Cash $822 acquirer stock

13. Post-acquisition Structure: Forward Triangular Type-“A” Merger Acquirer: Subsidiary of the acquirer owns substantially all of the assets of the target. The acquirer has a basis in acquirer subsidiary stock of $200. Acquirer Subsidiary: Takes a carryover basis in the target’s assets ($200). Target Shareholders: Own stock of the acquirer and some boot. Acquirer Shareholders: Maintain ownership of the acquirer.

14. IRC §368 “B” Reorganization— Stock-for-Stock Acquisition The acquirer exchanges its voting stock directly with that of target shareholders, obtaining ownership of the target’s assets through ownership of its stock. The target becomes a subsidiary of the acquirer and, thus, maintains its legal identity while the owners of the target’s stock change (much like a reverse triangular merger under §368 “A”).

15. Requirements to Qualify for Tax-free Treatment Under IRC §368(a)(1)(B) 100% of the consideration used in the acquisition must be voting stock of the acquirer. The deal’s tax-free treatment is disqualified if any cash (except cash paid for fractional shares) is used. The acquirer must obtain 80% control of the target.

16. Tax Consequences of a §368 “B” Target shareholders take a substituted basis in the acquiring firm stock received in the transaction: Substituted basis = same basis as had in T stock + any gain recognized – boot received The acquirer takes a carryover basis in the assets of the target and in the stock of the target equal to the target shareholder’s basis in the target’s stock pre-acquisition. The tax attributes of the target will carry over to the acquirer, but they will be limited by IRC §382. Gain realized by T’s shareholders = value of the consideration received - target shareholder’s basis in the target stock. Gain recognized by T’s shareholders = lesser of gain realized or boot received.

17. Tax Implications of a §368 “B” Reorganization Tax-free AcquisitionsTaxable Acquisitions Stock Sale w/o 368 "A"368 "B"*a 338 Election Purchase Price:$1,370.00 Cash548.000.001,370.00 Stock822.001,370.000.00 Target Corporation Tax Liability0.00 Target Shareholder Gain Recognized548.000.001,370.00 Target Shareholder Tax Liability109.600.00234.00 Target Shareholder After-tax Wealth: Cash$438.40$0.00$1,136.00 Stock822.001,370.000.00 Total$1,260.40$1,370.00$1,136.00 Acquirer Net After-tax Cost: Pre-tax Cost$1,370.00 Less: Incremental Tax Savings0.00 Net After-tax Cost$1,370.00 * Assumes that 100% of the consideration is voting common stock.

18. Tax-free Merger Under IRC §368(a)(1)(B)-- Stock-for-Stock Acquisition Acquirer: Transfers $1,370 in acquirer stock directly to target shareholders for all of the target’s stock. Target becomes a wholly owned subsidiary of the acquirer. Acquirer: Transfers $1,370 in acquirer stock directly to target shareholders for all of the target’s stock. Target becomes a wholly owned subsidiary of the acquirer. 100% of Target’s Stock $1,370 of Acquirer Stock Target: Owners of target’s stock change. Tax basis in the target’s assets is unchanged. Acquirer Shareholders: No direct tax effect.

19. Post-acquisition Structure: Stock-for-Stock Acquisition Acquirer: Owns all of the stock of the target. Target is a wholly owned subsidiary of the acquirer. The acquirer’s basis in the target stock is $200 (same as target shareholder’s basis). Target (now a subsidiary of the acquirer): Asset basis carries over ($200). Target Shareholders: Own stock of the acquirer and some boot. Acquirer Shareholders: Maintain ownership of the acquirer.

20. Non-tax Issues Associated w/ the §368 “B” Structure The acquirer is liable for all of the target’s liabilities, but.. The acquirer’s liability is limited to its investment in the target since the target is a subsidiary of the acquirer. Title to the target’s assets does not change since the target retains its corporate identity. (This is a benefit if the target has assets that are difficult to transfer.) Target’s intangibles, contracts, goodwill, preserved. Difficult to force out dissident shareholders of the target. Dilution may be a problem for acquiring firm’s shareholders.

21. Reverse Triangular Merger Reverse Triangular Merger-- the surviving entity is the target corporation, which is a subsidiary of the acquirer after the transaction. Target must retain substantially all of T’s assets * At least 80% of consideration must be in the form of acquiring firm’s voting stock. Functionally similar to “B” reorganization except can force out dissenters and use more cash. *90% of net fair market value of the target’s assets and 70% of gross fair market value of those assets.

22. Reverse Triangular Merger T T S/Hs -TRANSACTION- “A” Voting Stock Merged T S/Hs Transfer Control (80%) for “A” Voting Stock. T must hold Sub-all of Acquisition Sub and T’s Assets. Acq. Sub. A

23. Reverse Triangular Merger A Former T S/Hs Same result as a Type B. -RESULT- T

24. IRC §368 “C” Reorganization-- Stock-for-Assets Acquisition The acquirer exchanges its voting stock (and possibly some boot) for the target’s assets. The target distributes the acquirer’s stock and other consideration received in the acquisition to its shareholders in liquidation.

25. Requirements to Qualify for Tax-free Treatment Under IRC §368(a)(1)(C) The acquirer must purchase “substantially all”* of the target’s assets but is not required to assume all of the target’s liabilities. At least 80% of the total consideration used must be voting stock of the acquiring firm. If the acquirer uses any boot in the transaction, the liabilities of the target assumed by the acquirer count as boot in the 80% test. *90% of net fair market value of the target’s assets and 70% of gross fair market value of those assets.

26. Tax Consequences of a §368 “C” Target shareholders take a substituted basis in the acquiring firm stock received in the transaction: Substituted basis = same basis as had in T stock + any gain recognized – boot received The acquirer takes a carryover basis in the assets of the target. The tax attributes of the target will carry over to the acquirer, but they will be limited by IRC §382. Gain realized by T’s shareholders = value of the consideration received - target shareholder’s basis in the target stock. Gain recognized by T’s shareholders = lesser of gain realized or boot received.

27. Tax Implications of a §368 “C” Reorganization Tax-free AcquisitionsTaxable Acquisitions Stock Sale w/o 368 "A"368 "B"368 "C"*a 338 Election Purchase Price:$1,370.00 Cash548.000.00274.001,370.00 Stock822.001,370.001,096.000.00 Target Corporation Tax Liability0.00 Target Shareholder Gain Recognized548.000.00274.001,370.00 Target Shareholder Tax Liability109.600.0054.80234.00 Target Shareholder After-tax Wealth: Cash$438.40$0.00$219.20$1,136.00 Stock822.001,370.001,096.000.00 Total$1,260.40$1,370.00$1,315.20$1,136.00 Acquirer Net After-tax Cost: Pre-tax Cost$1,370.00 Less: Incremental Tax Savings0.00 Net After-tax Cost$1,370.00 * Assumes that the mix of consideration is 20% cash and 80% acquiring firm voting stock.

28. Tax-free Merger Under IRC §368(a)(1)(C)— Stock-for-Asset Acquisition Target: Receives $1,370 of consideration from acquirer and distributes all of the consideration to shareholders in liquidation. Acquirer: Transfers $1,370 in consideration to target for its assets and liabilities. Target Shareholders: Basis in target stock = $200. Gain realized is $1,170 ($1,370 received - $200 stock basis). Gain recognized is $274 (lesser of gain realized or boot received). Acquirer Shareholders: No direct tax effect. All of Target’s Stock $274 Cash $1,096 Stock “Substantially All” of the Assets and Liabilities of Target $274 Cash $1,096 Stock

29. Post-acquisition Structure: Stock-for-Asset Acquisition Acquirer: Holds substantially all of the assets and liabilities of the target. Has a carryover basis in the target’s assets. Target Shareholders: Now own acquirer stock and have some boot. Acquirer Shareholders: Remain owners of the acquirer.

30. Non-tax Issues Associated w/ the §368 “C” Structure The acquirer is not required to assume all of the target’s liabilities since the deal is done by contract instead of under state merger laws. Consent of acquiring firm’s shareholders not required. Possible dilution of acquiring firm’s stock because at least 80% of consideration must be stock. Unwanted assets may be a problem. T’s shareholders must approve liquidation of T.

31. Limitations on Target Firm Tax Attributes Under IRC §382, any transaction after 1986 that results in a 50% change in ownership of a corporation triggers a limitation on the firm’s tax attributes. The annual limitation on the amount of the firm’s tax attributes that can be used equals the market value of the subject firm’s equity at the date of the ownership change times the long-term tax-exempt rate of return. Note: Losses generated by a target firm post- acquisition can be offset by profits of the acquirer.

32. More Rules on Target Firm Tax Attributes The target firm’s NOLs can be used to offset the corporate level gain on the actual or deemed asset sale in taxable transactions in which the tax basis of the target’s assets are stepped-up. However, the valuable tax attributes of the target that are not used to offset the gain on the step-up are lost.

33. Example of Tax Implications of Tax-free Acquisitions of Free-Standing C Corporations

34. Comparison of Tax Implications of Tax-Free Acquisitions of Free-Standing C Corporations Tax-free AcquisitionsTaxable Acquisitions Stock Sale w/o 368 "A"*368 "B"*368 "C"*351*a 338 Election Purchase Price:$1,370.00 Cash548.000.00274.00822.001,370.00 Stock822.001,370.001,096.00548.000.00 Target Corporation Tax Liability0.00 Target Shareholder Gain Recognized548.000.00274.00822.001,370.00 Target Shareholder Tax Liability109.600.0054.80164.40270.00 Target Shareholder After-tax Wealth: Cash$438.40$0.00$219.20$657.60$1,100.00 Stock822.001,370.001,096.00548.000.00 Total$1,260.40$1,370.00$1,315.20$1,205.60$1,100.00 Acquirer Net After-tax Cost: Pre-tax Cost$1,370.00 Less: Incremental Tax Savings0.00 Net After-tax Cost$1,370.00 Pre-Tax Price to Leave Target Shareholders Indifferent$1,195.66$1,100.00$1,145.84$1,250.00$1,370.00 60% stock & 40% cash 100% stock 80% stock & 20% cash 40% stock & 60% cash