What is a tax-free reorganization under Section 368?
Available when every requirement is met
A reorganization under IRC §368 lets corporations combine or restructure while shareholders exchange stock without recognizing gain under §354. It requires one of the statutory forms (types A through G), a plan of reorganization, a business purpose, continuity of interest, and continuity of business enterprise under Treas. Reg. §1.368-1. Cash or other boot is taxed under §356, and the deferred gain carries into the new stock under §358.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- Section 368(a)(1) lists seven reorganization types, labeled A through G.
- Shareholders must keep a meaningful continuing equity stake, and the business must continue.
- Boot triggers gain up to the boot received, and it can be taxed as a dividend (§356).
- Some types, such as the stock-for-stock B reorganization, allow no boot at all.
- If a requirement fails, the exchange is generally a fully taxable sale.
What it is
Corporate combinations and restructurings happen for business reasons: mergers, acquisitions for stock, spin-offs, recapitalizations, reincorporations, and bankruptcy restructurings. The tax question is whether the shareholders and the corporations must recognize gain now or can defer it.
Section 368 defines the transactions Congress treats as continuations of an investment in modified corporate form rather than sales. When a transaction fits, gain is generally deferred, and the old basis carries into the new stock so the gain is taxed later.
What the law says
IRC §368(a)(1) defines reorganizations, including (A) a statutory merger or consolidation, (B) an acquisition of stock solely for voting stock that results in control, (C) an acquisition of substantially all of the assets for voting stock, (D) certain transfers to controlled corporations, (E) a recapitalization, (F) a mere change in identity, form, or place of organization of one corporation, and (G) certain transfers in bankruptcy. Section 354 provides nonrecognition for shareholders who exchange stock solely for stock in a reorganization.
Under §356(a)(1), when a shareholder receives money or other property (boot) along with stock, gain is recognized but not in excess of the boot. Under §356(a)(2), if the exchange has the effect of a dividend, part of that gain can be treated as a dividend. Section 358 sets the basis of the stock received.
Treas. Reg. §1.368-1 adds judicial requirements. There must be a plan of reorganization and a business purpose. Continuity of interest requires that a substantial part of the target's value be preserved in the form of stock of the acquiring corporation. Continuity of business enterprise requires the acquirer to continue the target's historic business or use a significant portion of its historic business assets in a business.
Requirements and tests
Every reorganization must satisfy:
- One of the statutory forms in §368(a)(1), with its specific requirements (for example, 'solely for voting stock' in a B reorganization).
- A plan of reorganization adopted by the parties.
- A valid business purpose beyond tax savings.
- Continuity of interest: enough of the consideration must be acquirer stock; Treas. Reg. §1.368-1(e) gives an example in which 40% stock consideration is sufficient.
- Continuity of business enterprise under Treas. Reg. §1.368-1(d).
- Any step-transaction, control, or 'substantially all' requirements that apply to the chosen type.
How it works
In a qualifying merger, a target shareholder who receives only acquirer stock recognizes no gain. The shareholder's basis and holding period carry over to the new shares, so the gain is deferred until those shares are sold.
If the shareholder also receives cash, gain is recognized up to the amount of cash. Whether that gain is capital gain or a dividend depends on a comparison of the shareholder's ownership before and after the exchange. The new stock's basis is the old basis, reduced by the cash and increased by the gain recognized.
Some forms are less flexible. A B reorganization must be solely for voting stock, so even a small amount of cash can disqualify it. A C reorganization allows limited boot. Forward and reverse triangular mergers have their own requirements.
Parties often obtain a tax opinion from counsel before closing, and some request a private letter ruling for unusual facts. Both the corporations and significant shareholders have reporting obligations, including statements under Treas. Reg. §1.368-3.
Assumptions: Tax year 2026; the target shareholder is married filing jointly, lives in Texas, and has a $1,000,000 basis in target stock worth $10,000,000, held for more than one year.; In a qualifying statutory merger, the shareholder receives $8,000,000 of acquirer stock and $2,000,000 cash; the cash is assumed not to have the effect of a dividend.; Gain is taxed at 20% plus the 3.8% net investment income tax (23.8%), because the shareholder's other income already exceeds the $613,700 top of the 2026 joint 15% band and the $250,000 NIIT threshold.
| Gain realized ($10,000,000 − $1,000,000) | $9,000,000 |
|---|---|
| Gain recognized (limited to $2,000,000 of cash) | $2,000,000 |
| Tax on recognized gain (23.8%) | $476,000 |
| Basis in acquirer stock ($1,000,000 − $2,000,000 + $2,000,000) | $1,000,000 |
| Gain deferred in the acquirer stock ($8,000,000 − $1,000,000) | $7,000,000 |
| If the merger fails to qualify: gain recognized | $9,000,000 |
| If the merger fails to qualify: tax at 23.8% | $2,142,000 |
If the merger qualifies, the shareholder pays tax only on the $2,000,000 of cash and defers $7,000,000 of gain; if it fails, the full $9,000,000 gain is taxed now.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
The IRS can recast a transaction under the step-transaction doctrine, challenge continuity of interest when shareholders sell their new stock under a prearranged plan, or disqualify a transaction for lack of business purpose. If the reorganization fails, target shareholders generally recognize their full gain, and in an asset acquisition the target may be taxed on its asset gain as well.
Who it is not for
This is not for a seller who wants to be cashed out; a sale for cash is a taxable sale no matter how it is documented. It is not for a transaction in which the owners plan to sell the acquirer's stock right after closing under a prearranged plan. And it is not for anyone who has not confirmed that every requirement of the specific reorganization type is met.
How ebotCPA helps
We map the proposed transaction to the reorganization types, test continuity and boot, compute each shareholder's recognized gain and new basis, and prepare the required statements. We work alongside counsel who issues any tax opinion. We coordinate with your attorney, who drafts the legal documents.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
We coordinate with your attorney, who drafts the legal documents.
Frequently asked questions
What are the types of reorganizations?
IRC §368(a)(1) lists seven: A (statutory merger or consolidation), B (stock for voting stock), C (assets for voting stock), D (transfers to a controlled corporation), E (recapitalization), F (mere change in form), and G (bankruptcy).
Is cash in a reorganization taxable?
Yes. Under §356, gain is recognized up to the cash and other boot received, and part of it can be a dividend. In a B reorganization, any boot can disqualify the transaction.
How much stock is enough for continuity of interest?
The regulations look at the value of the acquirer stock relative to total consideration. Treas. Reg. §1.368-1(e) includes an example in which 40% stock consideration preserves continuity.
What happens if the reorganization fails?
Shareholders generally recognize their full gain as in a taxable sale, and in an asset acquisition the target corporation may also be taxed.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.