Taxes and Business Decisions 351of the General Utilities doctrine. He was further disappointed when reminded
that even subchapter S corporations recognize all built-in gain that existed at
the time of their subchapter S election, if their assets are sold within 10 years
after their change of tax status.
As a result of the previous considerations, Morris was determined to avoid
structuring the sale of his corporation as a sale of its assets and liabilities, to
avoid any tax on the corporate level. He was already determined not to structure
it as a sale of stock by the target stockholders, because he was not entirely sure
Brad could be trusted to sell his shares. If he could structure the transaction at
the corporate level, he would not need Brad’s minority vote to accomplish it.
Thus, after intensive negotiations, he was pleased that the acquiring corporation
had agreed to structure the acquisition as a merger between Plant Supply and a
subsidiary of the acquirer (to be formed for the purpose of the transaction). All
stockholders of Plant Supply would receive a cash down payment and a five-
year promissory note from the parent acquirer in exchange for their stock.
Yet even this careful preparation and negotiation leaves Morris, Lisa, and
Brad in jeopardy of unexpected tax exposure. To begin with, if the transaction
remains as negotiated, the IRS will likely take the position that the assets of
the target corporation have been sold to the acquirer, thus triggering tax at the
corporate level. In addition, the target’s stockholders will have to recognize as
proceeds of the sale of their stock both the cash and the fair market value of
the promissory notes in the year of the transaction, even though they will re-
ceive payments on the notes over a period of five years.
Under the General Utilities doctrine, a corporation that was selling sub-
stantially all its assets needed to adopt a “plan of liquidation” prior to entering
into the sale agreement to avoid taxation at the corporate level. The repeal of
the doctrine may have left the impression that the adoption of such a liquida-
tion plan is unnecessary because the sale will be taxed at the corporate level in
any event. Yet, the Code still requires such a liquidation plan if the stockhold-
ers wish to recognize notes received upon the dissolution of the target corpo-
ration on the installment basis. Moreover, the liquidation of the corporation
must be completed within 12 months of adoption of the liquidation plan.
Thus, Morris’s best efforts may still have led to disaster. Fortunately, a
small adjustment to the negotiated transaction can cure most of these prob-
lems. Through an example of corporate magic known as the reverse triangular
merger, the newly formed subsidiary of the acquirer may disappear into Mor-
ris’s target corporation, but the target’s stockholders can still be jettisoned for
cash, leaving the acquirer as the parent. In such a transaction, the assets of the
target have not been sold; they remain owned by the original corporation. Only
the target’s stockholders have changed. In effect, the parties have sold stock
without the necessity of getting Brad’s approval. Because the assets have not
changed hands, there is no tax at the corporate level. In addition, since the tar-
get corporation has not liquidated, no plan of liquidation is required, and the
target stockholders may elect installment treatment as if they had sold their
shares directly (see Exhibit 11.9).