In a tax‑free reorganization, shareholders can receive boot (cash or other property) in addition to stock. Under § 356(a)(1), the shareholder recognizes gain to the extent of the boot (or the gain realized, whichever is less). But if the exchange “has the effect of the distribution of a dividend,” the boot is treated as a dividend (ordinary income) to the extent of the shareholder’s share of E&P. § 356(a)(2).
So how do you tell whether boot has the effect of a dividend? In Commissioner v. Clark, 489 U.S. 726 (1989), the Supreme Court adopted a post‑reorganization redemption approach. Clark owned all the stock of Basin. In a triangular merger, he received 300,000 shares of NL (the acquirer) and $3.25 million cash. He could have taken 425,000 shares of NL instead. The Court held the boot was not a dividend. It viewed the transaction as if Clark had taken 425,000 shares, then had NL redeem 125,000 shares for cash. That redemption met the substantially disproportionate test of § 302(b)(2) (Clark’s interest was reduced from 1.3% to 0.9%, less than 80% of his pre‑redemption interest, and he owned less than 50% after). So the boot was capital gain.
The Court rejected the Commissioner’s pre‑reorganization approach, which would have treated the boot as if Basin had paid a dividend before the reorganization. That approach would have made all boot a dividend in most cases.
The Clark test requires knowing the value of the acquiring corporation’s stock and the number of shares outstanding. If the boot represents a substantial reduction in the shareholder’s interest (like in Clark), it’s capital gain. If the shareholder’s interest doesn’t change much, the boot may be a dividend.
So if you’re negotiating a reorganization and want to take some cash, try to structure it so that your stock interest is meaningfully reduced – otherwise, you’re looking at dividend treatment.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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