[Federal Register Volume 68, Number 16 (Friday, January 24, 2003)]
[Rules and Regulations]
[Pages 3384-3388]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-1544]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9038]
RIN 1545-BB46


Statutory Mergers and Consolidations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that define the 
term statutory merger or consolidation as that term is used in section 
368(a)(1)(A). These regulations affect corporations engaging in 
statutory mergers and consolidations, and their shareholders. The text 
of the temporary regulations also serves as the text of the proposed 
regulations set forth in the notice of proposed rulemaking on this 
subject in the proposed rules section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective January 24, 
2003.

FOR FURTHER INFORMATION CONTACT: Richard M. Heinecke or Reginald 
Mombrun at (202) 622-7930 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

A. Section 368(a) Generally

    The Internal Revenue Code of 1986 (Code) provides general 
nonrecognition treatment for reorganizations specifically described in 
section 368(a). Section 368(a)(1)(A) provides that the term 
reorganization includes ``a statutory merger or consolidation.'' 
Section 1.368-2(b)(1) currently provides that a statutory merger or 
consolidation must be ``effected pursuant to the corporation laws of 
the United States or a State or Territory or the District of 
Columbia.''

B. Disregarded Entities Generally

    A business entity (as defined in Sec.  301.7701-2(a)) that has only 
one owner may be disregarded as an entity separate from its owner for 
Federal tax purposes. Examples of disregarded entities include a 
domestic single member limited liability company that does not elect to 
be classified as a corporation for Federal tax purposes, a corporation 
(as defined in Sec.  301.7701-2(b)) that is a qualified REIT subsidiary 
(within the meaning of section 856(i)(2)) (hereinafter referred to as 
``QRS''), and a corporation that is a qualified subchapter S subsidiary 
(within the meaning of section 1361(b)(3)(B)) (hereinafter sometimes 
referred to as ``QSub'').
    Because a QRS and QSub are corporations under state law, state 
merger laws generally permit them to merge with other corporations. In 
addition, many state merger laws permit a limited liability company 
(LLC) to merge with another LLC or with a corporation.

C. Previous Proposals of Regulations

    On May 16, 2000, the IRS and Treasury issued a notice of proposed 
rulemaking (REG-106186-98; 65 FR 31115) (hereinafter referred to as the 
2000 proposed regulations) providing that neither the merger of a 
disregarded entity into a corporation nor the merger of a corporation 
into a disregarded entity would qualify as a reorganization under 
section 368(a)(1)(A). While commentators generally agreed that the 
merger of a disregarded entity into a corporation should not qualify as 
a reorganization under section 368(a)(1)(A), commentators asserted that 
the merger of a corporation into a disregarded entity with a corporate 
owner should be able to qualify as a reorganization under section 
368(a)(1)(A).
    On November 15, 2001, after consideration of the comments received 
regarding the 2000 proposed regulations, the IRS and Treasury withdrew 
the 2000 proposed regulations (REG-106186-98; 66 FR 57400) and issued 
another notice of proposed rulemaking (REG-126485-01; 66 FR 57400) 
(hereinafter referred to as the 2001 proposed regulations).
    The 2001 proposed regulations provide that, for purposes of section 
368(a)(1)(A), a statutory merger or consolidation must be effected 
pursuant to the laws of the United States or a State or the District of 
Columbia. Pursuant to such laws, the following events must occur 
simultaneously at the effective time of the transaction: (1) All of the 
assets (other than those distributed in the transaction) and 
liabilities (except to the extent satisfied or discharged in the 
transaction) of each member of one or more combining units (each a 
transferor unit) become the assets and liabilities of one or more 
members of one other combining unit (the transferee unit); and (2) the 
combining entity of each transferor unit ceases its separate legal 
existence for all purposes. For this purpose, a combining entity is a 
business entity that is a corporation (as defined in Sec.  301.7701-
2(b)) that is not a disregarded entity)

[[Page 3385]]

and a combining unit is a combining entity and all of its disregarded 
entities.
    The 2001 proposed regulations provide that the merger of a 
disregarded entity into a corporation will not qualify as a statutory 
merger or consolidation under section 368(a)(1)(A) because all of the 
transferor unit's assets may not be transferred to the transferee unit 
and the separate legal existence of the combining entity of the 
transferor unit does not terminate as a matter of law. The 2001 
proposed regulations, however, generally provide that the merger of a 
corporation into a disregarded entity will qualify as a statutory 
merger or consolidation if it satisfies the requirements of the 
regulations.
    No public hearing regarding the 2001 proposed regulations was 
requested or held. Nonetheless, a number of written comments were 
received.

Explanation of Provisions

    The IRS and Treasury have studied the comments received regarding 
the 2001 proposed regulations. Although the IRS and Treasury are 
continuing to study a number of the comments received regarding the 
proposed regulations, in response to a number of comments requesting 
immediate guidance in this area upon which taxpayers may rely, the IRS 
and Treasury are promulgating these regulations as temporary 
regulations in this Treasury Decision. The temporary regulations retain 
the general framework of the 2001 proposed regulations, but make 
certain modifications in response to comments received. The following 
sections describe a number of the most significant comments and the 
extent to which they have been incorporated in these temporary 
regulations. Further changes to the temporary regulations, however, are 
possible before these regulations are finalized.

A. Definition of Combining Entity

    As described above, the 2001 proposed regulations define a 
combining entity as a business entity that is a corporation that is not 
a disregarded entity. Although the preamble to the 2001 proposed 
regulations clarifies that, for this purpose, the term corporation is 
defined as provided in Sec.  301.7701-2(b), commentators requested that 
that clarification also be provided in the text of the regulations. In 
response to these comments, the temporary regulations provide that a 
combining entity is a corporation (as defined in Sec.  301.7701-2(b)) 
that is not a disregarded entity.

B. The All of the Assets Requirement

    As stated above, the 2001 proposed regulations require that all of 
the assets of a transferor unit become the assets of a transferee unit. 
A number of comments were received regarding this requirement. The 
following paragraphs describe these comments and the extent to which 
the temporary regulations reflect them.
    One comment suggested that the regulations be amended to clarify 
that whether the all of the assets requirement is satisfied is 
determined by reference to the assets of the transferor unit 
immediately prior to the merger. These temporary regulations add an 
example that illustrates that a transaction that is preceded by a 
distribution by the transferor unit to its shareholders may qualify as 
a statutory merger under these temporary regulations, even if the 
``substantially all'' requirement applicable to certain other types of 
reorganizations would not be satisfied. The example is provided solely 
to illustrate the meaning of the all of the assets requirement. No 
inference is intended regarding the shareholder level and other tax 
consequences of the transaction described therein.
    Another comment stated that the proposed regulations are unclear as 
to whether a transaction in which an entity that is disregarded as an 
entity separate from the combining entity of the transferor unit 
becomes an entity that is disregarded as an entity separate from the 
combining entity of the transferee unit satisfies the all of the assets 
requirement. These temporary regulations amend Example 2 of the 2001 
proposed regulations, as described below, to clarify that this 
transaction may satisfy the all of the assets requirement and, 
therefore, qualify as a statutory merger or consolidation.

C. The Cessation of Separate Legal Existence Requirement

    The 2001 proposed regulations require that the combining entity of 
each transferor unit ``ceases its separate legal existence for all 
purposes.'' One comment requested that the phrase ``for all purposes'' 
be deleted from this requirement. The comment suggested that under some 
corporate laws a merged corporation may continue its existence for a 
specified time period and for certain limited purposes, such as 
bringing and defending against lawsuits. This limited continued 
existence of a combining entity of a transferor unit, the comment 
suggested, should not prevent a transaction from being treated as 
failing to satisfy the requirement that the combining entity of each 
transferor unit cease its separate legal existence for all purposes.
    The IRS and Treasury do not believe that the deletion of ``for all 
purposes'' from the regulation will alter the terms of the requirement. 
Nonetheless, these temporary regulations provide that this requirement 
will be satisfied even if, pursuant to the laws of the United States or 
a State or the District of Columbia, after the effective time of the 
transaction, the combining entity of the transferor unit (or its 
officers, directors, or agents) may act or be acted against, or a 
member of the transferee unit (or its officers, directors, or agents) 
may act or be acted against in the name of the combining entity of the 
transferor unit, provided that such actions relate to assets or 
obligations of the combining entity of the transferor unit that arose, 
or relate to activities engaged in by such entity, prior to the 
effective time of the transaction, and such actions are not 
inconsistent with the all of the assets requirement.

D. Example 2 of the 2001 Proposed Regulations

    A number of comments were received regarding Example 2 of the 2001 
proposed regulations, which involves the merger of a target corporation 
into a disregarded entity. The last sentence of the facts of Example 2 
states that, ``[p]rior to the transaction, [the combining entity of the 
transferor unit] is not treated as owning any assets of an entity that 
is disregarded as an entity separate from its owner for Federal tax 
purposes.'' One commentator indicated that it is not clear why this 
fact is relevant to the conclusion that the transaction qualifies as a 
statutory merger or consolidation and suggested either deleting or 
clarifying this fact.
    As described above, in order to qualify as a statutory merger or 
consolidation, all of the assets of a transferor unit must become 
assets of the transferee unit. In order to determine whether this 
requirement has been satisfied, it is necessary to know whether the 
combining entity of the transferor unit owns the interests of any 
entity that is disregarded as an entity separate from its owner for 
Federal tax purposes. The last sentence of the facts of Example 2 was 
merely intended to convey the fact that the only assets of the 
transferor unit were those that the combining entity owned directly. To 
clarify the significance of this fact, the temporary regulations amend 
the analysis in Example 2 to indicate that the transaction would still 
qualify as a statutory merger or consolidation even if the combining 
entity of the transferor unit were treated as owning assets of an

[[Page 3386]]

entity that is disregarded as an entity separate from the combining 
entity of the transferor unit for Federal tax purposes, provided that 
those assets become assets of the transferee unit.

E. Additional Examples

    One commentator suggested that the scope of the proposed 
regulations be clarified through additional examples. The following 
paragraphs describe the suggested examples and the extent to which they 
have been incorporated in these temporary regulations.
1. QSub That Becomes a C Corporation
    A QSub may cease to be a disregarded entity because of an event 
that renders the subsidiary ineligible for QSub status, such as a 
merger into an entity owned by a C corporation. For example, suppose Z, 
an S corporation, owns all of the stock of B, a QSub, and Z merges with 
and into X, an entity that is disregarded as an entity separate from Y, 
a C corporation. B's status as a QSub will terminate at the end of the 
day on which the merger occurs. See Treas. Reg. Sec.  1.1361-
5(a)(1)(iii). A commentator suggested that, in this case, it is not 
clear whether B is a member of the transferor unit. If B were treated 
as a member of the transferor unit, the transaction may not qualify as 
a statutory merger or consolidation because the assets of B may not 
become assets of the transferee unit. If, however, B were not treated 
as a member of the transferor unit, the transaction may qualify as a 
statutory merger or consolidation. The commentator suggested that B 
should not be treated as a member of the transferor unit. 
Alternatively, the commentator suggested that the principles of Example 
9 of Sec.  1.1361-5(b)(3) could be applied to this case. In Example 9 
of Sec.  1.1361-5(b)(3), the acquisition of the stock of a QSub is 
treated as a transfer of the QSub's assets followed by the transfer of 
those assets by the acquirer to a new corporation.
    The IRS and Treasury agree with the commentator that the principles 
illustrated by Example 9 of Sec.  1.1361-5(b)(3) apply to determine 
whether the merger of Z into X qualifies as a statutory merger or 
consolidation. In particular, the transaction should be treated as a 
transfer of B's assets to X followed by a transfer of such assets by X 
to a new corporation. Accordingly, the transaction may qualify as a 
statutory merger or consolidation provided that the other requirements 
of a statutory merger or consolidation are satisfied. These temporary 
regulations include an example illustrating this result.
2. Transitory Surviving Disregarded Entity
    One commentator suggested that the 2001 proposed regulations be 
amended to provide an example in which the surviving disregarded entity 
in an otherwise qualifying statutory merger or consolidation is 
transitory. For example, suppose corporation Z merges into X, an entity 
that is disregarded as separate from corporation Y. In the transaction, 
the shareholders of Z exchange their Z stock for Y stock. Immediately 
after the merger of Z into X and as part of a plan that includes that 
merger, X merges into Y. The commentator noted that, in Rev. Rul. 72-
405 (1972-2 C.B. 217), the IRS held that a forward triangular merger of 
a target corporation into a newly formed controlled corporation of a 
parent corporation followed by the liquidation of the controlled 
corporation into the parent corporation would be treated as a 
reorganization under section 368(a)(1)(C) rather than a reorganization 
under sections 368(a)(1)(A) and 368(a)(2)(D). The commentator suggested 
that the principles of Revenue Ruling 72-405 should not be applied to 
prevent the merger of Z into X from qualifying as a reorganization 
under section 368(a)(1)(A).
    The IRS and Treasury agree that the merger of Z into X followed by 
the merger of X into Y does not implicate the principles of Revenue 
Ruling 72-405. Because the merger of X into Y does not alter the 
identity of the tax owner of the former assets of X, that merger would 
be disregarded. The IRS and Treasury do not believe that an additional 
example is necessary to illustrate this result.

F. The Domestic Entity Requirement

    The 2001 proposed regulations provide that a transaction in which 
any of the assets and liabilities of a combining entity of a transferor 
unit become assets and liabilities of one or more disregarded entities 
of the transferee unit cannot qualify as a statutory merger or 
consolidation unless such combining entity, the combining entity of the 
transferee unit, such disregarded entities, and each business entity 
through which the combining entity of the transferee unit holds its 
interests in such disregarded entities is organized under the laws of 
the United States or a State or the District of Columbia. One 
commentator suggested that where an entity that is disregarded as an 
entity separate from the combining entity of the transferor unit 
becomes an entity that is disregarded as an entity separate from the 
combining entity of the transferee unit, whether such disregarded 
entity is organized under the laws of the United States or a State or 
the District of Columbia is not relevant to whether the transaction 
qualifies as a statutory merger or consolidation. The IRS and Treasury 
agree and have clarified the domestic entity requirement to exclude 
such disregarded entities.
    Another comment suggested that the domestic entity requirement be 
eliminated for the disregarded entity into which a target corporation 
is merged and each business entity through which the combining entity 
holds its interests in the disregarded entity into which a target 
corporation is merged. Although these temporary regulations retain that 
requirement for those entities, as described in the preamble to the 
2001 proposed regulations, the IRS and Treasury are continuing to 
consider further revisions to the regulations under section 
368(a)(1)(A) to address statutory mergers and consolidations that 
involve one or more foreign corporations, including transactions 
involving a disregarded entity.

Special Analyses

    It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because the regulation does not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of 
the Code, these temporary regulations will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these temporary regulations is Richard M. 
Heinecke, Office of Associate Chief Counsel (Corporate). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and record keeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:


[[Page 3387]]


    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec.  1.368-2, paragraph (b)(1) is revised to read as 
follows:


Sec.  1.368-2  Definition of terms.

* * * * *
    (b)(1) For rules regarding statutory mergers or consolidations on 
or after January 24, 2003, see Sec.  1.368-2T(b)(1). For rules 
regarding statutory mergers or consolidations before January 24, 2003, 
see Sec.  1.368-2(b)(1) as in effect before January 24, 2003 (see 26 
CFR part 1, revised April 1, 2002).
* * * * *
    Par. 3. Section 1.368-2T is added to read as follows:


Sec.  1.368-2T  Definition of terms (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.368-2(a).
    (b)(1)(i) Definitions. For purposes of this paragraph (b)(1), the 
following terms shall have the following meanings:
    (A) Disregarded entity. A disregarded entity is a business entity 
(as defined in Sec.  301.7701-2(a) of this chapter) that is disregarded 
as an entity separate from its owner for Federal tax purposes. Examples 
of disregarded entities include a domestic single member limited 
liability company that does not elect to be classified as a corporation 
for Federal tax purposes, a corporation (as defined in Sec.  301.7701-
2(b) of this chapter) that is a qualified REIT subsidiary (within the 
meaning of section 856(i)(2)), and a corporation that is a qualified 
subchapter S subsidiary (within the meaning of section 1361(b)(3)(B)).
    (B) Combining entity. A combining entity is a business entity that 
is a corporation (as defined in Sec.  301.7701-2(b) of this chapter) 
that is not a disregarded entity.
    (C) Combining unit. A combining unit is composed solely of a 
combining entity and all disregarded entities, if any, the assets of 
which are treated as owned by such combining entity for Federal tax 
purposes.
    (ii) Statutory merger or consolidation generally. For purposes of 
section 368(a)(1)(A), a statutory merger or consolidation is a 
transaction effected pursuant to the laws of the United States or a 
State or the District of Columbia, in which, as a result of the 
operation of such laws, the following events occur simultaneously at 
the effective time of the transaction--
    (A) All of the assets (other than those distributed in the 
transaction) and liabilities (except to the extent satisfied or 
discharged in the transaction) of each member of one or more combining 
units (each a transferor unit) become the assets and liabilities of one 
or more members of one other combining unit (the transferee unit); and
    (B) The combining entity of each transferor unit ceases its 
separate legal existence for all purposes; provided, however, that this 
requirement will be satisfied even if, pursuant to the laws of the 
United States or a State or the District of Columbia, after the 
effective time of the transaction, the combining entity of the 
transferor unit (or its officers, directors, or agents) may act or be 
acted against, or a member of the transferee unit (or its officers, 
directors, or agents) may act or be acted against in the name of the 
combining entity of the transferor unit, provided that such actions 
relate to assets or obligations of the combining entity of the 
transferor unit that arose, or relate to activities engaged in by such 
entity, prior to the effective time of the transaction, and such 
actions are not inconsistent with the requirements of paragraph 
(b)(1)(ii)(A) of this section.
    (iii) Statutory merger or consolidation involving disregarded 
entities. A transaction effected pursuant to the laws of the United 
States or a State or the District of Columbia in which any of the 
assets and liabilities of a combining entity of a transferor unit 
become assets and liabilities of one or more disregarded entities of 
the transferee unit is not a statutory merger or consolidation within 
the meaning of section 368(a)(1)(A) and paragraph (b)(1)(ii) of this 
section unless such combining entity, the combining entity of the 
transferee unit, such disregarded entities other than entities that 
were disregarded entities of the transferor unit immediately prior to 
the transaction, and each business entity through which the combining 
entity of the transferee unit holds its interests in such disregarded 
entities is organized under the laws of the United States or a State or 
the District of Columbia.
    (iv) Examples. The following examples illustrate the rules of 
paragraph (b)(1) of this section. In each of the examples, except as 
otherwise provided, each of V, Y, and Z is a domestic C corporation. X 
is a domestic limited liability company. Except as otherwise provided, 
X is wholly owned by Y and is disregarded as an entity separate from Y 
for Federal tax purposes. The examples are as follows:

    Example 1. Divisive transaction pursuant to a merger statute. 
(i) Under State W law, Z transfers some of its assets and 
liabilities to Y, retains the remainder of its assets and 
liabilities, and remains in existence following the transaction. The 
transaction qualifies as a merger under State W corporate law. Prior 
to the transaction, Y is not treated as owning any assets of an 
entity that is disregarded as an entity separate from its owner for 
Federal tax purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets 
and liabilities of Z, the combining entity of the transferor unit, 
do not become the assets and liabilities of Y, the combining entity 
and sole member of the transferee unit. In addition, the transaction 
does not satisfy the requirements of paragraph (b)(1)(ii)(B) of this 
section because the separate legal existence of Z does not cease for 
all purposes. Accordingly, the transaction does not qualify as a 
statutory merger or consolidation under section 368(a)(1)(A).
    Example 2. Merger of a target corporation into a disregarded 
entity in exchange for stock of the owner. (i) Under State W law, Z 
merges into X. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z become the assets and liabilities of X 
and Z's separate legal existence ceases for all purposes. In the 
merger, the Z shareholders exchange their stock of Z for stock of Y. 
Prior to the transaction, Z is not treated as owning any assets of 
an entity that is disregarded as an entity separate from its owner 
for Federal tax purposes.
    (ii) The transaction satisfies the requirements of paragraph 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z, the combining entity and sole member of 
the transferor unit, become the assets and liabilities of one or 
more members of the transferee unit that is comprised of Y, the 
combining entity of the transferee unit, and X, a disregarded entity 
the assets of which Y is treated as owning for Federal tax purposes, 
and Z ceases its separate legal existence for all purposes. 
Paragraph (b)(1)(iii) of this section does not apply to prevent the 
transaction from qualifying as a statutory merger or consolidation 
for purposes of section 368(a)(1)(A) because each of Z, Y, and X is 
a domestic entity. Accordingly, the transaction qualifies as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A). The result would be the same if Z were treated as 
owning assets of an entity that is disregarded as an entity separate 
from Z, regardless of whether such disregarded entity became an 
entity disregarded as an entity separate from Y as a result of the 
transaction, or merged into X or a domestic entity disregarded as an 
entity separate from Y.
    Example 3. Merger of a target S corporation that owns a QSub 
into a disregarded entity. (i) The facts are the same as in Example 
2, except that Z is an S corporation and owns all of the stock of U, 
a QSub.
    (ii) The deemed formation by Z of U pursuant to Sec.  1.1361-
5(b)(1) (as a consequence of the termination of U's QSub election) 
is disregarded for Federal income tax purposes. The transaction is 
treated as a transfer of the assets of U to X, followed by X's 
transfer of these assets to U in exchange for stock of U. See Sec.  
1.1361-5(b)(3), Example 9. The transaction will, therefore, satisfy 
the

[[Page 3388]]

requirements of paragraph (b)(1)(ii) of this section because the 
transaction is effected pursuant to State W law and the following 
events occur simultaneously at the effective time of the 
transaction: all of the assets and liabilities of Z and U, the sole 
members of the transferor unit, become the assets and liabilities of 
one or more members of the transferee unit that is comprised of Y, 
the combining entity of the transferee unit, and X, a disregarded 
entity the assets of which Y is treated as owning for Federal tax 
purposes, and Z ceases its separate legal existence for all 
purposes. Paragraph (b)(1)(iii) of this section does not apply to 
prevent the transaction from qualifying as a statutory merger or 
consolidation for purposes of section 368(a)(1)(A) because each of 
Z, Y, and X is a domestic entity. Moreover, the deemed transfer of 
the assets of U in exchange for U stock does not cause the 
transaction to fail to qualify as a statutory merger or 
consolidation. See Sec.  368(a)(2)(C). Accordingly, the transaction 
qualifies as a statutory merger or consolidation for purposes of 
section 368(a)(1)(A).
    Example 4. Triangular merger of a target corporation into a 
disregarded entity. (i) The facts are the same as in Example 2, 
except that V owns 100 percent of the outstanding stock of Y and, in 
the merger of Z into X, the Z shareholders exchange their stock of Z 
for stock of V. In the transaction, Z transfers substantially all of 
its properties to X.
    (ii) The transaction is not prevented from qualifying as a 
statutory merger or consolidation under section 368(a)(1)(A), 
provided the requirements of section 368(a)(2)(D) are satisfied. 
Because the assets of X are treated for Federal tax purposes as the 
assets of Y, Y will be treated as acquiring substantially all of the 
properties of Z in the merger for purposes of determining whether 
the merger satisfies the requirements of section 368(a)(2)(D). As a 
result, the Z shareholders that receive stock of V will be treated 
as receiving stock of a corporation that is in control of Y, the 
combining entity of the transferee unit that is the acquiring 
corporation for purposes of section 368(a)(2)(D). Accordingly, the 
merger will satisfy the requirements of section 368(a)(2)(D).
    Example 5. Merger of a target corporation into a disregarded 
entity owned by a partnership. (i) The facts are the same as in 
Example 2, except that Y is organized as a partnership under the 
laws of State W and is classified as a partnership for Federal tax 
purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section. All of the assets and 
liabilities of Z, the combining entity and sole member of the 
transferor unit, do not become the assets and liabilities of one or 
more members of a transferee unit because neither X nor Y qualifies 
as a combining entity. Accordingly, the transaction cannot qualify 
as a statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 6. Merger of a disregarded entity into a corporation. 
(i) Under State W law, X merges into Z. Pursuant to such law, the 
following events occur simultaneously at the effective time of the 
transaction: all of the assets and liabilities of X (but not the 
assets and liabilities of Y other than those of X) become the assets 
and liabilities of Z and X's separate legal existence ceases for all 
purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets 
and liabilities of a transferor unit do not become the assets and 
liabilities of one or more members of the transferee unit. The 
transaction also does not satisfy the requirements of paragraph 
(b)(1)(ii)(B) of this section because X does not qualify as a 
combining entity. Accordingly, the transaction cannot qualify as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 7. Merger of a corporation into a disregarded entity in 
exchange for interests in the disregarded entity. (i) Under State W 
law, Z merges into X. Pursuant to such law, the following events 
occur simultaneously at the effective time of the transaction: all 
of the assets and liabilities of Z become the assets and liabilities 
of X and Z's separate legal existence ceases for all purposes. In 
the merger of Z into X, the Z shareholders exchange their stock of Z 
for interests in X so that, immediately after the merger, X is not 
disregarded as an entity separate from Y for Federal tax purposes. 
Following the merger, pursuant to Sec.  301.7701-3(b)(1)(i) of this 
chapter, X is classified as a partnership for Federal tax purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because immediately after 
the merger X is not disregarded as an entity separate from Y and, 
consequently, all of the assets and liabilities of Z, the combining 
entity of the transferor unit, do not become the assets and 
liabilities of one or more members of a transferee unit. 
Accordingly, the transaction cannot qualify as a statutory merger or 
consolidation for purposes of section 368(a)(1)(A).
    Example 8. Merger transaction preceded by distribution. (i) Z 
operates two unrelated businesses, Business P and Business Q, each 
of which represents 50 percent of the value of the assets of Z. Y 
desires to acquire and continue operating Business P, but does not 
want to acquire Business Q. Pursuant to a single plan, Z sells 
Business Q for cash to parties unrelated to Z and Y in a taxable 
transaction, and then distributes the proceeds of the sale pro rata 
to its shareholders. Then, pursuant to State W law, Z merges into Y. 
Pursuant to such law, the following events occur simultaneously at 
the effective time of the transaction: all of the assets and 
liabilities of Z related to Business P become the assets and 
liabilities of Y and Z's separate legal existence ceases for all 
purposes. In the merger, the Z shareholders exchange their Z stock 
for Y stock. Prior to the transaction, Z is not treated as owning 
any assets of an entity that is disregarded as an entity separate 
from its owner for Federal tax purposes.
    (ii) The transaction satisfies the requirements of paragraph 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z, the combining entity and sole member of 
the transferor unit, become the assets and liabilities of Y, the 
combining entity and sole member of the transferee unit, and Z 
ceases its separate legal existence for all purposes. Paragraph 
(b)(1)(iii) of this section does not apply to prevent the 
transaction from qualifying as a statutory merger or consolidation 
for purposes of section 368(a)(1)(A) because each of Z and Y is a 
domestic entity. Accordingly, the transaction qualifies as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A).

    (v) Effective dates. This paragraph (b)(1) applies to transactions 
occurring on or after January 24, 2003. Taxpayers, however, may apply 
these regulations in whole, but not in part, to transactions occurring 
before January 24, 2003, provided that, if the taxpayer is the 
acquiring corporation (or a shareholder of the acquiring corporation 
whose tax treatment of the transaction reflects the tax treatment by 
the acquiring corporation, such as a shareholder of an acquiring S 
corporation), the target corporation (and the shareholders of the 
target corporation whose tax treatment of the transaction reflects the 
tax treatment by the target corporation) also applies these regulations 
in whole, but not in part, to the transaction, and if the taxpayer is 
the target corporation (or a shareholder of the target corporation 
whose tax treatment of the transaction reflects the tax treatment by 
the target corporation), the acquiring corporation (and the 
shareholders of the acquiring corporation whose tax treatment of the 
transaction reflects the tax treatment by the acquiring corporation) 
also applies these regulations in whole, but not in part, to the 
transaction. For all other transactions, see Sec.  1.368-2(b)(1) as in 
effect before January 24, 2003 (see 26 CFR part 1, revised April 1, 
2002).
    (b)(2) through (k) [Reserved]. For further guidance, see Sec.  
1.368-2(b)(2) through (k).

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
    Approved: January 17, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-1544 Filed 1-23-03; 8:45 am]
BILLING CODE 4830-01-P