The following article is adapted and reprinted from the M&A Tax Report, Vol. 10, No. 6, January 2002, Panel Publishers, New York, NY.


By Robert W. Wood

As we pointed out recently in these pages, step transaction doctrine authority doesn't come along too often. See Wood, "Revisiting the Step Transaction Doctrine," Vol. 10, No. 5, The M&A Tax Report (Dec. 2001), p. 1. Only occasionally does the Service weigh in on this important and perennial topic. Revenue Ruling 2001-46, 2001-42 I.R.B. 321 provides an important statement of the IRS' position on the step transaction doctrine as applied to stock acquisitions and certain mergers. There are two situations presented in the ruling. Both involve a common set of facts.

Parent corporation forms a Subsidiary corporation for the sole purpose of acquiring an unrelated Target corporation. Subsidiary then merges into Target with Target surviving. As part of an integrated plan, Target then merges into Parent with Parent surviving. In Situation 1, Target's shareholders receive consideration consisting of 70% voting stock of Parent and 30% cash. In Situation 2, Target's shareholders receive solely voting stock of Parent as consideration for the merger. The ruling gives important insights not only into the Service's views about the step transaction doctrine, but also into the more specific question of the circumstances under which a transitory merger will be disregarded.

Cash and Stock

The first situation involves the combination of Parent voting stock and cash. The ruling concludes that the Subsidiary/Target merger cannot qualify as either an A or E reorganization if the Target/Parent merger is ignored, simply because of the large amount of cash involved. The Subsidiary/Target merger could, however, be treated as a qualified stock purchase under Section 338 as long as this transaction is examined without regard to the Target/Parent merger.

On this point, Revenue Ruling 90-95 is the pertinent authority, suggesting that the step transaction doctrine should not be applied. The question in Situation 1 of Revenue Ruling 2001-46, though, is whether this Revenue Ruling 90-95 approach should apply when the step transaction doctrine would otherwise apply to treat a stock acquisition as qualifying as a reorganization.

Once upon a time, the IRS issued Revenue Ruling 67-274, 1967-2 C.B. 141. There, Corporation Y acquired all of the stock of Corporation X in exchange for some of the voting stock of Y. Thereafter, X was completely liquidated into Y. Revenue Ruling 67-274 concludes that, because the two steps were part of a plan of reorganization, they cannot be considered separately. Thus, the steps do not qualify as a reorganization followed by a liquidation, but instead qualify as an acquisition of X's assets in a C reorganization.

If this approach were applied to Situation 1 in Revenue Ruling 2001-46, the transaction would be treated as an integrated acquisition of Target's assets by Parent in a single statutory merger (without a preliminary stock acquisition). Thus, unless the policies underlying Section 338 would otherwise dictate, an integrated asset acquisition would simply be treated as a statutory merger of Target into Parent, qualifying as an A reorganization. The ruling thus advises that it is necessary to determine whether the approach of Revenue Ruling 90-95 applies where the step transaction doctrine would otherwise apply to treat the acquisition as an asset acquisition qualifying as a reorganization.

An all cash acquisition (a topic raised in Situation 2 of Revenue Ruling 90-95) coupled with a subsequent liquidation, would not qualify as a reorganization. An all cash deal would involve no continuity of interest. Here, Revenue Ruling 2001-46 finds it appropriate to apply the step transaction doctrine to both mergers in Situation 1, because treating the overall transaction of statutory merger of Target into Parent would qualify as an A reorganization. No purpose of Section 338 would be frustrated, because Parent ends up with a carryover basis in Target's assets.

Steps in a Whole

Thus, Situation 1 of Revenue Ruling 2001-46 says that in appropriate cases the IRS will use the step transaction doctrine for a stock acquisition coupled with a merger, if this results in a transaction that will qualify as a reorganization. If the acquisition cannot, as a whole, qualify as a reorganization by use of the step transaction doctrine, then the transaction will be treated as: (1) a taxable sale, plus; (2) a stock purchase (the latter may or may not be a qualified stock purchase under Section 338); and finally (3) a separate liquidation under Section 332. Presumably this same kind of analysis could apply to a stock acquisition that could be recharacterized as an asset acquisition qualifying as a reorganization.

In Situation 2 in Revenue Ruling 2001-46, the only difference is that the acquisition merger, if viewed independently of the upstream merger, would qualify as an A reorganization. According to the ruling, this difference does not change the result. Thus, the transaction is treated as a single statutory merger of Target into Parent, qualifying as an A reorganization.

Situation 1 in this ruling may not be too enlightening, but it does help answer a question that has caused practitioners to scratch their heads for some years. Before Section 338 was enacted, would the IRS have reached the same conclusion regarding the step transaction doctrine in Revenue Ruling 67-274 if the stock acquisition/liquidation of Target into Parent could not have qualified as a C reorganization? Most people tended to think the answer was no, so that this would have been treated as a stock acquisition followed by a Section 332 liquidation. This view is certainly strengthened by Revenue Ruling 2001-46.

So, in appropriate cases (a nettlesome phrase that we'll come back to later), the IRS is going to apply the step transaction doctrine if it results in a transaction qualifying as a reorganization. If the acquisition cannot qualify as a reorganization (with or without the step transaction doctrine), then the transaction will simply be treated as a taxable sale and stock purchase.

When Is a Step a Step?

Of course, the big question here is not tackled in the ruling. That question is just when it is appropriate to apply the step transaction doctrine and when it is not. In the language of Revenue Ruling 2001-46, what are the appropriate cases or circumstances?

In particular, should the step transaction doctrine apply to recharacterize the tax treatment of one side of an acquisition, based on the unilateral action taken by another party to the deal? Early authority had suggested that at least some degree of cooperation between the target and the buyer was needed. See Revenue Ruling 72-405.

Interestingly, Revenue Ruling 2001-46 does not deal with the specific factors that will make the step transaction doctrine apply. Rather, the ruling gives the results in the two situations presented only if the step transaction doctrine applies. The ruling refers to the mergers as being part of a plan, and as an integrated asset acquisition. Of course, earlier revenue rulings have essentially done the same thing. Revenue Ruling 67-202 found transitory control over a target lacked substance, since that control was merely the initial step of a pre-arranged plan to liquidate the target. Likewise, Revenue Ruling 67-274 refers to a stock acquisition as pursuant to a plan of reorganization, with the liquidation of the target being part of the same plan.


It seems unlikely that we will get any definitive guidance from the Service on exactly when it thinks the mystical step transaction doctrine should take effect. Of course, there is plenty of authority out there dealing with binding commitments, mutual interdependence, and the fatalistic "end result" test.

Step Transaction Doctrine and Mergers, Vol. 10, No. 6, M&A Tax Report (January 2002), p. 6.