Revenue Ruling 83-58: The Test for Boot in Mergers

Revenue Ruling 83-58 is an Internal Revenue Service (IRS) pronouncement for shareholders who receive a mix of stock and cash in a corporate merger. When a shareholder exchanges shares for stock in an acquiring company plus cash, that cash is called “boot.” The ruling provides the method for determining whether this boot is taxed as a capital gain or as a dividend distribution. This distinction is important because capital gains and dividends are often subject to different tax rates and treatments under the Internal Revenue Code.

The Transactional Context

The principles of Revenue Ruling 83-58 are applied within a corporate reorganization known as a “Type A” reorganization. This is a statutory merger or consolidation where one corporation acquires another. In these transactions, shareholders of the target company often receive a combination of stock in the new entity and other property, most commonly cash.

This additional consideration is termed “boot.” The presence of boot means the exchange is not entirely tax-free for the shareholder. While the stock-for-stock portion of the exchange qualifies for nonrecognition of gain or loss, the boot is treated differently. The receipt of cash triggers the recognition of any realized gain, up to the amount of cash received.

The Analytical Framework of the Ruling

Revenue Ruling 83-58 provides a hypothetical sequence to analyze the tax character of boot. The ruling instructs that the transaction should be viewed as if the target shareholder first exchanged all of their old stock solely for stock in the acquiring corporation. Then, the acquiring corporation is treated as having redeemed a portion of that newly issued stock from the shareholder for the cash boot that was received.

This hypothetical redemption is then tested under the principles of Internal Revenue Code Section 302(b) to determine its tax treatment. This section provides tests to distinguish between a stock redemption that is a sale versus one that is equivalent to a dividend. The tests look for a “meaningful reduction” in the shareholder’s proportionate interest in the corporation. For instance, the “substantially disproportionate” test is met if the shareholder’s voting stock ownership after the redemption is less than 80% of their ownership before it.

If the hypothetical redemption results in a significant reduction of the shareholder’s ownership, it is treated as a sale or exchange, and the boot is taxed as a capital gain. If the redemption does not meaningfully reduce their stake, the cash is considered a dividend distribution. The tax impact depends on whether the distribution is a “qualified dividend,” taxed at capital gains rates, or a non-qualified dividend, taxed at higher ordinary income rates.

The Clark Supreme Court Decision

The analytical approach in Revenue Ruling 83-58 was not universally accepted at first, leading to conflicting interpretations among courts. The issue was settled by the United States Supreme Court in its 1989 decision, Commissioner v. Clark. The case involved a shareholder who received both stock and cash in a merger and disputed the IRS’s characterization of the boot as a dividend.

The Supreme Court endorsed the post-reorganization redemption framework outlined in Revenue Ruling 83-58. It rejected an alternative view that would have tested the cash payment as a redemption made by the target corporation before the merger. The Clark decision solidified the ruling’s methodology as the legal standard for analyzing boot in reorganizations.

The Court’s decision confirmed that the proper way to measure the reduction in a shareholder’s interest is by comparing their hypothetical all-stock interest in the acquiring company with their actual post-merger interest after receiving the cash. This ensures the dividend equivalency test properly reflects the shareholder’s continuing stake in the combined enterprise. As a result of Clark, the framework of Revenue Ruling 83-58 is the established authority used today.