The diagram walks through a three-step merger of one corporation into another corporation’s disregarded entity. In the Initial Structure, Corp Y (the acquiror and combining entity) owns 100% of LLC X, a disregarded entity. Together Y and X form the “transferee combining unit.” Separately, the Z shareholders own Corp Z, the target and combining entity.
In the Merger step, Corp Z merges into LLC X under State W law. Because LLC X is disregarded, its assets are treated as owned by Corp Y for Federal income tax purposes. All of Z’s assets and liabilities pass into X, the Z shareholders surrender their Corp Z stock, and in exchange they receive Corp Y stock. Z’s separate legal existence ceases for all purposes.
At the Ending Point, the former Z shareholders own Corp Y, which continues to own LLC X 100%. Corp Y and LLC X remain one legal entity for U.S. tax purposes, and that single entity now holds the former Corp Z assets and liabilities.
Because the merger is effected under State W law, all of Z’s assets and liabilities become assets and liabilities of a member of the transferee unit (Y, whose disregarded entity X is treated as owned by Y), and Z ceases its separate existence, the transaction is a statutory merger that qualifies as a reorganization under § 368(a)(1)(A).
A statutory merger of a target corporation into a disregarded entity can be an A reorganization, because the disregarded entity’s assets are treated as owned by its regarded corporate owner. Treas. Reg. § 1.368-2(b)(1)(iii), Example 2.
The transferee “combining unit” is Corp Y (the combining entity) together with its disregarded LLC X; the transferor unit is Corp Z. Z’s assets and liabilities must become those of a member of the transferee unit.
The Z shareholders surrender their Corp Z stock and receive Corp Y stock, so proprietary interest in the target continues through stock of the acquiring corporation.
Under State W law all of Z’s assets and liabilities pass to X simultaneously at the effective time and Z’s separate legal existence ends for all purposes, meeting the requirements of paragraph (b)(1)(ii).
