Determining whether boot received in an acquisitive reorganization has the effect of a dividend.

• Author: Ellentuck, Albert B.

Facts: Sara owns all the shares of Target Corp. After negotiations with Acquiring Corp., Sara agrees to merge Target into Acquiring. Both corporations are calendar-year S corporations. The reorganization will qualify as a type A acquisitive reorganization and is scheduled to close on January 1 of the following year. In the merger, Target will merge all of its assets and liabilities into Acquiring, and Sara's stock in Target will be converted into 175 shares of Acquiring stock worth $1,000 per share; she will also receive $75,000 cash. * Sara is concerned about the treatment of the cash payment and its effect on any gain realized on the merger. Issues: Is Sara required to recognize gain on the exchange of Target stock for Acquiring stock? Is the $75,000 cash payment equivalent to a distribution?

Analysis

The tax adviser should begin by reviewing the proposed merger and be satisfied that it will qualify as a type A merger. The tax adviser projects that Sara will have a $50,000 basis in her Target stock on the day of the merger. She will realize a gain of $200,000 on the exchange of her Target stock for Acquiring stock:

Amount realized: FMV of 175 shares of Acquiring stock $175,000 Cash 75,000 ------- 250,000 Less: Adjusted basis of Target stock 50,000 ------- Gain realized $200,000 =======

No gain or loss is recognized if stock or securities in a corporation that is a party to a reorganization are exchanged solely for stock or securities in the same or another corporation also a party to the reorganization. However, gain must be recognized to the extent of the gain realized or boot received, whichever is less. The recipient of the boot must treat the gain recognized as a distribution if the boot has the effect of the distribution of a dividend. In Clark, 489 US 726 (1989), the Supreme Court applied the Sec. 302(b) dividend equivalency rules for redemptions to determine whether the boot payment had the effect of a dividend. The Court held that in an acquisitive reorganization, the dividend equivalency rules should be applied post-reorganization to the acquiring corporation. The boot payment should be treated as a redemption of the acquiring corporation in a hypothetical redemption of the acquiring corporation's stock that the shareholder would have received if there had been no boot distribution.

In Rev. Rul. 93-61, the IRS held that in an acquisitive reorganization, boot is tested for dividend equivalency by comparing the interest the...