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

• Author: Ellentuck, Albert B.

Facts: Sara owns all the outstanding shares of Target Corp. After extensive negotiations with Acquiring Corp., Sara agrees to merge Target into Acquiring. Both corporations are calendar-year S corporations.* The reorganization is structured to qualify as a Type A acquisitive reorganization and is scheduled to close on January 1 of the following year.* In the merger, Target win transfer all of its assets and liabilities to Acquiring, and Sara will exchange all her stock in Target for 175 shares of Acquiring stock (worth $1,000 per share) and $75,000 cash. Acquiring has five unrelated shareholders who own all 1,000 shares of its currently outstanding stock.* Sara is concerned about the tax treatment of the cash payment and its effect on any gain realized on the merger. Issues: Must Sara recognize gain on the exchange of Target stock for Acquiring stock?* Is the $75,000 cash payment equivalent to a distribution?

Analysis

A tax adviser should begin by reviewing the proposed transaction and be satisfied that it will qualify as a Type A merger. Sara's tax adviser projects that she 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, determined as follows:

Amount realized: Fair market value (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 that is also a party to the reorganization. However, gain must be recognized to die extent of the gain realized or boot received, whichever is less. The recipient of the boot must treat the gain recognized on the exchange 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 a boot payment had the effect of a dividend distribution. The Court held that, in an acquisitive reorganization, the dividend equivalency rules should be applied post-reorganization to the acquiring corporation. Thus, 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...