The IRS reviews revenue procedure 81-70: the stakes for taxpayers are high.

• Author: Keppler, Juliane Laura
• Position: Determining the tax basis of stock acquired in tax-free corporate acquisitions

With billions of tax dollars at stake, the Internal Revenue Service has undertaken a review of Revenue Procedure 81-70, a seemingly innocuous revenue procedure that addresses the methodology employed in determining tax basis of the stock acquired in certain types of tax-free corporate acquisitions. Given the plethora of the stock acquisitions in the 1990s and subsequent corporate re structurings and reorganizations, the review could be anything but innocuous. Indeed, any procedure that establishes the gain or loss of such a transaction could be monumentally significant. This article discusses the issues raised by the IRS's review.

Background

An acquiring corporation can acquire the shares of stock of a target corporation through a tax-free stock-for-stock exchange in two common ways. The first way is through a direct exchange with the target corporation's shareholders, commonly known as a "B" reorganization. The acquiring corporation has a total tax basis in the stock received equal to the total tax basis that the transferor shareholders had in the shares surrendered. (This is also known as carryover basis or outside basis.) The acquiring company has the burden of collecting the data regarding the tax basis of the shares surrendered.

The second way to acquire the shares of stock of a target corporation is through a reverse stock merger, commonly referred to as an (a)(2)(E) reorganization. In general, reverse stock mergers dwarf "B" reorganizations in number and dollar value. The acquiring corporation may elect from two methods how it determines its total tax basis in the stock received. The first method allows the use of the "B" reorganization rules and hence carryover basis. The second method has the total tax basis in the shares received equal to the total basis that the target corporation has in its assets, net of liabilities. In many cases, the total basis using the first method (outside basis) has been found to be upward of four times greater than the total basis using the second method (inside basis).

Consider this scenario: There is a multi-billion dollar stock-for-stock merger, where the outside basis of the acquired target's stock is $1 billion, and the inside basis is only $250 million. A few years and a corporate reorganization later, the stock is sold for $300 million. Using the inside basis results in a $50-million gain. If the outside basis had been identified, there would be a $700-million loss, a seemingly more palatable...