Smeal College of Business Taxation and Management Decisions: ACCTG 550Pennsylvania State University Professor HuddartMergers and Acquisitions ProblemsThese problems illustrate the variety of ways in which assets transfersmay be taxed, and also some of the ways in which basis is adjusted.(1) Cain owns a tract of land with a cost basis of $15,000. He exchangesthe tract with Abel for a tract of land worth $85,000, plus $4,000cash. Assume for tax purposes this is a like-kind exchange [26 U.S.C.1031]. Assume for financial accounting purposes this is an exchange ofproductive assets—assets employed in production rather than held forsale in the ordinary course of business—for similar productive assets[APB29¶7].• How much gain does Cain recognize?These questions are based on problems by Richard Sansing.cSteven Huddart, 1995–2005. All rights reserved. www.smeal.psu.edu/faculty/huddartACCTG 550 M&A• What is the tax basis of Cain’s new land?• What is the financial accounting?Page 2M&A ACCTG 550(2) We Be Toys (WBT) is a corporation owned by Alan Schwartz. WBThas two divisions, a game division and a toy division. Alan wishes toretire, and has received three offers for WBT. He can:a. sell his stock to Amalgamated Toys for $1,000,000;b. have WBT sell the toy division to Toy Box for $600,000 and the gamedivision to Avalon Hill for $700,000, then liquidate the corporation; or,c. exchange his stock for a 1% interest in Three Initial Corporation (TIC).The TIC stock is worth $875,000; it pays constant annual dividends of$87,500, does not appreciate, and Alan will never have to sell the stock.Alan can invest his proceeds from a sale or liquidation in 10% taxablebonds. Alan’s basis in WBT stock is $600,000, and WBT’s basis in itsassets is $400,000. WBT’s tax rate is 34%, and Alan’s tax rate is 28%.Rank Alan’s three alternatives.Page 3ACCTG 550 M&A(3) Joel, Rick, and Amir each own1/3of the shares of T Corporation; theyeach have a basis of $500 in their stock. T owns property with a taxbasis of $1,000. P Corporation transfers $1,600 of its own stock and $800cash to T in exchange for all of T’s assets and liabilities; T distributesthe P shares equally to Joel and Rick and the cash to Amir in exchangefor their stock in liquidation of T. The transaction qualifies as a type ‘A’reorganization. An ‘A’ reorganization is a statutory merger under statelaw. The name comes from §368(A) of the US tax code. The effectof this provision is that gains are taxed only to the extent of “boot”received and only at the shareholder level.• How much gain is recognized by T?• How much gain is recognized by Joel?• What is Joel’s basis in his newly acquired P stock?• How much gain is recognized by Amir?• What is the tax basis of T’s assets in the hands of P?Page 4M&A ACCTG 550(4) T Corporation owns real property with a tax basis of $400 and a fairmarket value of $1000. Shareholder S owns all the stock in T. S’s basisin the T Corp. stock is $600. T Corp.’s tax rate is 30%. P purchases T’sstock for $1,100 cash, liquidates T, and makes an election to treat thestock purchase as an asset purchase under §338. This is an election totreat the transaction as a sale of assets followed by a liquidation. Thismeans two rounds of tax are levied, one at the corporate level and oneat the shareholder level.• Assume P pays for T’s tax via a capital contribution. How much gainis recognized by T?• How much gain is recognized by S?• What is the tax basis of the land in the hands of P?• What is the tax basis of T’s goodwill?Page