A Cash and Stock Merger on Your Tax Return: What You Need to Know

Begin by congratulating both KSU and Canadian Pacific Railway on their successful merger (CP). There is no joy in getting an unexpected tax bill due to December 2021’s merger, so we’ll attempt to describe the details below.
The following are the regulations that apply when cash or property is obtained as part of a merger or transaction that is otherwise exempt from taxation: You initially apply or transfer your original cost basis to the equity of the acquiring firm. A part of your cost basis will be deducted from the purchase price of the acquiring company’s shares if your cost basis is higher. Any additional cash or property acquired in addition to the stock is taxed again if the cost basis of the acquiring company’s shares is less than or equal to your cost basis.

An Exemplification of the First Observation

For a total merger consideration of $20,000, you paid $15,000 for the acquiring company’s shares and $5,000 in cash when you first purchased the stock for $10,000. To put it another way, in this scenario, you have $10,000 in the purchasing company’s stock (which is now worth $15,000) plus $5,000 in realised capital gains (since your cost basis was less than or equal to the stock received of the acquiring company).

Second Case Study

KSU stockholders got 2.884 shares of CP and $90 in cash in December 2021 for each share of KSU stock they held prior to the merger between KSU and CP.

For example, if you held 1,000 shares of KSU when it merged, how would you record that transaction on your 2021 tax return?

  • Shareholders who acquired shares in KSU more than a year ago paid $65,000.00 (or $65.00 per share).
  • CP stock and cash totaled $298,657.40 in merger consideration.
  • 1,001 KSU shares and 2.884 CP shares, each at $72.35 on the day of the transaction, equate to $208,657.40 in CP stock.
  • (1,000 shares of KSU x $90 cash per share): $90,000
  • There was no additional payment for fractional shares since the stock conversion resulted in a full number (i.e., 2,884.00 shares vs 2,884.50 shares).
  • It costs $65,000 to buy 2,884 new shares of CP, which works out to $22.54 per share. There was no change in the cost base (explained below).

$90,000 was realised and reported in 2021 as a long-term capital gain. Because the individual’s cost basis was lower than the shares acquired from the acquiring business, the cash received is recognised as a capital gain in the year of receipt (CP in this case). KSU was likewise kept unmodified under the new CP cost base, which was also the case.

Case Study #3:

In this scenario, what if fractional CP shares were created? What would be the ramifications for tax computation if such were the case? Instead of having 1,000 shares of KSU, what if you had 1,150 stock options?

  • Shares acquired more than a year ago were originally purchased at a cost basis of $65,000, or $56.52 each.
  • Cash and CP stock totaled $343,456.01 in merger consideration.
  • 1,150 KSU shares x 2.884 CP shares x $72.35 = 3,316 CP stock value $239,912.60 (1,150 KSU shares x 2.884 CP shares x $72.35 = 3,316 CP stock)
  • (1,000 shares of KSU x $90 cash per share): $103,500
  • The $43.41 (CP shares at $72.35 x 0.60) cash in lieu of fractional shares (the outcome of 3,316.60 CP shares conversion to 3,316.00 CP shares): $31.65, which will be regarded as a capital gain in 2021.
  • [$43.41 cash for a fractional share of CP stock-(19.60 new CP cost basis per share * 0.60 shares)]. It is necessary to divide the original KSU cost basis by 3,616.60 CP shares in order to arrive at the new CP cost basis, which is equal to 65,00 dollars.
  • $64,988.24 / $19.60 = CP’s new cost base as of today. In order to calculate the capital gain on cash received in lieu of fractional shares, the new CP cost basis equals the KSU cost basis minus $11.76.

A long-term capital gain of $103,531.65 ($103,500 cash plus $31.65 cash in lieu of fractional shares) was realised and declared in the tax year 2021. Because the individual’s cost basis was lower than the shares acquired from the acquiring business, the cash received is recognised as a capital gain in the year of receipt (CP in this case).

The fourth and last case study:

Is there a scenario in which you didn’t realise as much of a profit on the position when the transaction occurred? What if instead of $65,000, you paid $280,000 for 1,150 shares of stock?

  • acquired more than one year ago.
  • Cash and CP stock totaled $343,456.01 in merger consideration.
  • $3,316.60 worth of CP stock (3,316.60 shares of CP stock valued at $239,912.60 (1,150 KSU shares x 2.884 CP stock shares @ $72.35 on day of transaction)
  • (1,000 shares of KSU x $90 cash per share): $103,500
  • The outcome of converting 3,316.60 CP to 3,316.00 CP is $43.41 of which $0.00 will be taxed as a capital gain in 2021.
  • capital gain calculation: $0.00 [$43.41 cash obtained for a fractional share of CP stock – ($72.35 cost basis per share * 0.60 shares)]
  • CP’s new cost base is now $239,912.60, or $72.35 per share. The new CP cost basis matches the price of CP shares on the day of the transaction since the KSU cost basis was larger than the quantity of CP stock obtained in the merger.

As of the end of the year, KSU had accumulated a long-term capital gain of $63,456.01 (the difference between the value of the 3,316.60 KSU shares and the value of the cash obtained from the sale of the stock), which would be reported in the tax year 2021. The $280,000 initial KSU cost basis is more than the amount of CP stock acquired, thus only a portion of the cash received is recognised as a capital gain. As a result, the amount received is taxed as a capital gain until the remaining cost basis is spent up.

Case Study No. 5:’s

The stock and cash combination between CP and KSU occurred less than a year before you purchased KSU shares. Any gains earned would be taxed at the ordinary income tax rates for Federal taxes if they were short-term capital gains. Short-term capital gains are taxed at the lower long-term capital gains tax rate of 15%.

To prevent any fines, you should be aware that the realised capital gain component of these transactions may require an estimated tax payment for both the federal and state (depending on which state you reside in).

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