Consider the following facts to quantify the tax costs of various taxable acquis

Question

Consider the following facts to quantify the tax costs of various taxable acquisition sturctures when the target is a freestanding C corporation. Wolverine Inc., wants to purchase Reel Deal., in a taxable acquisition.  Reel Deal is a freestanding C corporation with a net asset tax basis of $250.  Reel Deal has no NOLs and is currently owned by five shareholders that have a basis in their Reel Deal stock of $5.  Wolverine is planning to offer $10,000 for all of the assets of Reel Deal.  The corporate tax rate is 40%, the after-tax rate discount rate is 15%, and the shareholder-level capital gains tax rate is 20%.

a.  How much cash after tax will the shareholders of Reel Deal have in a taxable asset sale at a price of $10,000?

b.  What is Wolverine's net after-tax cost of this transaction assuming that any step-up in Reel Deal's assets are amortized/depreciated over 15 straight-line, the appropriate corporate tax rate is 40%, and the after-tax discount rate is 15%?

c.  What price could Wolverine pay for Reel Deal in a taxable stock acquisistion without a Section 338 election?

      What would Wolverine's net after-tax cost of this structure be?

d.  Given the price computed in part c, what would ADSP be if Wolverine decided to make the Section 338 election?  What would Wolverine's net after-tax cost be with this structure of taxable stock sale with a Section 338 election?

e.  Which stucture should be used n this acquistion?

1.  Taxable stock sale with 338 election

2.  Taxable stock sale with no 338 election

3.  Non taxable stock sale using residual valuation approach under Section 1060

4.  Taxable stock sale using Section 197

5.  Taxable stock sale limited by Section 382

Why?

Explanation / Answer

Your post asks two specific questions but raises one major issue.

C CORPORATION

A "C Corporation" is named for "Subchapter C" of the Internal Revenue Code (specifically: Title 26, Subtitle A, Chapter 1, Subchapter C). Similarly, an "S Corporation" is named for "Subchapter S" of the same code.

Under the code, a C Corporation is taxed on its own net income. If a C Corporation gives some or all of its after-tax net income to its shareholders -- which is called a "stock dividend" -- then the shareholders themselves are taxed on the amount they receive. On the other hand, if a C Corporation suffers a net loss, the shareholders cannot deduct any part of the loss on their personal returns. Thus, a "C Corporation" is taxed as a separate entity from its owners, the shareholders.

S CORPORATION

Under the code, an S Corporation is not taxed on its own net income. Instead, the net income or net loss of an S Corporation is passed directly through to its owners (thus, it is called a "pass through entity", like a partnership). Thus, there is no tax directly on an S Corporation and, if the S Corporation suffers a net loss, the loss can be deducted by the shareholders. Therefore, an S Corporation is not taxed as a separate entity from its owners, the shareholders.

Two side notes.

(1) Contrary to a previous response, an S Corporation is not required to distribute any of its cash (or income or retained earnings). Moreover, there are no penalties for failing to distribute its cash, income or retained earnings. Again, an S Corporation is a pass-through entity, so its shareholders include on their individual returns their share of the corporation's net income (or deduct their share of its losses), irrespective of whether or not they actually receive any portion of the income.

(2) To clarify another response, it is not the "taxes" of an S Corporation which pass-through to its shareholders. Instead, it is the "income" (technically each of the separate items of income and expense) that pass-through.

MAJOR ISSUE: PERSONAL INVESTMENT COMPANY

The major issue is raised by your description of your having formed your corporation "earlier this year to claim my stock and options trading as a business and avoid the capital gains taxes that come with short term trading."

You have described a Personal Investment Company ("PHC"), which is a type of Personal Holding Company ("PHC"). This involves very complex and potentially dangerous classification issues, because you and your corporation could be subject to significant tax penalties on undistributed income.

This area is too complex for most tax accountants and tax attorneys, You should consult a _highly qualified_ tax attorney to ensure that you avoid such classification and potential penalties.

Please re-post if we can provide further information -- and consider re-posting in the US tax category.

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