In some cases, such as the Schering-Plough merger with Merck, the cash portion of a "cash to boot" merger is treated as a redemption (sale) of a portion of the original stock. This treatment is more favorable to the taxpayer than the normal "cash to boot" rules where the entire cash portion may be capital gain. However, if you owned any of the acquiror's stock (Merck) before the merger, you must meet one of the three tests set forth in Section 302 of the Internal Revenue Code before you can treat the cash proceeds as a redemption.
The three tests are as follows:
1. Substantially Disproportionate Test If the percentage of outstanding shares owned in the acquiring company after the merger is less than 80% of the percentage of the outstanding shares owned in the target company before the merger, redemption treatment may be used. 2. Not Essentially Equivalent to a Dividend Test If the percentage interest of a shareholder in the combined companies after the merger is less than the percentage interest in the target company before the merger, redemption treatment may be used. 3. Complete Termination Test If all the shares of the target company are sold or disposed of contemporaneously with the completion of the merger as part of a single integrated plan which includes participation in the merger, redemption may be used.
What does "redemption treatment" mean? It means that the cash portion of the merger is treated as sales proceeds and cost basis is deducted to arrive at the capital gain or loss. This is also called "sale or exchange" treatment. The alternative if none of the Section 302 tests are met is to treat the cash portion as a taxable dividend (not reduced by any cost basis) so the entire cash portion is income.
All of this is totally beyond the average taxpayer, but that's why we are here to help.
Click on the image to the right to access our calculator for the Section 302 tests described above.
The data values for the recent Schering-Plough/Merck "cash to boot" merger have been pre-filled for you.