United States

Tax Court rejected taxpayer’s claimed netting of gains and losses


When a shareholder separately acquires two or more blocks of stock, and later disposes of all the stock in a single transaction, tax rules generally require him or her to compute gain or loss separately for each block of stock. A recent Tax Court case (Tseytin v. Commissioner, T.C. Memo. 2015-247) illustrates this principle. 

The merger involved two companies that operated franchise restaurants.The taxpayer held 75 percent of the shares of the target company with a tax basis of zero. He bought the remaining 25 percent for $14 million about three weeks before the merger. In the merger, he received stock worth about $30.8 million, plus about $23.1 million of cash.

The shareholder’s receipt of stock was not taxable because the merger was a reorganization qualifying under section 368(a)(1)(A). The cash, however, was taxable “boot” under section 356(a) to the extent it did not exceed gain realized by the taxpayer on the exchange. 

To compute the gain realized required separate accounting for the two separately-acquired blocks of stock. Regulations allow parties to a reorganization to allocate boot to specific blocks, classes, or shares of stock in accordance with the terms of their exchange in an economically reasonable manner. Section 1.356-1(b). Agreeing to an allocation can mitigate shareholders’ tax liability for boot received in some circumstances. The parties did not do so here, however, so the shareholder’s cash received here was allocated in proportion to the fair market value of each block of stock he exchanged. 

The shareholder received about $17.3 million of cash with respect to the 75 percent block of stock, and about $5.8 million of cash with respect to the 25 percent percent block. He realized a gain of about $40.4 million on the 75 percent block, and a loss of about $0.5 million on the 25 percent block. Accordingly, the taxpayer was required to recognize $17.3 million of taxable capital gain– the amount of cash received with respect to the 75 percent block (which did not exceed the $40.4 million gain realized with respect to that block). 

The taxpayer presented two arguments for reducing the amount of his taxable gain, but the Tax Court rejected them as unsupportable. One argument involved an attempt to net the $0.5 million realized loss on the 25 percent block against the $17.3 million of boot received on the 75 percent block. The Tax court rejected this argument as contrary to section 356(c), which prohibits netting of amounts computed with respect to diferent blocks of stock. 

The other argument the taxpayer presented was that he was not the actual owner of the 25 percent block he had purchase three weeks before the merger. The Tax Court rejected that argument was not supported by persuasive evidence and contrary to the form of the transaction.  

The Tseytin case serves as a reminder that when a shareholder disposes of separately acquired blocks of stock, the gain and loss calculations are separate for each block of stock.  The taxpayer in Tseytin did not follow this principle, and the Tax Court upheld the IRS’ tax and penalty assessments.  


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