spin-offs, mergers, and acquisitions as a shareholder

In short

A friend of mine once opened his mail and found shares of a company he had never heard of. He thought it was a mistake. It was a spin off, and it happens more often than folks expect. If you own a stock, you may someday see your company split, merge, or get bought. Each event changes what you hold, and each carries its own tax rules. Your broker and the company will send notices, and those notices matter. A shareholder who keeps them has an easy time at tax season. The cost basis, which is what you paid, often gets divided or moved around, and the IRS wants it tracked.

The whole of it

What it is

I once watched a neighbor trade a pickup truck for a smaller truck and a boat, and he came out feeling like he had the same wealth in a different shape. That is a fair picture of a spin off. A parent company takes one of its business units and sets it free as its own public company. You, as a shareholder, get new shares in that fresh company, usually in proportion to what you already own. You keep your old shares too.

A merger works differently. Two companies join into one. The shareholders of one or both companies receive shares in the combined business, or cash, or some mix of the two. An acquisition is close kin. One company buys another, and the shareholders of the bought company are paid in cash, in the buyer's stock, or in both.

You have probably noticed that the news calls all of this deal making. For a shareholder, the real question is simpler. What lands in my account, and what does the taxman say about it? Fair question. Worth asking early.

How it works

If you are holding shares when a spin off happens, the parent company sets a record date. A person who owns the stock on that date gets the new shares. Your broker posts them to your account, and sometimes you get a small cash payment for a fractional share, which is a piece of a share too small to hand out whole.

A friend of mine who worked in a brokerage back office told me the paperwork is the hard part. When a spin off or merger closes, the company reports how the deal changes basis. The company must file IRS Form 8937, Report of Organizational Actions Affecting Basis of Securities, and post it on its investor relations page. That form shows how to split the original cost basis between the old and new shares. That form is a shareholder's best friend in these deals, because it shows how the basis gets divided.

In a merger paid in stock, the rules often let the shareholder put off paying tax. The deal is called tax free if it meets the requirements of the Internal Revenue Code, and the shareholder carries the old cost basis over to the new shares. In a cash deal, the shareholder has sold. The gain or loss is the cash received minus the basis, and it gets reported on the tax return for that year. A mixed deal splits the difference, and the shareholder may owe tax on the cash part only.

Holding period matters too. If you held the old shares for more than one year, a gain on the cash part is a long term gain. If the shares were held a year or less, it is a short term gain, taxed at ordinary rates. Those long term rates are set by law and change by year, so check the current brackets at the current figure, which the official source publishes each year.

The numbers, and where to find yours

I once helped an aunt look for a number buried in a drawer of old statements. We found it, but it took an afternoon. A shareholder who keeps basis records in one place saves that afternoon.

Your cost basis lives on your broker's cost basis page and on your trade confirmations. For a spin off or merger, the allocation between old and new shares comes from the company's Form 8937, and the company posts it for the public. The Internal Revenue Service explains basis in Publication 550, Investment Income and Expenses, and Publication 551, Basis of Assets. Both are free on irs.gov.

Your broker also reports sales on Form 1099-B. For shares you bought in recent years, the broker must track basis and report it. For older shares, the form may show the basis as missing, and then the job lands on the shareholder. Old purchase records are what fill that gap.

The long term capital gains rates, and the income thresholds where they change, are set by law each year. The current figures are at the current figure, which the official source publishes each year. A higher income may also bring the net investment income tax, found at the current figure, which the official source publishes each year.

A worked example

Let me tell you about a woman named Marlene. She owns 200 shares of Harbor Foods, which she bought for $40 a share. Her total basis is 200 shares times $40, which is $8,000.

One spring, Harbor Foods spins off its snack division as a new company called Crisp Co. Marlene gets 1 share of Crisp for every 4 shares of Harbor. She owns 200 shares, so 200 divided by 4 is 50 shares of Crisp.

The company posts its Form 8937. It says that 80 percent of the original basis stays with Harbor and 20 percent moves to Crisp. Marlene works it out. Her basis in Harbor is 80 percent of $8,000, which is $6,400. Her basis in Crisp is 20 percent of $8,000, which is $1,600. Check the sum. $6,400 plus $1,600 is $8,000. Good.

Her Harbor shares now have a per share basis of $6,400 divided by 200, which is $32. Her Crisp shares have a per share basis of $1,600 divided by 50, which is also $32. She owes no tax on the spin off itself.

Two years later, Crisp is bought for cash at $50 a share. Marlene receives 50 times $50, which is $2,500. Her gain is $2,500 minus $1,600, which is $900. She held the Crisp shares for the same time she held the Harbor shares, since the holding period carries over in a spin off. That is more than one year, so the $900 is a long term gain. She reports it on her return for that year, and the rate comes from the bracket tables at the current figure, which the official source publishes each year.

Not so bad. Just paperwork.

Where it goes wrong

A fellow I know ignored a letter from his broker and paid for it later. The usual trouble starts with lost records. If the basis is not split, the broker may show the entire old basis on one stock and zero on the other. Then the shareholder reports too much gain and pays tax that was never owed.

Another snag is the cash in lieu of a fractional share. That small payment counts as a sale. The gain is tiny, but it still goes on the return.

A third snag is the type of deal. Some spin offs and mergers fail to meet the tax free tests, and then the receipt of shares is taxed. The company's notice will say which one applies. Read the notice, and when in doubt, ask a tax professional, because the rules are technical and a mistake is costly.

People also forget the wash sale rule. I once watched a neighbor sell a losing stock in December and buy it right back in January, sure he had banked the loss. The IRS explains the wash sale rule in Publication 550, and the idea is plain. A loss can be disallowed when the seller buys the same stock, or stock that is substantially identical, close to the date of the sale. The window is set by the rule, so read that publication for the exact days. The calendar decides whether a loss counts.

One more trap is the shareholder vote. In some deals, a shareholder with a stake may have appraisal rights, which let the holder ask a court to set a fair price in place of the offer. Those rights come from state law and carry strict deadlines. A missed deadline means the right is gone.

Questions to answer before you leave this page

If you are holding a stock that just announced a spin off, a merger, or a sale, have you found the company's notice and its Form 8937? Do you know your original cost basis, and can you prove it with a statement or a confirmation? Has your broker split the basis correctly between the old shares and the new ones, and does it match the company's numbers? Was the deal paid in stock, in cash, or both, and which part of it is taxable this year? Did you hold the shares more than one year, and which long term rate applies to you? Are there fractional shares that were cashed out, and have you counted that small gain? Could a wash sale touch any trade you made near the deal? And have you put the notices, the forms, and your math in one folder, so that a year from now you are not digging through a drawer like my aunt?