We Reach Out and Help Someone Calculate the Cost Basis of Vodafone AirTouch Shares

I received shares of AirTouch Communications, when it was spun off from Pacific Telesis back in April 1994. That transaction created no tax liability. Vodafone bought AirTouch in June 1999, and last week I learned that my broker has reported to the Internal Revenue Service the full value of the Vodafone stock I got for my AirTouch.

In addition, when Vodafone bought AirTouch, there was a cash distribution of about 10% of the value of the transaction. What do you want to bet that was designed to cover the tax liability for the U.S. shareholders?

All I saw was a change of ticker symbols. Why do I have to pay tax? How do I figure the cost basis in the AirTouch to determine the gain? Do I have to go back to the Pacific Telesis days and take a percentage of that basis proportional to the relative value of the two stocks on the day of the spinoff?

-- Harry Stanton

Harry,

Just because the Vodafone-AirTouch merger qualified as "tax-free" doesn't mean you won't pay tax on the extra cash they put in your pocket.

So pour yourself a cup of coffee and break out the calculator. We've got numbers to crunch, and, yes, you have to go back to the Pacific Telesis days to get the ball rolling.

This exercise should be good practice for you, if you own any of the companies that resulted from the 1984 breakup of AT&T (T Quote). The way those companies recombine and spawn new ones, these questions will inevitably come up again.

Let's start at the beginning. AirTouch was spun off from Pacific Telesis in April 1994. (Pacific Telesis was later acquired by SBC Communications (SBC Quote).) So before you start considering the Vodafone deal, you need to allocate your cost basis in Pacific Telesis to the AirTouch shares you received.

You got one share of AirTouch for each share of Pacific Telesis you owned in a nontaxable transaction. According to the terms of the deal, 60.17% of your original basis was allocated to your Pacific Telesis shares, and the remaining 39.83% went to the new AirTouch shares.

For simplicity's sake, let's assume you owned one share of Pacific Telesis pre-spinoff, and you paid $100 for it. After the spinoff, you now have one share of Pacific Telesis and one share of AirTouch. If you allocate your $100 basis accordingly, $39.83 applies to AirTouch and $60.17 goes to Pacific Telesis.

Easy so far, right?

Fast forward to June 1999, when U.K.-based Vodafone acquired AirTouch. The combined company changed its name to Vodafone AirTouch (VOD Quote).

AirTouch shareholders had to surrender their shares in exchange for 0.5 shares of Vodafone AirTouch and $9 in cash.

Hint: If you're getting cash, count on having to pay some tax.

Here's where it gets hairy. The amount on which you'll owe tax is the lesser of:

• The cash received, or

• The fair market value of the sum of your new Vodafone AirTouch share and the cash received minus the cost basis of the AirTouch share you surrendered.

Let's try to put some numbers to this.

The cash you received is $9.

The fair market value of one share of the combined company on June 30 was $197. You got half of that, or $98.50. Add in the $9 cash distribution and you received $107.50 for your old AirTouch share. Now you have to subtract your basis in the share you're giving up. In our example above, your basis is $39.83 (your actual basis will differ from our example). Subtract that from the $107.50, and you have $67.67.

The lesser of the two figures, $67.67 and $9, is taxable. So you'll pay long-term capital gains tax on the $9.

OK. On to your new basis in your Vodafone AirTouch shares.

Going back to our example, your original basis in the AirTouch share was $39.83.

According to the terms of the merger, your new basis in the Vodafone AirTouch equals the basis of the AirTouch share you gave up plus the amount of capital gain you must recognize, reduced by the amount of cash received when you exchanged shares.

In our example, your original basis was $39.83. Add $9 (the capital gain recognized) and subtract $9 (the cash received).

So we're back to your original basis. Your new 0.5 share of the new company now has a basis of $39.83. This might not work out so neatly, if your original cost basis is less than the cash received.

When your Form 1099B-- Proceeds from Broker and Barter Exchange Transactions arrives, just the cash portion should be reported on your tax return.

A hearty thanks to Denise Davidson, an editor and analyst at CCH, a supplier of tax law information in Riverwoods, Ill., who patiently held my hand as we trod through this convoluted transaction.

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