Spinoff Math: Divvying Up Your Cost Basis in H-P and Agilent

Can you make some sense of the calculation for the spinoff of Agilent (A) from Hewlett-Packard (HWP)? I find the formula published on Hewlett-Packard's Web site hard to follow.

-- Ron Dunn

Ron,

I read the information statement on the Hewlett-Packard's Web site. And let me tell you, the Calculus I took seemed less confusing. Even worse, the H-P site offers some conflicting information.

Here's what you need to know:

For every share of H-P you owned at 5 p.m. EDT on May 2, the record date, you received 0.3814 shares of Agilent. The company began distributing these shares to shareholders on June 2, says Randy Lane, company spokesman.

So you need to adjust the cost basis of your H-P shares to account for the spinoff. If you ever sell the H-P shares, the selling price minus your cost basis will determine your taxable gain.

Let's assume you bought 100 shares of H-P in January 1999 for $54. On May 2 of this year, you qualified for 38.14 shares of Agilent. (For the purposes of this example, we'll assume you didn't reinvest dividends.) You'll get the fractional share in cash, and it's subject to capital gains tax, either short-term or long-term, depending on how long you've held your H-P stock.

Your cost basis prior to the spinoff is $54 per share. The company has determined that 78.04% of that basis now is attributable to your H-P shares, and 21.96% should be allocated to your new Agilent shares.

For some reason, the percentages have been rounded to 78% and 22% on H-P's Web site. Ignore that. Use the exact percentage.

H-P's Web site makes a lame attempt to explain how these new basis percentages were derived. Should you care?

No.

Let the Internal Revenue Service worry about that. You've got enough to fret over trying to figure out your new cost basis in these shares.

In our example, the cost basis of each H-P share you bought for $54 now becomes $42.14 ($54 x 78.04%), and the basis in your 0.3814 share of Agilent is $11.86 ($54 x 21.96%). So the basis in one whole share of Agilent becomes $31.10 ($11.86 / 0.3814 share).

But remember, you started with 100 shares of H-P, and you got 38.14 shares of Agilent -- and that fractional share should have arrived in cash. So you need to determine your cost basis in that fractional Agilent share to know what you'll owe in capital gains tax.

In this example, the basis in that 0.14 share that arrived in cash is $4.35 ($31.10 x 0.14 share). So you will owe tax on the difference between the cash you receive and $4.35.

Since you pay tax on that fractional share, its basis is no longer part of your overall Agilent basis. You're left with 38 shares, each with a cost basis of $31.10, so your remaining Agilent basis is $1,181.80.

Whew.

Special thanks to Denise Davidson at CCH, a supplier of tax law information in Riverwoods, Ill., for helping with this monster.

H-P's Web site has an FAQ (frequently asked questions) that's not bad if you need to know administrative details, such as when you should have received your shares.

An Inherited House Full of Taxes

My mother died last year. Her house was sold, and the proceeds, after expenses, were split between my two brothers and myself. One of my brothers, a lawyer, told me the proceeds are not taxable to us because they represent an inheritance. He checked this with a tax consultant, who agreed. Do you?

-- William G. Daughan

William,

It depends on how much the house was sold for and how much your mother's estate was worth. There are two taxes to worry about -- capital gains and estate. Let's take capital gains first.

If the proceeds were greater than the house's appraised value, the excess is subject to capital gains tax.

The home should have been appraised before it was sold. Let's assume its fair market value was appraised at $500,000. If the house sold for $560,000, that extra $60,000 is subject to capital gains tax, says Sandy Schlesinger, partner and chairman of the wills and estates department at Kaye Scholer Fierman Hays & Handler, a New York law firm.

But who pays it? If the home was sold while still in your mother's estate, the estate would pay the tax. If the house was distributed to you and your brothers, and the three of you decided to sell it, you would split the capital gains tax. Assuming you all had equal ownership, you would each report $20,000 in long-term capital gains.

Now, the estate tax.

Everyone is entitled to a lifetime gift and estate tax exclusion of $675,000. If the house was the only asset in the estate and is worth less than $675,000, there should be no federal estate tax. (The state estate tax laws may be different.)

If your mother hadn't used up any of that exclusion in the past by giving away very large assets, the house should be free of estate tax.

If her estate was worth more than $675,000, any amounts above that would be taxable. But the estate would owe the tax, not you and your brothers. But your share of the estate would be reduced by the amount of the tax.

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