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Golden West Deal Has Golden Tax Treatment

The mortgage lenders' agreement with Wachovia bucks the trend toward 'divorce insurance.'

Updated from May 10

Golden West Financial


shareholders -- from Herb and Marion Sandler on down -- have reason to rejoice. And it's not just because of the premium bid from


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Unlike many other recent M&A transactions, this one stipulates that the stock that Golden West shareholders get from the North Carolina bank's acquisition will be tax free. Shareholders of the West Coast mortgage lender will only be taxed on the cash portion of the transaction.

On the basis of terms of the $25 billion deal announced Sunday, Golden West shareholders will receive 1.051 shares of Wachovia common stock and $18.65 in cash for each Golden West share. The Sandlers stand to gain an estimated $2.25 billion from the deal, which valued each 308.55 million of Golden West's shares at $81.07, a 15% premium over Golden West's May 5 closing price. Wachovia agreed to pay a combination of cash and stock, with 77% of the price in Wachovia stock and 23% in cash. (On Wednesday, Golden West shares closed at $74.66; Wachovia shares at $55.20.)

The Golden West-Wachovia deal bucks the recent trend of structuring M&A cash-and-stock deals with so-called divorce insurance, which puts a tax burden on the target company's shareholders. (See below for more details on the tax savings for Golden West shareholders.)

"Where you have the husband and wife team of Golden West as large shareholders, it is probably not doable," Robert Willens, tax and accounting analyst at Lehman Brothers, says of the divorce insurance structure. "Otherwise, there is no question this is going to be the dominant approach to doing cash and stock deals."

Indeed, several recent acquisitions have been structured so that the acquiring company puts a tax burden on the target company's shareholders. This is done by structuring the deal so that it does not qualify as a "reorganization" for IRS purposes.

This distinction means that the target's shareholders will be taxed on their gains on the stock they receive and the cash they get. The benefit to the buyer in these cases is that it provides the acquirer with a higher basis from which to calculate its taxes if it ever decides to unload the acquired company at a later date -- thus, the catchy divorce insurance name, says Willens.

The first to do this was

Boise Cascade

with its $1.3 billion acquisition of

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in 2003. Most recently, some



shareholders griped about the tax burden when

Boston Scientific

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announced its $27 billion acquisition of the company.


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acquisition of Maytag, which was completed in March, was also structured this way. Investors can expect more of these tax-heavy deals, notes Willens. "This is now something that everyone considers."

They get away with it because "capital gains taxes are at historical lows," and when companies are paying a premium for a target, "how upset can you really be?" says Willens.

Depending on one's income tax bracket and how long one holds investment securities, capital gains taxes can be anywhere between 5% and 35%. The oft-quoted 15% rate applies to individuals in the 25% tax bracket, with net gains from selling securities they've held for longer than one year. Individuals in the 10% or 15% tax brackets pay only 5% on capital gains. If you sell securities held for less than one year, gains are taxed at the individual's income tax rate.

Furthermore, Congress finally came to an agreement Tuesday on a tax bill that will extend several tax cuts initiated during President Bush's first term, including the 5% to 15% capital gains tax.

Assuming the bill becomes law, the tax structure Golden West shareholders received from Wachovia is likely to become rarer still.

Breakdown of a Tax Break

Because of the structure of the deal, the tax savings to the Sandlers could be as much as $260 million, depending on how their stake is classified. For an average shareholder, if the Golden West deal is structured

a la

Boston Scientific and Guidant, he or she would be treated as though they sold their stock to Wachovia. So, each shareholder's gain would be the difference between the original purchase price of his or her Golden West stock and the value of the stock and cash they receive from Wachovia in the deal.

For example, if a shareholder bought Golden West stock for $10 and the deal offers a Wachovia share worth $62.42 and $18.65 cash per Golden West share, the gain would be $71.07 per share, and the shareholder's 15% tax would be $10.66 per share.

If the Sandlers' stake is considered "founder's stock," then their basis in the securities is zero, and their recognized gain would be $2.25 billion and the tax liability would be $338 million at a 15% tax rate. The way the deal is structured, however, only the $517 million cash portion of the $2.25 billion is recognized as a gain. Tax on that would be $78 million at a 15% rate, so, the tax savings to the Sandlers could be as much as $260 million.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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