Now that April 15 is out of the way, we can take a look at some tax issues that are a little more unusual. First, we've got a merger stock issue, then we'll look at the rationale behind discounting securities in a family limited partnership. We've also thrown in a trader issue and a little something for our Canadian investors.
Keep sending your questions to
firstname.lastname@example.org. Please include your full name.
Mergers Can Affect Capital Gains
Is the holding period interrupted when a company is bought out for cash? I'm referring, of course, to the owner of shares in the company that is bought out who now has cash instead of stock. Does the holding period for long-term capital gains tax treatment terminate upon the buyout? It seems like this could turn a potentially positive situation into a big negative. I also wonder about a stock-for-stock acquisition. Is the holding period transferred to the new stock? -- Charles J. Costello
If you are a shareholder in a company being acquired in a cash deal, you essentially have to sell your shares to the acquiring company, says Bob Almon, a strategic transactions partner at
Ernst & Young
. The day you sell your shares to the acquiring company is the day you will use to determine whether your gain or loss is long term or short term.
So even if your intent was to buy the stock and hold it for the long term, you'll incur a short-term gain or loss if, six months later, the company is acquired in a cash deal. "You would walk away with cash and no longer be a shareholder," notes Almon.
If the deal is a tax-free stock swap, the acquiring company will swap your shares for shares in its company. This generally is not a taxable event, and you keep the original basis and holding period, says Almon. So if you bought your original shares at $10, that would be your basis in the shares of the acquiring company after the swap. You will not have to worry about capital gains tax until you decide to sell those new shares.
For more on cash-deal mergers, see this recent
Discounting Securities in an FLP
I can see how a family limited partnership is a good way to go for a family business or family farm in which you can be aggressive with the discount rate. However, if the assets are held in brokerage accounts containing stocks, mutual funds, etc., then would the FLP discount be 0%? If yes, would FLP still make sense based on the future appreciation of the assets? -- Michael Abrishaman
recent Fund Forum we suggested creating a family limited partnership as a good way to pass on a family business or portfolio to heirs as a gift at a discounted rate.
But first, let's quickly discuss why the
Internal Revenue Service
allows you to discount assets in the first place. It is because once those assets are placed in a partnership, they can no longer be freely bought or sold so their value has decreased -- at least in theory.
In general, you would structure a family limited partnership with a 1% general partnership interest and a 99% limited partnership interest. Then you'd set yourself up as the general partner so that you keep control of the assets and give away pieces of the limited partnership each year.
But those limited partners don't have any voting rights so the securities in the FLP have a very "limited" value to your beneficiaries.
It's easier to understand discounting a family business or family farm because there's a lot more room for debate about their value. For securities, which have a readily determined fair market value, the discount may not be as obvious. But it's still there.
Think of it this way: If you give away shares in an FLP that is comprised of securities, you are not giving the actual securities, notes Bill Fleming, director of personal financial services for
. You're just giving your heirs a receipt of ownership in the partnership.
So let's say you put
shares in an FLP. Giving pieces of the partnership to your heirs is just not the same as giving them the IBM stock directly.
That's why you can discount them. "Just how much you discount them depends on how much you want to dance with the IRS," notes Fleming. "But anything over 0% is gravy." Just make sure you get at least as much as you paid in fees.
Note that the discount rates are not uniform throughout the country. They're different at each IRS service center.
My Brother Trades on the Floor
My brother trades Section 1256-regulated futures contracts at the Chicago Board of Trade. In 1998 he had a $113,000 loss in his personal trading account but made $143,000 brokering contracts for his customers. He only brokers about two hours per day, but has the ability to trade all 24 hours a day, in the pits or on a computer. Can he be considered a trader for tax purposes? He doesn't rely on his personal trading for his next meal. But the personal trading is the more significant part of his day. -- E.J. Hansen
"If he trades on the floor, this puts him in another category" -- that of a broker, says Ted Tesser, a certified public accountant in Boca Raton, Fla., and author of
The Trader's Tax Survival Guide
I generally don't address broker tax issues. But in a nutshell, your brother's brokering income would be considered self-employment income, reported on
Schedule C --
Profit or Loss from Business
. So the income would be subject to self-employment tax. The good news here is that he can then set up a retirement account for the trading, notes Tesser.
Assuming he keeps his brokering accounts separate from his personal accounts, he can report his gains, or in your brother's case, losses, as a trader, notes Tesser . If he elects to mark to market his trades at year-end, he would be able to report all his losses on Schedule C this year. (Otherwise gains and losses must be reported on
- Capital Gains and Losses
and would be limited to $3,000 per year.) For more on filing as a trader and marking your trades to market, see a
story from our Taxes for Traders series.
Canadian Stock Options
I held non-qualified stock options in Vienna Systems, a Canadian-based start-up company, which recently was acquired by Nokia (NOK) - Get Nokia Oyj Sponsored ADR Report. Nokia bought all the outstanding options, for which I received about $76,000 in U.S. currency. Now I have just received a Revenue Canada tax form, which looks to be the equivalent of our W-2 form, reporting the net imputed income from the purchase of my Vienna stock options. And unfortunately it is reported as a 1998 tax transaction. I had been told that it was to be a 1999 transaction. The payoff was in late January. I know I must report the income on my U.S. tax forms. But what must I report in the U.S. and Canada? -- Al Crawford
Let's first do a quick refresher on non-qualified stock options. The difference between the fair market value at the date of exercise and the actual exercise price is ordinary income. This income will come through on your W-2 as compensation. That's because essentially you're buying the shares from the company, so the company gives the income back to you through your compensation.
Even though your options were bought out by another company, in this case Nokia, the income still is reported the same way -- as wages on a W-2. That's why you received a tax form from Canada, notes Nick Morrow, foreign tax specialist at
, a New York accounting firm. It's the Canadian version of the U.S. W-2. Any Canadian taxes withheld will be reported here as well.
I'm assuming you're a U.S. citizen. That means you are taxed on worldwide income for U.S. purposes, notes Morrow. So that income will be subject to U.S. income tax. But you'll get a foreign income tax credit back from the U.S. for the Canadian tax you paid on foreign source income.
You'll have to file
Form 1116 . Page 2 of the form will help you determine how much of the Canadian tax can be used toward your U.S. tax credit.
It's important that you contact Canadian tax authorities for more information on your Canadian filing requirement. In addition, please be sure to check with your financial advisor and get some good tax planning advice, suggests Morrow.