If you were a shareholder in Advanced Fibre Communications when it was acquired by

Tellabs

(TLAB)

or the Chelsea Property Group when it was absorbed by the

Simon Property Group

(SPG) - Get Report

and got stock as a result of the taxable merger, that's your little secret. Uncle Sam has no idea.

Technically, you owe capital gains tax on the difference between the original cost (a.k.a. thebasis) of your old shares, and the fair market value of the new shares you received from themerger. But since the IRS has no idea about either your original shares or the new ones, the taxburden is left completely up to you and your conscience.

Sounds crazy, but it's been a huge flaw in the system. There are no reporting requirements to UncleSam any time you buy a stock or get a new one as a result of a merger.

So in an effort to keep track and start collecting what could be millions of dollars in unpaidtaxes, the IRS is cracking down.

Well, sort of.

Currently, if you get cash from a corporate merger, it's reported on your 1099-B. So the IRSknows about it and you owe him money on the capital gains tax.

But if you got stock in a taxable merger, the IRS has no idea. That's because the acquiringcompany doesn't have to report a thing to the IRS. It just gives you the new shares and moves onits merry way. It's up to you to do the right thing and pay tax on the difference between thefair market value of the stock you received and the original cost of your old shares, says StevieD. Conlon, senior tax analyst for CCH Capital Changes, a company that provides coverage ofcorporate actions affecting publicly traded companies.

And while we'd all like to believe in the intrinsic good nature of mankind, it's too easy toslide the whole transaction under the rug. So the American Jobs Creation Act of 2004 gave the IRSpower to expand the reporting requirements of corporate actions. The acquiring company in anytaxable merger or acquisition that occurs after October 22, 2004, will now have to tell the IRSwhich shareholders got shares and how many they received. Holy paperwork!

Offshore First

If you sold any stock or mutual fund in 2004 and got cash, you should've gotten a 1099-B by nowreporting the sale. And while you probably just threw the form in your tax file, when you pull itout to prepare your return, you'll notice the form is pretty different from last year.

This year, cross-border corporate actions, known to the tax folks as corporate inversions,will be reported on your 1099-B. That means if you were a shareholder in a company that took itscorporate headquarters offshore -- often the case is to Bermuda -- and you get new shares as a result, the IRS will now know aboutthose new shares.

The IRS decided to focus on corporate inversions first because the Treasury Department isworried that too many companies will move offshore. Multinational corporations,headquartered in the U.S., owe U.S. tax on their worldwide income. If the company moves itsheadquarters offshore, then only the income earned in the States will be subject to U.S taxes. In aneffort to get their tax bills down, many large companies, such as

Tyco International

(TYC)

and

Ingersoll-Rand

(IR) - Get Report

, movedoffshore.

So for this year, any offshore deal involving at least $100 million worth of stock must bereported on a 1099-B.

As a result, the form has changed to meet these corporate inversion requirements. Boxes 5, 6 and 12 are new. The number of shares exchanged by the shareholder must go in Box 5. Box 6 showsa listing of the class or classes of stock exchanged for cash or other property and Box 12 requiresa check if the recipient cannot take a loss on their 2004 tax returns.

"Box 12 will likely cause the most concerns as the instructions accompanying the form do notexplain how the brokerage firm or institution determines whether the loss box must be checked,"said Conlon. (It would be too easy to supply explicit instructions, I guess.)

The IRS has no intention of stopping at offshore transactions. Eventually all taxablemergers will be reported.

The problem is the administrative burden on an acquiring company. "There are true economiccosts to imposing reporting requirements and shareholders ultimately pay those costs. The IRS andthe Treasury struggle with this," says Conlon.

Because of the sensitivity of the issue, the IRS opened it up to the public. The Serviceissued a notice on Dec. 30, 2004, requesting comments on the new rules it plans to impose.Hopefully final guidance will be available soon.

While this might not drastically effect your 2004 return, be aware that it could effect yourtax situation going forward. Soon enough, the IRS will know about any taxable mergers you'reinvolved with and you will owe tax.

Consider that one less thing you can sweep under the rug.