IRS clarifies taxation of "boot." (Brief Article)

Corporate

In revenue ruling 93-61, the IRS finally announced its implementation of the U.S. Supreme Court's 1989 Commissioner v. Clark decision, which concerned the proper method of taxing "boot" received in mergers qualifying as tax-free reorganizations.

If shareholders receive both stock and other property (the so-called boot) in such mergers, the realized gains are taxable--but in an amount not greater than the amount of boot received. The gain is taxed as a dividend if the exchange has "the effect" of a dividend distribution. If it does not, the gain is taxed as a capital gain at a rate not exceeding 28%.

In determining whether an exchange had the effect of a dividend, the IRS previously had treated the boot as though it had been distributed by an acquired corporation before the merger exchange. This approach generally resulted in findings that such transactions essentially were dividends.

But in Clark, the Supreme Court rejected this approach and concluded boot treatment should be determined by examining the exchange as a whole. Accordingly, the boot is treated as a distribution by the acquiring corporation in a stock redemption that the shareholder would have received had no boot been distributed. The effect of this approach is to classify boot gain as capital gain in virtually every possible circumstance.

Observation: For noncorporate shareholders, the IRS pronouncement is decidedly positive. It converts a boot gain from a dividend taxed at top marginal rates, to capital gain income. Some corporate shareholders may be dismayed by this news, however, because intercorporate dividends received can be deducted from income. --Robert Willens, CPA, managing director at Lehman Brothers, New York City.