Treating receivables as cash equivalents in a bargain purchase transaction.
The purchase of assets that make up a trade or business is an applicable asset acquisition for Sec. 1060 purposes. The purchase price of such an acquisiiton is allocated among the acquired assets using the same rules as for Sec. 338 qualified stock purchase elections. Generally, accounts receivable are included among Class III (noncash equivalent) assets, along with inventory, fixed assets, patents and prepaid expenses, etc. Under the residual method of purchase price allocation, consideration paid in a Sec. 1060 applicable asset acquisition is allocated first to cash (Class I assets) on a dollar-for-dollar basis, then to cash equivalents (Class II assets), such as marketable securities, certificates of deposit, etc., to the extent of fair market value (FMV), and finally to Class III and Class IV assets. Consideration remaining after the allocation to Class II assets is allocated among Class III assets based on relative FMVs, with any remaining consideration allocated to Class IV assets, or nondepreciable goodwill and going convern value.
A bargain purchase transaction occurs when the assets of the corporation acquired are appraised at an FMV in excess of total consideration paid for the assets. Under the residual method of allocation, all noncash equivalent assets receive a tax basis less than FMV. For example, assume that the remaining purchase price to be allocated to the Class III assets is $400,000, and the total FMV of the Class III assets is $630,000. If accounts receivable have a face amount and an FMV of $100,000, an allocation based on relative FMVs will allocate a tax basis of $63,492 to the accounts receivable. When the full face amount of the accounts receivable is collected, an additional $36,508 will be recognized as income. This additional income is, in essence, an allocated portion of the gain, or "bargain" realized by the "new corporation" on the purchase of the assets.
When significant amounts of depreciable or amortizable assets are acquired by the purchasing entity as part of a bargain purchase, the more consideration that can be allocated to accounts receivable the less additional income resulting from the bargain purchase will be recognized in the current year. However, if the accounts receivable and depreciable property are part of the same class of assets, all of the gain resulting from the "bargain" will be recognized in the current year regadless of the composition of Class III assets.
However, the UFE case gives a possible position (though not without risk) for treating existing accounts receivable at the date of the bargain purchase as Class II assets. In UFE, the court allowed over 90% of the purchased accounts receivable to be treated as cash equivalents under pre-Sec. 338 rules. The attributes of those receivables used to support the claim of cash equivalency included the following.
* The accounts receivable were from well-established businesses with longstanding and superlative credit histories.
* Almost all of the receivables were collected within 60 days, and all were eventually collected.
* The accounts receivable had a present FMV equal to their face value.
* The accounts receivable had been examined and valued at the time of the sale.
It is important to note that the UFE decision involved a Mar. 31, 1981 tax year. Sec. 338 was enacted a year later, and Sec. 1060 became law in 1986. Sec. 338 temporary regualtions, allocating purchase price to classes of assets, were promulgated Jan. 23, 1986; the Sec. 1060 temporary regulations on the same subject were promulgated July 15, 1988, and both have yet to be made final. Those temporary regulations, however, hold unequivocally that accounts receivable are Class III assets.
Thus, recommending a position following the UFE case is clearly at variance with the Sec. 338 and 1060 temporary regulations. A preparer would have to conclude that there was a realistic possibility that the UFE position would succeed on the merits to sign the return without disclosure; a taxpayer would have to conclude that there was substantial authority for the position to avoid disclosure or, in the alternative, an accuracy-related penalty. If disclosure were considered appropraite, it would presumably be on new Form 8275-R, Disclosure Statement Under Section 6661, since the position disagreed with is one taken by regulation.
Although the classification of accounts receivable as Class II assets appears beneficial, other factors must also be considered. The client may be in a loss situation already, in which case it may be desirable to recognize more income currently and take larger depreciation deductions at a later date. The availability of credits or lower rates currently as opposed to future years, when tax rates may be expected to rise above current levels, is also a consideration.
From David Brian Johnson, CPA, Portland, Ore.
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|Author:||Johnson, David Brian|
|Publication:||The Tax Adviser|
|Date:||Mar 1, 1992|
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