Circle Inc. (CI) is a calendar year C corporation that has two equal shareholders – Doug and Jane. Doug, age 81, owns 1,000 shares of CI’s common stock, with a basis of $300,000. Jane, age 34, also owns 1,000 shares, but her basis is $7million. Jane inherited the stock from her father. CI’s balance sheet assets and liabilities are set forth below.
Olson Inc. (Olson) wants to buy CI, and Doug and Jane are ready to sell. Assume that CI is subject to a combined federal and state income tax rate of 40%, and Doug and Jane’s combined federal and state ordinary marginal income tax rate is 40% and capital gain rate is 20%.
CI’s Assets and Liabilities.
Book value basis Fair market value
Cash $ 1,500,000 $ 1,500,000
Inventory $2,500,000 $3,000,000
Accounts Receivable $2,000,000 $2,000,000
Equipment $2,000,000 $3,000,000
Customer Lists – $500,000
Copyrights $200,000 $500,000
Goodwill – $11,000,000
Total Assets $8,200,000 $21,000,000
Accounts Payable $ 1,500,000 $ 1,500,000
a. CI sells its assets to Olson for $20 million plus an assumption of all liabilities. CI pays its taxes and distributes all remaining proceeds to Doug and Jane. What is Olson’s basis in the assets? Any suggestions for Doug or Jane?
b. Olson buys CI’s stock from Doug and Jane for $18 million. Is this a sensible price under the circumstances? Calculate the tax impacts to CI, Doug, and Jane. What is Olson’s basis in its CI stock?
c. Olson buys 70% of CI’s stock from Doug and Jane for 12.6 million. CI redeems the remaining 30% by paying $2.7 million cash to Doug (it will borrow an additional $1.2 million) and distributing the equipment to Jane. Calculate the tax impacts to CI, Doug and Jane.
d. Olson forms a new subsidiary (S). CI is merged into S, and Doug and Jane are each issued 100,000 shares (value $90 per share) of Olson’s common stock. What are the tax impacts to CI, Doug, Jane, Olson and S in such a reorganization? If Doug and Jane wanted some cash out of the deal, how much cash could they be paid without destroying the tax-free reorganization?
e. Same as d., except S is merged into CI. What are the tax impacts to CI, Doug, Jane, Olson and S in such a reorganization? If Doug and Jane wanted some cash out of the deal, how much cash could they be paid without destroying the tax free character of the reorganization for everyone?
f. Same as a. except CI is and always has been an S corporation and Doug’s basis in his stock is $3 million and Jane’s basis is $ 8 million.
g. Same as b. except CI is and always has been an LLC taxed as a partnership, and Doug’s basis in his partnership interest is $ 3 million and Jane’s basis is $8 million