Acquisitions of national and international businesses are being made at a phenomenal pace. Normally, these acquisitions are either by an asset purchase or a stock purchase, and often engender a technical maze in complying with federal, state, and other tax provisions. Acquisitions subject to federal tax laws and regulations are either taxable or nontaxable. With the changes coming about with TRA 86, practitioners may have concluded that taxable acquisitions are a dying breed. However, practice situations indicate taxable acquisitions remain quite common, and there are options and strategies to be considered and pitfalls of which to be aware.

Among other things, taxable acquisitions require careful tax planning concerning: 1) the allocation of purchase price; 2) the inheritance of the target's tax attributes; 3) the deductibility of acquisition expenses; and 4) miscellaneous tax provisions. (1)

ALLOCATION OF PURCHASE PRICE

After years of uncertainty and the proliferation of massive and onerous rules for allocating purchase price to assets for deemed asset acquisitions under Sec. 338, Congress has imposed Sec. 338(b)(5) (and related regulations) to allocations for taxable asset purchases.

The Old and New Rules Under Sec. 338

TEFRA 82 enacted Sec. 338. In general, if property was received by a corporate distributee in a complete liquidation under Sec. 332, the adjusted basis of the property to the recipient was the same as it would have been in the hands of the transferor. No gains or losses were recognized. However, the election permitted by Sec. 338 allowed the acquiring corporation to have a basis in the subsidiary's assets equal to the grossed-up basis (2) of any recently purchased stock plus liabilities of the target. The subsidiary need not be liquidated. Before 1987, generally no gain or loss would have been recognized on the deemed sale triggered by the liquidation of the target because of the tax respite granted by the General Utilities rule.

Since 1986, in accordance with Sec. 338, gain or loss is recognized by the target. The target is treated as if it had sold all of its assets on acquisition date at fair market value and simultaneously repurchased them. While it would appear that the elimination of a tax-free step-up in basis would virtually have eliminated Sec. 338 elections, that has not been the case. There are instances in which a step-up, even though taxable, can be advantageous to the acquirer of the target company. The most common example is the presence of an NOL in the target.

The amount of the grossed-up basis is allocated to the acquired assets by the residual method prescribed in the regulations authorized by Sec. 338(b)(5). Sec. 338 applies only to taxable qualified stock purchases. In taxable asset acquisitions occurring before May 7, 1986, allocation of purchase price was generally a matter of agreement between the buyer and seller, The guidelines provided that the allocation must be realistic and based on the relative fair market value of each asset at the time of sale.

Sec. 1060

For taxable acquisitions of assets constituting a trade or business after May 6, 1986, Sec. 1060 provides cost allocation rules based on the residual rules of Sec. 338(b)(5). Therefore, the residual method now applies to any direct or indirect transfer of assets that constitute a trade or business in the hands of either the seller or the purchaser and where the transferee's basis is determined wholly by reference to the purchaser's consideration. (3)

However, an acquisition that includes like-kind property still may fall within the

purview of Sec. 1660 even though the basis is not determined wholly by the consideration.

The residual method categorizes acquired assets into four mutually exclusive classes.

* Class I.- Cash, demand deposits, and similar balances in financial institutions;

* Class II.- Certificates of deposit, marketable securities, and foreign currency;

* Class III.- Default category tangible and some intangible assets); and

* Class IV.- Intangible assets in the nature of goodwill or going concern value.

Class III assets are generally depreciable or amortizable. To the extent that classes I to ill absorb the purchase price, nothing is allocated to goodwill or similar intangible assets. A long standing principle of the tax law does not permit amortization of goodwill to reduce taxable income. To avoid unfavorable treatment as a class IV asset, intangibles such as customer lists and core deposits of financial institutions should have: 1) ascertainable values separate and distinct from goodwill; and 2) a limited useful life which can be reasonably estimated. Failure in either of these requirements results in a disallowance of deductions for amortization of these assets.

Covenants-not-to-compete must have economic reality to permit a deduction for payments under such agreements. Economic reality may be questioned when the seller is unlikely to be able to compete. The negotiation of the covenant-not-to-compete should be recorded and the value and life of the covenant should be reasonable and clearly stated. It is important to note however, the chance of sustaining deductibility is normally improved if the covenant-not-to-compete is the subject of a separately bargained agreement. The following example illustrates the residual method of allocation:

Example 1. Corporation A acquired the assets of Corporation T on January 1, 1989, for $250,000. Corporation A paid $200,000 in cash and assumed $50,000 of T debt. The assets acquired include the following:

AcquiredFairMarketSec.1060

AssetsValueClass

Demanddeposits$30,000I

CertificateofDeposit20,000II

Property,plantand

equipment100,000III

Covenant-not-to

compete25,000III

Software25,000III

_________

$200,000

*ifnotthesubjectofaseparatelybargained

agreement.

Assuming the assets constitute a trade or business (in order for Sec. 1060 to apply), $30,000 is first allocated to class I assets, then $20,000 to class II. The remaining $200,000 ($250,000 - $30,000 - $20,000) is allocated to class III and IV assets as appropriate. Of this amount, $150,000 ($100,000 + $25,000 + $25,000) is allocated to class III assets. The remaining $50,000 $200,000-$150,000) is allocated to class IV as goodwill. Had the purchase price been less than $200,000, nothing would have been allocated to goodwill.

Each party in applicable acquisitions within the purview of Sec. 1060 must file Form 8594 with the tax return detailing the purchase price allocation. The form is due as part of the tax return in which the purchase or sale is included. Subsequent increases or decreases in consideration paid also must be reported by filing Form 8594.

Table 1 summarizes in a question and answer format factors relevant to asset allocation considerations.

INHERITANCE OF TAX ATTTRIBUTES

Taxable stock purchases allow the acquirer to inherit the tax attributes of the target if certain requirements are met. These tax attributes include the target's unused NOLs and tax credits, earnings and profits account, and other tax characteristics (such as accounting methods and period). inheriting the E&P balance may not be as desirable as inheriting the unused losses and credits. The extent of the E&P balance determines whether the subsequent distributions will be considered taxable dividends or a nontaxable return of capital.

Some issues affecting carryover of tax attributes include:

1. Applicability of the Sec. 382 annual limitation on the acquirer's using the target's net operating losses (NOLs), capital loss carry forwards, and tax credit carry forwards; and

2. Applicability of Sec. 269 tax avoidance principles.

Limitations on the Use of Tax Attributes

Secs. 382 to 384 limit the possibility of tax windfalls arising from the corporate target's unused NOLs and tax credits. This limitation comes into play if at least a 50 percentage point ownership change of the target occurs within a three-year testing period. While Sec. 382 limits the loss corporation's taxable income that may be offset, the new Sec. 383 regulations provide for the conversion of the taxable income limitation into a credit limitation equivalent. A gross-up computation is provided to determine any unused Sec. 382 carryover.

Sec. 384 was added to limit the amount of preacquisition loss an acquirer can use to offset built-in gains of the acquired corporation. Table 2 answers questions relevant to the carryover of the target's tax history.

ACQUISITION EXPENSES

A variety of pre-acquisition expenses max, be incurred in consummating either a friendly or a hostile corporate takeover. These expenses can include the organizational expenses of a subsidiary newly created for acquiring the target, start-up expenses incurred by the acquiring corporation or its newly-created subsidiary, takeover defense expenses of the target, and greenmail expenses of the acquirer or target.

Organizational Expenses

In many instances, the acquirer creates a subsidiary to absorb the target with either a stock or asset purchase. Consequently, organizational expenses are a necessary part of the transaction. These expenses are: 1) connected directly with the creation of the new corporation; 2) chargeable to a capital account; and 3) of a character that would be amortizable over the life of the corporation if its life were limited by its charter. They include legal and accounting fees incurred in the creation of the new corporation, incorporation fees, and costs of the board of directors related to the corporate organization.

Sec. 248 allows the amortization of corporate organizational expenditures over 60 months or more, starting with the month business activity begins, if the expenses are incurred by the end of the first taxable year of business operation. Once the election is made by the corporate taxpayer and the amortization period selected, it cannot be changed subsequently. (4) Organizational expenses incurred later must be capitalized and are deductible only on dissolution of the corporation.

Start-up Expenses

Start-up expenses often are incurred in connection with a taxable acquisition. Special rules permit amortization of these expenditures by all classes of taxpayers (Sec. 195). They include amounts paid or incurred for investigating an acquisition of an active trade or business. As with organization expenses, taxpayers may elect to amortize start-up expenses over at least 60 months, commencing with the month business begins. For an acquiring entity, business is considered to begin on the date of acquisition of the target.

Takeover Defense Expenses

A target corporation in a hostile takeover attempt often incurs costs related to fighting the takeover. The IRS recently held that such expenses were immediately deductible under Sec. 162 as trade or business expenses (PLR 8927005). Confusing the issue, however, is a recent Tax Court case in which the target of a friendly takeover was required to capitalize advisory expenses incurred in the takeover (National Starch 93TC No. 7). In the hostile takeover, the IRS allowed the current deduction because the expenses were related to the directors' fiduciary duties; but in the friendly takeover, the expenses were disallowed on the basis that the target corporation would benefit economically over a future period. The distinguishing characteristic between deductible and capitalizable expenditures is whether the expenditures are to facilitate the transfer of stock (capital expenditures) or are tied to the board of directors' fiduciary duty to evaluate the takeover offer (deductible expenses). The allocation of expenditures between these two distinct activities may insure at least a partial Sec. 162(a) deduction.

Greenmail Expenses

To avoid a hostile takeover, target corporations may incur greenmail expenses, which are premiums paid to the hostile holder of the target stock to entice a resale to the corporation and legal, appraisal, brokerage, and transfer fees. Greenmail expenses were made nondeductible by TRA 86 with the addition of Sec. 162(k). This change clarified that expenditures incident to the redemption of a corporation's own stock are nondeductible. Such expenses must be capitalized and are recognized only on dissolution of the corporation. if the target corporation incurs greenmail costs, these expenditures are capitalized.

MISCELLANEOUS CONSIDERATIONS

Consolidated Tax Returns

When only the stock of the target company is acquired, the acquirer can either keep the target as a going concern or liquidate the target into itself or a subsidiary. If a corporate purchaser chooses to keep its 80% or more owned target corporation as a separate legal entity, the consolto 1504 may apply. If the acquirer already has elected the consolidated return provisions, it must apply those provisions to the newly acquired target. The provisions apply when the target is an "eligible corporation" and the acquirer has the requisite stock ownership in the target.

The stock ownership test is met under the following conditions:

1. The acquirer, together with each includible consolidated return member, owns 80% or more of the voting stock and the value of the target; and

2. The target is an includible corporation as defined in Sec. 1504.

For purposes of stock ownership, nonvoting, nonconvertible limited and preferred stock may be excluded. Failure to satisfy the consolidated return provisions may result in a "controlled group" designation for the acquirer and the target. The controlled group designation applies a set of rules that are analogous to, but more punitive than, the consolidated return rules.

Consolidation with the newly created target carries a number of tax advantages and disadvantages, shown in Figure 1.

Intercompany dividends generally are eliminated when consolidated returns are filed; intercompany gains or losses, however, are deferred until the selling member leaves the consolidated group or when the goods are sold outside the group. The group can elect to recognize currently gains and losses, but it cannot switch from deferral to recognition to achieve the tax result desired each year. Deferral of intercompany gains is tax-favored since the tax liability on the gain is postponed. However, deferral on intercompany losses is tax-punitive because the tax benefit on the loss is postponed.

Corporate taxpayers cannot deduct capital losses. These losses must be absorbed by capital gains. However, consolidating with a target that has current capital gains may allow the acquirer to currently offset its capital losses with the target's capital gains. The NOLs carried forward by the target can sometimes be used to offset the current or future profits of the existing members of the consolidated group. Table 3 summarizes critical factors in filing consolidated returns after an acquisition.

Alternative Minimum Tax

The tax characteristics of the newly acquired target can either trigger the alternative minimum tax (AMT) or can suppress it. For example, targets that are in capital intensive industries can trigger the AMT for an acquirer in the service industry. Indeed, capital intensive entities are expected to have significant positive AMT adjustments because of the accelerated depreciation of operating assets. Service industries ire not expected to have significant operating assets because they generally do not hold significant depreciable property. The AMT provisions require a positive adjustment to taxable income in arriving at AMT when the tax depreciation exceeds an AMT amount that is determined under the alternate depreciation system (ADS). The target also may have significant tax preference items that, taken collectively, cause the tentative minimum tax to exceed the regular tax.

Other Considerations

While the matters described above are important in taxable acquisitions, there are a number of other factors that also should be considered. Other general factors include installment sales, contingent payments, and imputed interest on contingent payments. Table 4 presents other critical miscellaneous issues to be considered.

FOOTNOTES

1 In the case of taxable business acquisitions, acquiring companies can inherit tax attributes of targets if the target is liquidated into the acquirer under Sec. 332, subject to anti-avoidance legislation.

2 The grossed-up basis is determined by a formula based on the percentage of stock held and the percentage of stock "recently purchased" as defined in Sec. 338(b)(6)(B).

3 The purchaser's consideration is typically the price paid for the assets plus any liabilities assumed in the transaction.

4 In the case of taxable business acquisitions, acquiring companies can inherit tax attributes of targets if the target corporation is liquidated into the acquiring corporation under Sec. 332.

TABLE 1

ASSET ALLOCATION (IRC SEC. 1060)

QUESTIONS, CONSIDERATIONS, AND ANSWERS

* When is an asset acquisition properly considered an applicable acquisition" within the purview of Sec. 1060?

An applicable asset acquisition" is any direct or indirect transfer of assets that constitute a trade or business, and the basis of such assets are determined completely by the consideration paid for the assets.

* How is a covenant-not-to-compete classified by the acquiring company?

To be a class Ill asset and not goodwill (class IV), the covenant must be separable from goodwill and have a readily determinable useful life. Furthermore, the covenant must possess economic reality. Economic reality may be evidenced by the nature of the continuing relationship between the seller and the buyer of the covenant. For example, an adversorial economic relationship between the seller and the buyer of the covenant has economic reality. The details of the covenant must be evaluated to determine if the designated status applies. The covenant must have a readily determinable and reasonable life span.

* is a customer list classified as a class ill asset?

As with covenants-not-to-compete, customer lists must have a finite useful life and be readily severable from goodwill to be recognized for tax purposes. Otherwise, the asset basis that could be amortized will be treated as goodwill.

* Can there be a continuing employment/consulting relationship between the acquiring firm and target shareholders?

The technical qualification of the renderer of any contracted services will be considered. Lock of technical expertise in the particular activity may indicate allocation of purchase price rather than a legitimate employer-employee or contractor relationship. Failure in this regard may result in the nondeductibility of such payments as current trade or business expenses.

* Is the purchase consideration (cash, notes, stock, etc.) fully determinable at purchase, or are subsequent adjustments to be made to the consideration?

If subsequent adjustments are made to the initially determined consideration, the allocation must be recalculated. Additions to consideration can increase all four classes depending on the original purchase price and asset values. However, if assets in the first three classes already are assigned their full fair market values, the addition will be made to class IV-goodwill. Reductions in the consideration decrease class IV assets before classes I-III are affected. Form 8594 must be filed to reflect the revised allocation.

* When is Form 8594 filed?

Form 8594 must be filed along with the tax return for the acquisition yea showing the allocation among the four Sec. 1060 categories. Allocation within classes does not have to be reflected on Form 8594. As a consequence appropriate measures con be taken to maximize depreciation. For instance, land can be appraised at minimum value and depreciable structures or component appraised at maximum value.

TABLE 2 LOSS CARRYOVER OF THE TARGET FIRM

QUESTIONS AND ANSWERS

* Are federal tax rates scheduled to be higher or lower than the tax rates in effect in the three years prior to the acquisition?

If rates are scheduled to be higher in future years than in the prior three years, losses should be carried forward to maximize cash flows, assuming that profits will exceed losses. if losses are about to expire and future profits are uncertain, the carryback of losses is tax- favored, however.

* Does the acquirer (new loss corporation) intend to use the assets of the target in a significant capacity over the next two years?

If the target's assets are sold, the use of the target's tax attributes will be precluded because of the continuity-of-business- enterprise requirement of Sec. 382,

* Is the Sec. 382 annual limitation on the use of NOLs and tax credits triggered?

The annual limitation is triggered if a change of ownership has occurred during the testing period ending on the testing date. A testing period is the three-year period commencing on the earlier of the carryover year or the first day of the year the testing date falls. If a net unrealized built-in loss, as defined in Sec. 382 h)(3), is present on the testing date, the testing period begins on the first day of the year the net unrealized built-in loss arose. If there has been a prior ownership change, the testing period con begin no earlier than the day after the prior ownership change. If the tax benefits to be derived from the losses are factored into the purchase price of the target an appropriate adjustment should be made for the amount of cash-flow that may be derived.

* Are there net unrealized built-in losses on the acquired assets?

Net unrealized built-in losses reduce the amount of usable NOLs. The presence of net unrealized built-in losses can potentially shift the beginning of the testing period to the beginning of the year of the accrual of the loss.

* is the acquisition motivated primarily by tax reasons?

If any single business reason is surpassed in importance by a tax motivated reason, the tax avoidance principles of Sec. 269 could be used to deny all or part of the otherwise usable losses.

* Are there options to acquire the loss corporation's stock?

Stock of the loss corporation that is subject to an option for acquiring such stock shall be treated as being exercised if such exercise causes a limitation to occur. For this purpose, each class of option shall be treated separately.

* Have there been equity structure shifts in the lost three years prior to the current testing date?

An equity structure shift is any tax-free reorganization of the target having net operating losses of built-in losses under Sec. 368 except for types D, G, and F reorganizations. The loss corporation must have been a party to the reorganization.

* Have there been owner shifts in the current testing period?

An owner shift is any change in the ownership of the target corporation's stock during the relevant testing period. Only owners with at least a 5% ownership interest are counted. Less than 5% owners are aggregated into a single 5% owner. Owner shifts can occur from purchases or dispositions of the loss corporation's stock within the three-year testing period. Redemptions, Sec. 351 transfers, and stock issuances also cause owner shifts. Equity structure shifts also come within the ambit of this definition.

* Has there been an ownership change?

Testing period for ownership change con begin no earlier than the day after the prior ownership change.

* Are the loss corporation's shareholders related parties within the meaning of Sec. 382?

Reg. Sec. 1.382-2T(h) requires the use of the forward attribution rules of Sec. 318(a)(2) in determining stock ownership in the loss corporation. For this purpose, stock attributed from an entity to its owners is no longer considered owned by such entity.

* Is the target company involved in a Chapter 11 bankruptcy proceeding?

The Sec. 382 limitation on the use of tax attributes does not apply under Chapter 11 events where historical creditors and stockholders own 50% or more of the value and voting power after the transaction.

* Is there net unrealized built-in gains in the target's assets?

If the target corporation has net unrealized built-in gains as of the date of an ownership change (Sec. 382 (h)(3)), the annual limitation on NOL use may be increased.

* Have capital contributions been made to the loss corporation's (target) capital in the lost two years?

Capital contributions within two years of the change of ownership date are presumed to be made primarily for avoiding federal taxes. As such, the amount of capital contribution made may be used to reduce the value of the loss corporation in applying the Sec. 382 limitation. Loss corporations that are contemplating an acquisition should increase retained earnings (defer dividends) or use other indirect measures rather than a direct capital contribution to increase the value of the target.

* Does the target have nonbusiness assets (assets not used in the active conduct of the target's business) in excess of 33.3% of its total fair market value?

If nonbusiness assets exceed 33.3% of the total fair market value of the target, the value of the loss corporation may be reduced by the excess of the value of the nonbusiness assets over the portion of the indebtedness associated with the nonbusiness assets. Nonbusiness assets include cash and marketable securities.

* is the acquirer bound by the depreciation rules applicable to the target under a Sec. 381 scenario?

Where Sec. 382(a) applies and the acquirer takes over depreciable assets of the target firm, the acquirer continues to depreciate the assets in the same way the target had to the extent basis carries over in the transaction.

TABLE 3 CONSOLIDATED TAX RETURN IMPLICATIONS

QUESTIONS AND ANSWERS

* Does a newly acquired subsidiary have to adopt the accounting methods of the parent corporation?

Sec. 466 governs the choice of accounting method in this respect. As reflected therein, each member of the group, including the newly acquired subsidiary, is free to choose its own accounting method in the consolidated return year that a Sec. 481 (a) adjustment may be applicable.

* Does the target have significant foreign source income?

The amount of foreign tax credit available to the group could be affected because of the corresponding increase/ decrease in the denominator relative to the numerator in the foreign tax credit formula.

* is the acquiring corporation liable for any subsequently determined tax deficiency incurred by the target?

Each member of the consolidated group is jointly and severally liable for any subsequently determined tax deficiency of the target. See Reg. Sec. 1.1502-6.

* Must the parent corporation pay the estimated tax of a newly acquired subsidiary?

Estimated tax payments may be made either jointly or separately for the first two years of consolidation with the target. However, if the target fails to pay a sufficient amount, the group could become responsible for the deficiency. After the expiration of two years, the parent is responsible for paying estimated taxes. However, each member of the group remains jointly and severally liable for the tax liability.

* Will the incurrence of an overall foreign loss by the target require the group to compute an overall foreign loss account?

The affiliated group must calculate its overall foreign loss on a consolidated basis. See Reg. Sec. 1.904(f)(1)-1.

* if the target does not have foreign source income, is it necessary to allocate other expenses of the target between foreign source and U.S. source income in determining consolidated taxable income from foreign sources-the numerator of fraction for foreign tax credit.

Gross income and expenses of members of the group that do not have foreign income are not included in the foreign tax credit numerator in the limitation formula. As such, a member of the group that does not have foreign source income will not have its expenses allocated. However, the amount of foreign tax credit available will be affected because of the increase in the denominator of the foreign tax credit limitation formula.

* Will the takeover result in the combination of two defined benefit plans-one held by the target and one held by the acquirer?

Sec. 414 requires that if two or more defined benefit plans are merged, the Sec. 401 qualification depends on whether or not the participants are entitled to benefits of at least as much as they had before the merger. All employees, the targets and the acquirer's employees, do not have to be treated equally as basis for consolidation. Sec. 414(c) does not apply unless the two plans are combined into a single plan. The fact that there is separate accounting for cost allocation, that there are separate benefit structures, or that there are investments in different trusts does not conclusively prove there is not a single benefit plan.

* Will the takeover result in the combination of two defined contribution plans?

Reg. Sec. 1.414(1)-1 (a)(2)(ii) requires that each participant in both the plans, the target and the acquirer have an account balance at least equal to the balance prior to the takeover as a basis for Sec. 401 (a) qualification.

* Is the amount of investment in the target small compared to the losses it is expected to generate? The consolidated group of which the newly acquired target is a member can utilize losses of the newly consolidated target in excess of the amount invested in the target. In such a scenario, an excess loss account must be created to accumulate the excess loss. The excess loss balance must be restored to income on disposition of the target's stock.

* Is the acquirer required to adjust the inventory practices of the newly acquired target?

If the acquirer and the target use the same inventory method, the acquirer firm must continue the inventory practices of the target. if, however, both use different inventory methods, the regulations specify special procedures which may cause conformity of methods.

* If a wholly owned subsidiary (T) with a qualified pension plan is sold to another consolidated group, which group deducts pension contributions of T made after the acquisition date but before the seller's last consolidated return including T is filed?

Sec. 404(a)(6) allows a payment made before the due date for the tax return to be deemed as made on the last day of the preceding tax year. The election as to which group takes the deduction should be negotiated between the buyer and seller.

TABLE 4

MISCELLANEOUS CONSIDERATIONS

QUESTIONS AND ANSWERS

* Can the acquirer inherit installment sale treatment for certain sales made by the target?

The acquirer shall be treated in a manner similar to the target on income attributable to an installment obligation coming under Sec. 453.

* Can an acquirer currently deduct payments on contingent liabilities?

Payments of contingent liabilities assumed from the target increase the purchase price received by the target. No interest is to be imputed see 1274(c)(4). The payment will be allocated among the four classes of assets. However, if the assets in classes I-III hove already been assigned their fair market values, the payment will increase goodwill. The seller must report income for the amount of contingent liability paid by the buyers. Furthermore, the seller will not be entitled to a corresponding tax deduction.

* is interest imputed on the amount due when a contingent liability is paid?

The entire amount of the payment will be considered as an adjustment to the basis of the acquired assets. See Sec. 1274(c)(4).

* Is the acquirer taxed on earnings attributable to an escrow account set up to fund a contingent liability?

The acquirer will not be taxed on earnings from the escrow account. instead, such earnings will be taxed to the target because it is the creator of the trust.

* Must all investment banking, legal, and other associated expenditures of a merger or reorganization be capitalized?

In National Starch, the Tax Court held that the deductibility of the costs incurred in obtaining a fairness opinion in the context of a takeover of a publicly held company must be determined by reference to all the facts and circumstances, and that such costs are not nondeductible as a matter of law.

* What determines if an expenditure incident to a merger or reorganization must be capitalized?

In National Starch and cases cited therein, the court looked to the nature of the benefit received. The court stood by the doctrine that expenditures which could be expected to produce returns for many years in the future are capital in nature.

FIGUREI

EFFECTSOFCONSOLIDATIONOFTARGETCOMPANY

TaxFactorConsequence

Intercompanydividends

Sec.1.1502-14Eliminated

IntercompanygainsandlossesDeferred(canelecttoreport

Sec.1.1502-131currently)

AlternativeminimumtaxSec.Cantriggerorsuppress

55applicabilityofAMT

Canacceleratetheuseof

CapitalgainsandlossesSec.capitallossesthatotherwise

1.502-22wouldbecarriedforward

NetoperatinglossesSec.Caninsomeinstancesbe

1.1502-21carriedbacktooffsetprior

taxableincomeofthegroup

CharitablecontributionCanalterthecurrently

Sec.1.1502-241deductibleamount

AccumulatedearningstaxCanbetriggeredwhere

Sec.531reasonablebusinessneeds

becomequestionable