By Laura Saunders
This is a tale of two similar mergers with very different tax
consequences for shareholders.
One is the $34.1 billion combination of two health-care giants,
Aetna Inc. and Humana Inc., announced July 3. The other is the
$28.3 billion merger of two insurance giants, ACE Ltd. and Chubb
Corp., announced July 1.
At first glance, the deals look alike--and like several other
mergers this year. In both, the shareholders of the acquired firms,
Humana and Chubb, will turn in their current holdings in exchange
for about half cash and half shares, assuming regulators approve
the deals. The cash payments will generally be taxable as capital
gains if the investor's holdings are in taxable accounts, rather
than in tax-sheltered retirement plans such as IRAs or 401(k)s.
There is a big difference between the deals, however. Humana
shareholders won't owe tax on their receipt of Aetna shares, while
Chubb shareholders will owe tax on their receipt of ACE shares.
Why is this? According to Robert Willens, an independent tax
expert in New York, the Aetna-Humana merger contains an extra
provision that allows the exchange of shares to be a tax-free swap.
"This small detail makes all the difference," he says.
Here's what could happen in practice, says Mr. Willens:
Say an investor bought a share of Chubb for $45 in 2005
(adjusted for a 2006 split). In the merger, this investor is slated
to receive about $64 worth of ACE stock (at recent prices) and $63
of cash in return for each share of Chubb. He or she will have a
taxable long-term capital gain of $82--the difference between the
investor's starting point of $45 and the total value of $127 a
share offered by ACE.
If the stock portion of the Chubb-ACE deal weren't taxable, says
Mr. Willens, the investor's capital gain would be $63 a share
instead of $82. Because the gain includes tax on the exchange of
Chubb shares, these investors in effect have to use more of the
cash they receive to pay Uncle Sam.
Humana shareholders, meanwhile, will owe tax on their cash
payment of about $125 a share, but not on the receipt of Aetna
stock--so their tax bills will be relatively lower.
To be sure, the Chubb shareholders get a benefit in return for
paying tax on the share exchange. Their starting point for
measuring a capital gain, or cost basis, on their ACE shares resets
higher--reducing taxes on the stock when they eventually sell
it.
Because share exchange isn't taxable to Humana shareholders,
their cost basis carries over to new Aetna stock. So if an investor
bought Humana for $3 a share many years ago, then that will be the
starting point for measuring a taxable gain when the Aetna shares
are sold.
But in many cases the Humana shares won't be sold soon. And if
the Humana investor holds the Aetna shares until death, no
capital-gains tax will be due on appreciation up to that point
because of a tax-code freebie known as "the step-up."
Some Humana shareholders say they are pleased that their deal
gives them more control over the timing of taxes. Benjamin
Klausing, a physician in Louisville, Ky., owns shares of very
low-cost Humana stock he was given in 2002. "I'm glad I have a
choice," he says.
A Chubb spokesman declined to comment on tax aspects of the
merger with ACE.
What if investors in Chubb or Humana--or other mergers under
way--don't want to pay any taxes triggered by the deals? Experts
say there are two good options, if the investor is willing to give
shares away soon.
One is to donate some or all shares to charity instead of
writing a check. Donors of appreciated assets to qualified
charities and donor-advised funds often can skip paying
capital-gains tax and still deduct the full market value. This move
can be highly tax-efficient for donors who have assets with lots of
gains, experts say.
The other option is to give shares to someone in a lower tax
bracket. The top rate on long-term capital gains is currently
23.8%, but joint filers with taxable income up to $74,900 in 2015
have a zero rate on capital gains, and many other taxpayers have a
15% rate.
In such a move, the giver's cost of the shares transfers to the
recipient, and it becomes the starting point for measuring taxable
gain when they are sold or exchanged in the merger.
But note that if the recipient is a child, "unearned" income
above $2,100 is often taxable at the parent's highest marginal
rate. And gifts above $14,000 to any one person a year typically
are deducted from the giver's lifetime exemption, which is
currently $5.43 million.
Investors considering these options should move quickly, says
Mr. Willens. If the gift or donation occurs too late in the merger
process--such as after the shareholder vote--then the taxable gains
arising from merger will be payable by the original owner. "That
would be the worst of all worlds," he says, "to give stock away and
still have to pay taxes on it."
Write to Laura Saunders at laura.saunders@wsj.com
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