IRS Issues Two Proposed Rules To Smooth Way for Stock Deals

The Internal Revenue Service issued two proposals Monday that would make it easier for banks to merge without paying capital gains and other taxes.

One proposal would free shareholders from paying capital gains taxes on shares they sell shortly after getting them in tax-exempt stock deals. The second proposal would eliminate the tax on stock warrants and options that are received in mergers or acquisitions.

Banking and tax lawyers said the proposals, which could take effect as early as June, would remove some hurdles that are frequently encountered when banks acquire other institutions.

"These proposals would be a step forward in that they eliminate uncertainties and risks and add flexibility," said Andrew S. Mason, a partner at the New York law firm of Sullivan & Cromwell.

The first IRS plan would abolish the requirement that shareholders who own more than 5% of the stock in an acquired institution retain for as long as three years the additional stock they receive in a tax-free merger.

The IRS generally considers all-stock mergers to be tax free because no cash changes hands. This means shareholders at the target bank do not have to pay capital gains taxes on the stock received from the acquiring institution.

However, these shareholders must agree to retain at least half of the new shares for as long as three years. Shareholders who sell more than half of their stock within that time frame must pay a tax on all their capital gains.

This restriction has caused some banks to resist being bought with stock, said Robert Willens, managing director at Lehman Brothers Inc.

"One of the most contentious problems in these transactions has been making sure the target bank's shareholders intended to hold onto stock for a period of time," Mr. Willens said.

"Putting restrictions on target shareholders has always been a sticking point," he said. "Getting rid of this requirement is going to make negotiating a deal a lot easier."

The IRS also proposed to clear up the uncertainty about whether gains realized from receiving stock warrants in mergers or acquisitions are taxed.

The proposal would fold stock warrants into the IRS' definition of stock, allowing them to be exchanged tax-free.

"It was always unclear how stock options and warrants were treated," Mr. Mason said. "You can't have uncertainty when you are trying to offer target shareholders a definitive plan."

Both proposed rules are open for public comment until March 24. The IRS said it will hold a March 25 public hearing on the stock-warrant plan. A hearing on the other proposal is slated for May 7.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER