Charles Rotblut recently spoke at the 2015 AAII Investor Conference. For information on how to subscribe to recordings of the presentations, go to www.aaii.com/conferenceaudio for more details.
To describe taxes as complicated is an understatement. Even with brokerage firms reporting the cost basis for stocks purchased after January 1, 2011, tracking your potential capital gains tax liability still requires a bit of effort and bookkeeping. Stock splits, mergers, and spin-offs add an additional layer of complexity.
Consider what DirecTV (DTV) shareholders could be facing later this year or sometime next year. As you know, the satellite television provider agreed to be acquired by AT&T Inc. (T) last month. If the merger is completed—and it is a big “if”—DirectTV shareholders will receive $28.50 per share in cash and $66.50 per share in AT&T stock. For those holding DirectTV shares in a taxable account, the cash proceeds will be taxable at their prevailing capital gains rate. The cost basis of their new AT&T shares will be a prorated amount based on the actual conversion less the cash received. Those of you facing this prospect may want to grab a pencil, a pad of paper and a calculator.
The tax consequences of corporate actions such as mergers, spin-offs and stock splits are often ignored. Yet they can create headaches when it comes to tax time, or at least when it comes to estimating your potential tax liability. Fortunately, a little math and a little recordkeeping can add a great amount of clarity.
Claude Paquin, a retired lawyer and actuary, uses Merck & Co. (MRK) to show how cost basis changes over time. Merck is a good case study because it split its stock and then issued shares in its former Medco unit. Plus, Medco was eventually acquired by Express Scripts (ESRX) for a combination of cash and stock. Claude’s article, which appears here, will help you understand how your cost basis changes over time.
Jumping back to the AT&T-DirecTV merger, I used the phrase “a big ‘if’” in referring to the merger because of the uncertainty surrounding it. The deal would receive considerable regulatory scrutiny if it were occurring in isolation. Given the proposed acquisition of Time Warner Cable Inc. (TWC) by Comcast Corp. (CMCSA), what regulators will ultimately decide is even tougher to predict. I cannot say if they will view the deals in isolation or if they will consider the impact of both on industry competition when they weigh their decision. Then there are the other factors associated with mergers, including what is uncovered in the due diligence phase, how the executive team will be structured, changes in both businesses and shareholder approval. Since we hold AT&T in the AAII Dividend Investing portfolio, we’ll be keeping an eye on the developments.
Each merger has a life of its own. Much can happen between the time a deal is first announced and the time it either is completed or falls apart. The eventual outcome is often difficult to predict. Given the high level of uncertainty, the rule we follow with stocks held in AAII portfolios is to sell a stock after its board of directors agrees to an acquisition offer. If we own the acquiring company or if the proposal is for a merger of equals, we will evaluate each deal separately.
In this month’s issue, you will also find an interview with John Bogle. Since “Jack” was both insightful and interesting, I saw no reason to edit down the transcript for reasons of space. So the first half of our conversation appears here, with my intention being to run the second half in the July issue. If the content stars align, the July issue will also include interviews with Jeremy Siegel and Nobel Laureate William “Bill” Sharpe. (One of the perks of my job is the opportunity to speak with some of the greatest minds in the field of finance.)
I also split Ben Branch’s article on covered call strategies into two parts. The first part appears here and the second is tentatively scheduled for the July issue.
Finally, this month’s Briefly Noted articles can be read here. We did not have enough space to include them in the print version.
Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal