Prepare memo for the file showing the ADSP

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Reference no: EM132060977

For example, let’s say that a corporation has assets valued at $15 Million and liabilities of $5 Million. One would expect that the stock would sell for $10 Million, which is the net asset value. That’s all we are doing with the ADSP. The only trick is that there is one liability that is missing – the tax liability that would arise if the assets were sold for their FMV. So let’s say that the assets above have a tax basis of $8 Million. A sale of the assets for $15 Million would create a corporate gain of $7 Million and a corporate tax of $1,470,000 at a 21% tax rate. The buyer of the stock is succeeding to this corporate-level tax liability. This means that the liabilities on the balance sheet, $5 Million, need to be increased by the tax liability of $1,470,000. They are now $6,470,000. So if the stock sold for $10 Million the assets must be worth $16,470,000. But if they are worth $16,470,000 the gain from a deemed asset sale is now $8,470,000 and the tax due is $1,778,700 instead of $1,470,000. The assets must be worth $17,778,700. But this changes the tax liability again.

So we have a simultaneous equation with one unknown (ADSP).

The ADSP = Stock Purchase Cost + Target Liabilities

Target Liabilities = Non-tax Liabilities + Tax Liability

Tax Liability = .21 (ADSP – Tax Basis of Assets)

So you solve for ADSP by taking the stock purchase price + known liabilities + the tax liability that would occur from a sale at the ADSP. Solve for ADSP by plugging in the above variables. Check your answer by asking yourself – does the stock purchase price make sense based on what I determined the deemed sale price of the assets to be and the liabilities, including the deemed tax liability. That is, Stock Price = Deemed Asset Price – Target Liabilities.

YOUR ASSIGNMENT

Prepare a memo for the file showing the ADSP in a 2018 sale and comparing it to the ADSP from a 2017 sale.

Acquiring Corporation pays $22,000,000 for 100% of Target stock in a single transaction.

Target assets have a tax basis of $12,000,000.

Target liabilities are on the balance sheet at $4,000,000, and this is a good number.

Reference no: EM132060977

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