May B. Kass v. Commissioner of Internal Revenue
60 T.C. 218; 1973 U.S. Tax Ct. LEXIS 129; 60 T.C. No. 26 (1973)
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Rule of Law:
Under the step-transaction doctrine, a statutory merger that follows a purchase of a controlling stock interest for cash as part of a single, integrated plan does not qualify as a tax-free reorganization if it fails the continuity-of-interest test. The test is applied by reference to the target corporation's historic shareholders, not the shareholders at the moment of the merger.
Facts:
- May B. Kass owned 2,000 shares of stock in Atlantic City Racing Association (ACRA), a racetrack operator with approximately 500 stockholders.
- A group of minority ACRA shareholders, including the Levy and Casey families, formed Track Associates, Inc. (TRACK) with the express purpose of gaining control of ACRA.
- TRACK's plan was to first purchase at least 80% of ACRA's stock and then merge ACRA into TRACK.
- On December 1, 1965, TRACK initiated a tender offer to purchase ACRA stock for $22 per share in cash.
- By February 11, 1966, TRACK had purchased 424,764 shares of ACRA, representing over 83% of its outstanding stock, for cash.
- Immediately following the stock purchase, on February 11, 1966, the boards of TRACK and ACRA entered into a merger agreement.
- The merger was approved, and Kass, who had not sold her shares in the tender offer, exchanged her 2,000 ACRA shares for 2,000 TRACK shares.
Procedural Posture:
- May B. Kass filed her 1966 Federal income tax return and did not report any capital gain from the exchange of her ACRA stock for TRACK stock.
- The Commissioner of Internal Revenue (Respondent) audited her return and determined a tax deficiency of $10,131.67, asserting that the exchange was a taxable event.
- Kass (Petitioner) filed a petition with the United States Tax Court to contest the Commissioner's determination of deficiency.
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Issue:
Does a statutory merger qualify as a tax-free reorganization for a minority shareholder when it is the second step of an integrated plan in which the acquiring corporation first purchased over 80% of the target's stock for cash?
Opinions:
Majority - Dawson, Judge
No. A statutory merger that is part of an integrated plan with a preceding cash purchase of a controlling stock interest fails the continuity-of-interest doctrine, and therefore does not qualify as a tax-free reorganization for the remaining minority shareholders. The court applied the step-transaction doctrine, viewing TRACK's initial cash purchase of over 80% of ACRA's stock and the subsequent statutory merger as a single, integrated transaction designed to acquire ACRA's assets. The continuity-of-interest test must therefore be measured by looking at the proprietary interest of ACRA's historic shareholders (before the tender offer), not just the shareholders who remained at the time of the merger. Because over 80% of the historic shareholders sold their shares for cash, their proprietary interest was terminated, not continued. The remaining 16% equity interest held by minority shareholders like Kass was insufficient to satisfy the continuity-of-interest requirement, which demands that a substantial part of the value of the property transferred be represented by a continuing proprietary stake. Therefore, the transaction was not a tax-free reorganization for Kass, and she must recognize the gain on the exchange of her stock.
Analysis:
This case is a foundational application of the step-transaction and continuity-of-interest doctrines to two-step acquisitions. It establishes that courts will integrate a stock purchase and a subsequent merger into a single transaction for tax purposes when they are part of an overall plan. The decision clarifies that for continuity purposes, the relevant shareholder group is the target's historic shareholders before the integrated transaction began. This prevents minority shareholders in squeeze-out mergers from obtaining tax-free reorganization treatment where the vast majority of their fellow shareholders were cashed out, ensuring that transactions that are substantively sales are treated as such.
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