Editor: Annette Nellen, J.D., CPA
In fall 2003, a joint task force of the AICPA and the American Taxation Association (ATA) “conducted a survey to (1) gather information about the current state of affairs in tax education and (2) obtain broad input about the tax component of the accounting curriculum” (Kern and Dennis-Escoffier, “Current Status of the Tax Curriculum in Accounting Programs,” 35 The Tax Adviser 712 (November 2004)).
The survey indicated that 43.7% of respondent schools required one tax course and offered one elective course, 29.1% required one tax course, and 11.7% required two tax courses (Id.). Within the first tax course, the survey revealed that little or no coverage related to, among other things, business entity taxation (Dennis-Escoffier and Rubin, “Curriculum Tools for Tax Educators,” 39 The Tax Adviser 110 (February 2008)). While the survey contributed to changes in the AICPA’s Model Tax Curriculum (MTC), it also suggests the need for tax educators to develop assignments that more efficiently convey important entity tax concepts.
Given the time and resource constraints most tax educators face (see, e.g., McGill and Outslay, “The GAAP in Tax Education: Integrating Tax and Financial Accounting in the Tax Curriculum,” 38 The Tax Adviser 118 (February 2007)), faculty need to enhance their courses with new technologies and pedagogies and develop a vision for their courses that they constantly evaluate and refine (see Newmark, “The Introductory Tax Course Revisited,” 34 The Tax Adviser 695 (November 2003)). They might also rely on an approach to teaching taxation that focuses on fundamental concepts and the acquisition of tax skills, gained through active participation by the student (see Jones and Duncan, “Teaching the Introductory Tax Course: A New Paradigm,” The Journal of American Taxation Association, 95–103 (Spring 1995); Gore and Wong-On-Wing, “The Acquisition and Transfer of Tax Skills,” Journal of American Taxation Association, 117–126 (Fall 1998); Dockter, “Taking the Student’s Lead in Teaching Tax,” American Journal of Business Education, 73–78 (July 2010)). In short, while the MTC, revised in 2007, “does not advocate a particular teaching method, it does call for faculty to use more active teaching methods” (see Dennis-Escoffier, et al., “The Revised Model Tax Curriculum,” Issues in Accounting Education, 148 (May 2009)).
By encouraging active learning, tax faculty can overcome the traditional perception that accounting education places too much emphasis on memorization and content, rather than on critical-thinking skills (see Efrat, “Teaching Tax Through the Socratic Method,” 39 The Tax Adviser 773 (November 2008)). Research on active learning “suggests that when students develop their own solutions and/or explanations, they take ownership of the knowledge they gain and are more likely to retain it” (see Chu and Libby, “Writing Mini-Cases: An Active Learning Assignment,” Issues in Accounting Education, 245–246 (May 2010)).
As an added incentive to incorporate active, technology-based assignments into courses, faculty will appeal to the “tech savvy” nature of Generation Y students who have grown up with technology and expect immediate feedback (see Manly and Thomas, “Adapting Accounting Education to the Generations: Working With Millennials,” 40 The Tax Adviser 119 (February 2009)). Additionally, as CPA firms have begun to use simulations and sophisticated technology to recruit and train Generation Y individuals (see Polimeni, et al., “Using Computer Simulations to Recruit and Train Generation Y Accountants,” The CPA Journal, 64–68 (May 2009)), by extension, tax faculty need to design courses to meet the technological needs and talents of these students.
This column addresses the call for more active teaching methods in the face of constraints by providing tax educators an example of an interactive spreadsheet assignment and describing how to incorporate it within an introductory taxation course. This column first presents the motivation for the topic of the assignment and some preliminary recommendations for instructors and then details each
assignment step and provides summary student results.
Assignment Motivation and Recommendations
Within an introductory taxation course, instructors may be compelled to rush through or omit the subject of tax-free acquisitive reorganizations in favor of more foundational entity topics (e.g., formations, distributions, liquidations). Given the interest that most students have regarding mergers and acquisitions, a compromise approach would be to administer an assignment that captures some of the basics of reorganizations without sacrificing class time. An interactive spreadsheet-based exercise that employs extensive simplifying assumptions and uses an inductive process allows students to gain a working understanding of type A, B, and C reorganizations and reinforce prior knowledge regarding stock basis and realized/
recognized gains and losses.
Educators should ideally introduce the assignment after students have gained some understanding of the basics of corporate taxation, particularly the general principles of Sec. 351 regarding corporate formation and the following associated topics:
- The effect of liability assumption (e.g., Sec. 357(a));
- The basis received by a shareholder (e.g., Sec. 358); and
- The basis received by a transferee corporation (e.g., Sec. 362).
While the assignment is designed to preserve classroom time, instructors may wish to spend a portion of one class period introducing the basic differences between taxable and nontaxable acquisitions and the major types of tax-free reorganizations. Instructors may also want to review various Code sections related to gain recognition (e.g., Sec. 61(a)(3) and Secs. 1001(a), (b), and (c)) that taxpayers seek to avoid when structuring a reorganization. Classroom coverage does not need to be extensive, however, as the assignment requires students to identify relevant authority for reorganization tests built into the spreadsheet.
Part 1. Introduction to reorganization spreadsheet; student input and test discernment: After distributing a balance sheet of a prospective target corporation at a hypothetical date of acquisition (see Exhibit 1), the instructor explains to students that an acquirer, with $1 million in cash, no other property, and no other assets and liabilities, has the choice of (1) purchasing some or all of the target’s assets (and assuming some or all of the target’s liabilities) or (2) purchasing some or all of the target’s stock.
The instructor then asks students to enter asset or stock acquisition assumptions into the input section of a preformatted spreadsheet (see Exhibit 2). More specifically:
- For an asset acquisition, students must enter the type and amount of target assets acquired (and liabilities assumed) and the type and amount of consideration provided. Students must also supply information regarding the termination/liquidation of the target.
- For a stock acquisition, students must enter the percentage of stock acquired and the type and amount of consideration provided.
For both asset and stock acquisitions, the instructor should reinforce two points. First, with respect to consideration in the form of stock, the acquiring corporation issues additional capital stock within a proposed acquisition transaction. Second, while the spreadsheet limits the maximum fair value of stock consideration to $1 million (to arbitrarily match the amount of an acquirer’s cash on hand at the date of acquisition), the fair value of additional capital stock issued could, of course, exceed $1 million in an acquisition.
After inputting their assumptions, students receive immediate feedback as to whether the transaction qualifies as a type A, B, or C reorganization. To clarify the transaction mechanics of each type, the instructor distributes flowcharts illustrating a forward A merger, a B reorganization (see Exhibit 3) and a C reorganization.
For any transaction that qualifies, students can then click on an “Effects” link that summarizes the effect of their assumptions on the following items (see, e.g., Exhibit 4):
- Target realized gain;
- Target recognized gain;
- Acquirer basis in target noncash property or target stock;
- Acquirer holding period for noncash property;
- Target shareholder realized gain;
- Target shareholder recognized gain; and
- Target shareholder basis in acquirer stock.
After gaining some initial familiarity with the spreadsheet, students are then asked to experiment with several input possibilities (facilitated by the spreadsheet’s “Clear All” function) to discern one or two tests the spreadsheet employs to determine whether a proposed transaction qualifies as a type A, B, or C reorganization.
Part 2: Instructor review/distribution of test solutions; student identification of related authority: After reviewing student conclusions, the instructor reveals the basic tests (see Exhibit 5) used within the spreadsheet—tests previously hidden—and asks students to identify authority (e.g., Code sections, Treasury regulations, or court cases) for each test using relevant textbook or treatise material. (For example, various sections of Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders (WG&L 2000), provide sufficient detail on the specifics of A, B, and C reorganizations.)
Part 3: Student delivery of reorganization assumptions; reporting on a business periodical related to reorganizations: Once students know the tests associated with the various acquisitive reorganizations and have gained some appreciation for the underlying authority, structure, and tax ramifications of each, the instructor requires two final deliverables designed to reinforce student understanding:
- A set of assumptions that produces each of the following:
- Target asset acquisition:
- Type A qualification.
- Type C qualification.
- Neither A nor C qualification.
- Target stock acquisition:
- Type B qualification.
- Type B disqualification.
- A Wall Street Journal or other business periodical article describing a recent corporate merger and a student assessment as to whether the transaction reported would likely qualify as a tax-free reorganization.
The goal of the assignment is to introduce students to acquisitive reorganizations. To keep coverage manageable within an introductory tax course, the assignment contains many simplifying features. Examples of these features follow:
- Student inputs are controlled by spreadsheet “spinners” to minimize errors.
- Type D acquisitive reorganizations are not included.
- Triangular/subsidiary mergers are not included.
- Type A transactions relate to statutory mergers, not consolidations.
- The spreadsheet presents the amount of realized/recognized gains and losses, not their character.
- The acquirer is presumed to have $1 million in cash, no other property, and no liabilities.
- In asset acquisitions, the consideration provided by the acquirer has to equal or exceed the fair value of net target assets acquired. In addition, the spreadsheet limits total consideration, whether in the form of cash or additional stock, to $1 million.
- In asset acquisitions, the liabilities assumed are limited to those liabilities shown on the target’s balance sheet on the date of acquisition (i.e., contingent liabilities are ignored).
- In stock acquisitions, the consideration provided by the acquirer has to equal or exceed the fair value of net target assets multiplied by the percentage of stock acquired.
- Various judicial restriction doctrines/requirements (e.g., continuity of interest, business purpose) are ignored.
Sample Student Results
To assess student ability to discern the reorganization tests (part 1 of the assignment), the author distributed the spreadsheet to a small test group of students enrolled in an introductory, entities-based tax course. While the response formats varied, almost all students were able to identify at least one rule for an A, B, and C reorganization, respectively. Most students identified two or three rules that triggered each of the reorganizations. Students responded with greater clarity on one-dimensional tests, such as liquidation of the target company and percentage tests for target assets or liabilities, rather than the relational tests of target assets and liabilities or target liabilities and acquirer cash. The results demonstrated the benefits of an inductive process and the reliance on critical-thinking skills by which students build their understanding of tax-free acquisitive reorganizations.
Conclusion and Future Implications
The revised MTC calls for more active teaching methods, and the reorganization assignment represents a step in that direction. The assignment is also beneficial in its incorporation of technology via an Excel spreadsheet application. The topic covered by the assignment, tax-free acquisitive reorganizations, is one that is often overlooked in an introductory taxation course. By using induction to identify the tests for A, B, and C reorganizations, ascertaining the authority for the various tests, and finding real-world examples, students can improve their knowledge of the tax treatment of corporate reorganizations. The technology used in the assignment and the inductive process can be adapted for use with other tax topics (e.g., divisive reorganizations). This exercise demonstrates an active approach to tax education that improves critical-thinking skills and allows for broader topic coverage in the tax course.
Note: The full spreadsheet assignment can be obtained from lead author Steve Harrington upon request (firstname.lastname@example.org).
Annette Nellen is a professor in the Department of Accounting and Finance at San José State University in San José, Calif. She is a former member of the AICPA Tax Division’s Tax Executive Committee and is chair of the Tax Division’s Individual Income Tax Technical Resource Panel. Steve Harrington is a professor of accounting, Anne Drougas is a professor of finance, and Richard Walstra is an assistant professor of accounting, all at Dominican University in River Forest, Ill. For more information about this column, please contact Prof. Harrington at email@example.com.