Once upon a time, you owned 100 shares of American Telephone and Telegraph Co., a solid blue-chip utility stock consistently paying a good dividend that was increased from time to time. It was so solid that it came to be known as the "widows and orphans" investment.
Then things changed. There were cries that AT&T was too big, that the comfortable family relationship among Ma Bell, her manufacturing arm, Western Electric, and her various operating companies was a little too cozy. After years of squabbling, a divorce was decreed.
So now, instead of your simple 100 shares of AT&T, you own 100 shares of something called the "new" AT&T plus 10 shares of each of seven new telephone companies with such exotic names as American Information Technologies, Nynex Corp. and Pacific Telesis Group.
If you had been keeping your AT&T stock certificate in your safe deposit box, you will have eight certificates now instead of one. And the single quarterly dividend check will grow to eight quarterly checks, plus eight year-end 1099 tax statements.
After a while, the paperwork may get a little burdensome, and you may decide to sell some of the "newborns" in an attempt to recapture some of the simpler pleasures of yesteryear. Besides, while you always felt comfortable with AT&T, you're not so sure about the upstart BellSouth Corp. and its siblings.
So in August 1984, you decide to deliver the 10-share certificates for several of the new telephone companies to your broker and ask that they be sold for you. But all of a sudden, you have a problem you hadn't thought about before: You know you must report any gain or loss on your 1984 tax return--but where do you obtain the numbers?
Well, you're in luck. There is a formula for working out the correct cost basis for each of the seven new operating companies and for the new AT&T shares as well. With a little help from Jack Milton at the Alexandria office of Merrill Lynch and Will Lobb at the Washington office of E. F. Hutton, we've put together the procedure.
The first step is to determine the cost basis of the 100 original AT&T shares. If you bought them yourself, go to the purchase confirmation slip and use the total cost (including the broker's commission). If you don't have the confirmation slip (you should always keep them), then use any other record you have of the cost.
If you received the shares as a gift or a bequest, the rules vary depending on the circumstances. At the time you received the shares, you should have been given a cost basis by the donor or the administrator of the estate. If you don't have such a record, get a copy of IRS Publication 551, "Basis of Assets," which explains how to determine the basis for calculating gain or loss on assets acquired in various ways.
After you have established the cost basis of the old AT&T shares, you must divide that amount by 100 to get the cost basis for a single share of old AT&T. (Of course, if your total cost basis was for some number other than 100 shares, divide the total cost by the number of shares involved--whether more or less than 100--to get the per-share cost.)
Now you must multiply the per-share cost of the original shares by a calculated percentage for each of the eight new companies--new AT&T and the seven regional operating companies. Here are the percentages to be used:
AT&T new (post-divestiture)--28.50 percent
American Info Tech--10.33 percent
Bell Atlantic Corp.--10.49 percent
BellSouth Corp.--13.53 percent
Nynex Corp.--9.84 percent
Pacific Telesis Group--8.88 percent
Southwestern Bell Corp.--9.49 percent
U S West Inc.--8.94 percent
One further step is required. The divestiture, as you know, provides 100 shares of new AT&T for each 100 old shares--but only 10 shares of each regional company for each 100 shares of old AT&T stock.
So to arrive at the correct valuation for each regional share, you must multiply the amount derived from the percentage calculation by 10. Be sure to apply this second multiplication to the shares of the regional companies only, and not to the new AT&T shares, which were exchanged on a one-for-one basis.
Let's check it out with an example. We'll assume you bought 100 shares of AT&T at 59 1/4, plus a $75 brokerage commission, for a total cost of $6,000. (It's easy to make the numbers come out even when you're setting up your own example.)
Divide that $6,000 figure by 100 and you get a cost of $60 for each share of old AT&T. If you multiply $60 by 28.50 percent (the percentage in the table above for the post-divestiture AT&T shares), you arrive at a value of $17.10, and that is the cost basis for each share of new AT&T.
The percentage for Ameritech is 10.33--so multiply the $60 figure by that amount and you get $6.20 (rounded). Now you have the extra multiply-by-10 step, which gives you a cost for each share of American Information Technologies of $62.00.
Repeating the same calculation for Bell Atlantic, using the 10.49 percent figure from the table gives you a per-share cost basis of $62.94. Continuing this procedure through the next five companies will provide a cost basis for each of the eight companies whose shares you now own in place of the old AT&T.
If you now multiply the per-share cost of new AT&T by 100, then multiply the per-share cost of each of the other seven companies by 10, you will have the correct cost basis for each of your eight new holdings. Add these eight totals together and you should come up with $6,000 (give or take a few dollars because of rounding).
Thus your total cost basis for the new shares is approximately the same as the cost basis for the original AT&T shares. And the cost for each of the eight holdings is proportionate to the market values of the eight stocks on Jan. 1, 1984--the official divestiture date--weighted to compensate for the 1-to-10 distribution.
Of course, the market wasn't open on Jan. 1. In the interest of precision, we should explain that the figures were reached by averaging the mean values on Dec. 30, 1983, and Jan. 3, 1984--the market days closest to Jan. 1.
There is one other aspect of these calculations that should be mentioned. All parties involved agree that, for the most part, the distribution of shares to AT&T stockholders is a tax-free exchange that generates no tax liability unless some of the new shares are disposed of, either by sale or by exchange in accordance with the AT&T divestiture option card.
The Internal Revenue Service, however, has taken the position that a small portion of the Pacific Telesis distribution, in fact, represents a taxable dividend that should be reported on your 1984 income tax return.
Corporate counsel for AT&T differs with this ruling, however, and believes that the entire distribution is a tax-free exchange which has no present tax impact (other than the calculation of new cost bases for future sales). You should discuss this question with your own tax adviser.
And a final tax tip: Assuming you owned the old AT&T shares on Jan. 1, 1984 (the distribution date), then your holding period for determining short-term versus long-term capital gain on a future sale includes the holding period of the old shares. That is, you use the date of purchase of the original AT&T shares as the date of purchase for all eight new certificates.