A recent article by Tax Analyst lead commentator, Lee Sheppard, speculates on the possibility of a tax angle in the Fed's bailout of Bear Stearns. (No surprise there, given the Wall Street legal talent that must have gone into billing overdrive structuring the deal.)

The deal consisted of a shotgun marriage (brokered by the Fed) between JPMorgan Chase and Bear Stearns. It was structured as a stock-for-stock exchange, JPMorgan stock being exchanged for Bear Stearns stock, the latter valued at two dollars per share. That valuation represented a gigantic loss for Bear Stearns shareholders, a loss that was only somewhat trimmed when the deal was re-priced at $10 for Bear Stearns' shares.

Ordinarily, when tax practitioners hear "stock-for-stock," they think "B" reorganization: a tax-free deal. But tax-free exchanges do not permit losses to be recognized (Section 354(a)(1), "No gain or loss ..."). Is there a way to maintain the structure of a stock-for-stock deal, while still permitting Bear Stearns shareholders to recognize their losses? Maybe so.

Turns out that Bear Stearns, in addition to its voting common stock, has outstanding an issue of non-voting preferred stock. The definition of a "B" reorganization requires the acquiring corporation to acquire "control" of the target company. Control is defined here in section 368(c): 80 percent of the voting power of the target, plus 80 percent of all other classes of target stock. (Note: A different definition of control exists in § 1504(a) for purposes of filing a consolidated return.)

Published reports indicate that JPMorgan Chase will not acquire the Bear Stearns preferred stock. An oversight? Not likely. More likely the omission was intentional, with the purpose of creating a stock-for-stock exchange failing the section 368(c) control test, thus allowing the Bear Stearns common shareholders to recognize their losses.

Subchapter C is often criticized as an overly complex rule-based system that can frustrate taxpayer compliance, the proverbial "trap for the unwary." But there's another side to complexity: sometimes it can be put to advantage by savvy practitioners.