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In a little-noticed wrinkle in Pfizer Inc.’s plan to become an overseas company after its merger with Allergan, some shareholders will face potentially huge tax bills as a result.
The so-called inversion will force stockholders to exchange the company's American-based stock for shares in the new Irish-based drug firm to be known as Pfizer plc. This means investors in the highest tax brackets will have to pay a 20 percent federal capital-gains tax as part of that process.
And that's without accounting for other state and federal taxes that could push the hit on affluent stockholders to 30 percent or higher, Patrick Gingras, a financial adviser and vice president of Essex Financial Services, said. The taxes will be based on the stock's appreciation in price over the years, while share losses will not be deductible.
"It's going to be a tax nightmare," retired Pfizer executive Tom Althuis of Groton said. "It's a substantial bite."
Pfizer has defended the inversion's effect on stockholders, saying in an online posting that the move will create a stronger company. An inversion occurs when companies buy overseas competitors and then convert to foreign domicile, usually to escape relatively high U.S. corporate tax rates.
"We believe the strategic benefits of the new corporate structure will be more beneficial to stockholders than the existing structure and outweigh the tax implications," Pfizer said in an online overview of the deal.
Pfizer has said it expects to pay out between $6 billion and $12 billion to stockholders who want to cash out of their positions in the company's stock to pay their taxes. Those who choose to convert their Pfizer holdings to the newly reconstituted company's stock will have to pay taxes out of pocket.
"With mergers like this ... company shareholders may be forced into realizing gains on shares they have been holding," said Russ Burgess, who owns an independent Charles Schwab & Co. brokerage in Mystic. "Individual investors need to think about their choices and prepare."
Employees at all levels of the company who work at or retired from the Groton laboratories or from Pfizer's former research-and-development headquarters in New London have long enjoyed lucrative stock options. And many of those options were purchased decades ago for just a few dollars, setting up huge appreciations with the stock now trading in the $30 range.
"It's going to be hard on some people," said Madeleine Lewis, an accountant who owns Lewis Representation LLC in Groton. "The higher income end are really going to be hurt."
The tax applies only to investors with personal holdings in the company as opposed to shares of Pfizer stock held in retirement plans or mutual funds.
Many retirees had hoped to hold Pfizer stock until their deaths, transferring their wealth to children and grandchildren, local financial experts said, but the taxes spurred by Pfizer's inversion — a move to reconstitute the drug giant as a foreign company to avoid billions of dollars in corporate taxes — will reduce their relatives' inheritance.
On the other hand, lower-income former Pfizer employees, including janitors and secretaries who were in the stock-option pool along with scientists and other highly paid personnel, may not have to pay any capital gains taxes, Lewis said. Such levies are reduced to zero for those whose earnings place them below the 15 percent tax bracket, she said, and even the forced sale of stock will not put them in a higher tax category.
A married couple in the 10 percent tax bracket would have to make no more than $18,450 a year; a single person qualifying for the lowest bracket would be capped at half that amount.
Tom McGuigan, principal of Exencial Wealth Advisors in Old Lyme, and Robert Henderson, who operates the Lansdowne Wealth Management office in Mystic, each said most investors in the region would not be significantly affected. That's because Pfizer, unlike General Dynamics, has not seen substantial and sustained stock growth over the past decade or so, leading many shareholders to sell out, Henderson said.
The exception, Henderson said, would be for employees from the 1970s through early 1990s who saw exceptionally large increases in the value of Pfizer's shares, including several stock splits.
"It's only a problem for people who never got rid of their Pfizer shares," McGuigan said. "That's why people should be diversifying their shares."
McGuigan said his firm has been reaching out to individual shareholders to let them know about the issue. Most people he has contacted about the inversion were unaware of the tax consequences, he said.
Local financial experts had several suggestions for investors trying to get ready for the inversion, which is expected to be completed in the second half of this year.
First, McGuigan said, investors should segregate their shares by block and consider giving away shares purchased at the lowest prices to family members who are in a lower tax bracket. Other advisers pointed out that a couple can give away as much as $28,000 in stock to individual family members with no tax consequences on either side of the transaction.
McGuigan warned, however, that for children under age 24, "kiddie tax" rules apply that would result in giveaways to them being taxed at the same rate as parents would pay.
At the same time, he said, investors should start taking losses on some stocks that have plunged over the past year during the current market turmoil. These losses will help offset gains realized with the forced sale of Pfizer stock, he said, reducing taxable income.
Finally, McGuigan and others said, Pfizer shareholders of a charitable bent should consider giving away shares. Donations can be set up in a variety of ways, including as donor advised funds that would allow for an immediate tax writeoff of the full promised amount this year without having to give away more than a part of those funds immediately.
For anyone who regularly gives money to a church or charity, "Donate highly appreciated stocks instead of writing checks every year," McGuigan suggested.
Some brokers noted that this would be a good time for the region's nonprofits to seek out retired Pfizer employees who see the inversion as an opportunity to shift shares to charitable causes as a way of avoiding heavy taxes.
Burgess, the Mystic broker, said there has been so much interest in the tax consequences of the inversion that he is holding a special free presentation for investors later this month at the Mystic Hilton (call (860) 415-8090 to register). The meeting, for which a dozen people have registered, will feature David Toung, a senior healthcare analyst at Argus Research Company, talking about the inversion's potential effects on taxes as well as a look at Pfizer's business prospects after the merger.
Bill Middleton, principal of Sound Portfolio Advisors in Mystic, said one of the biggest problems of the inversion is that it has become an "involuntary sale" of stock for which people were unprepared. The effect is particularly acute in this region of Connecticut because many investors have a "low basis point," he said, meaning they acquired shares before the Viagra effect sent prices soaring in the late 1990s to early 2000s.
Adding to the angst is the question of whether Pfizer executives will be compensated by the company for taxes owed based on the inversion. It's not yet clear what will happen, but the bite is expected to be hefty — over $1 million for chief executive Ian Read alone, according to one estimate — leading many to predict that the company will find a way to offset the cost.
But a Pfizer spokeswoman said such talk is only speculation.
"Pfizer has no plans to pay the capital gains tax for executives," spokeswoman Joan Campion said in an email.
Some locals might be hit nearly as hard, but won't have the same possibility of being compensated. One broker noted that he had a client in his mid-80s with millions of dollars in Pfizer stock who might face taxes in the seven-figure range.
"I'm being taxed for a decision I had no input into," Althuis, the Groton shareholder and Pfizer retiree, said. "It's as if you sold it and rebought it. ... I never thought it (the inversion) would mean anything adverse to me as a stockholder."
Russ Burgess, who owns an independent Charles Schwab & Co. brokerage in Mystic, said there has been so much interest in the tax consequences of the Pfizer inversion that he is holding a free presentation for investors later this month at the Mystic Hilton.
The meeting, for which a dozen people have registered, will feature David Toung, a senior healthcare analyst at Argus Research Company, talking about the inversion's potential effects on taxes as well as a look at Pfizer's business prospects after the merger.
Call (860) 415-8090 to register.