When negotiating merger and acquisition transactions, the tax impact of such transactions must be addressed urgently to allow each party to meet its tax and economic objectives without hurting the other party.
Here are the top 10 tax issues to watch out for:
Depending on your agreement, the transaction can be financed with cash, notes, and/or buyers stock. Typically, a higher concentration of notes and purchasers common stock may result in tax-free reorganization. In foreign-buyer or inter-state transactions, the domestic debtor might be required to withhold taxes on payment.
You will need to address tax credit carryovers, net operating carryovers, and high tax basis in operating assets. Where any of these attributes exist, rather than stock purchase, it may be preferable to pursue tax-free reorganization under IRC Section 368 or taxable purchase/sale of C Corp stock.
Purchase price allocation
Under IRC Section 1060, if either the buyer or seller is public company, the two parties should pursue the GAAP treatment that affords the seller greater flexibility on structuring and purchase price allocation. For greater tax benefits, the seller should always allocate a greater portion of the sales price to assets such as land and goodwill that generate capital gain.
Ordinary vs. capital gain
Not all gains are treated as capital gains. If the assets being sold are ordinary income assets such as inventory and depreciated assets, ordinary tax rates will apply to net gains associated with prior depreciation values allowed or allowable.
Legal status of the target
Different entities are reviewed differently under IRC regulations. The tax basis of C Corps, S Corps and LLCs are revalued using IRC Section 338 (g) and IRC Section 338(h) (10), while Partnerships revalued using IRC Section 754. However, for an entity to be reviewed under 338, at least 80% of the sellers stock must be sold.
Sales and other taxes
These include taxes on gross allocations made to certain assets such as vehicles, machinery and equipment, and certain software and can raise costs of assets by as much as 10%. It’s important to clarify who bears the transfer costs of these assets.
Actual transaction costs
Legal, accounting, and other transaction costs of both the buyer and seller, related to pre and post-acquisition, may qualify for tax deductions as general operating costs.
Post transaction filing requirement/elections
Taxable asset purchases allow new owners to make new tax elections of accounting methods and periods. A reorganization or stock purchase means that you continue using the former entity’s tax elections.
It’s very important for the buyer keep documentation of all pre-acquisition liabilities assumed from the seller. Tax deductibility provisions for post-acquisition payments may see only the owner or buyer or in some cases neither parties getting deductions on payments.
S Corp Target issues
What if a public company or any other tax payer wants to acquire an S Corp to make IRC Section 338(h) (10) elections? It is important that you ensure that the Target’s S Corp’s election and all operations are valid, and that the entity itself is a valid S Corp at the time of the transaction. Otherwise the acquisition followed by a 338 election may result in double taxation.
Considering these issues, it’s critical to perform careful technical analysis and financial evaluation to come with the best merger or acquisition structure.