Acquisitions can be good for business. They provide buyers with
immediate revenue growth, new markets and intellectual capital while
sellers have the opportunity to be financially rewarded for their efforts. But the
deal’s attractiveness can quickly wane
when the transaction results in a double
layer of taxes for the seller or a lack of
step-up in basis for the buyer. Advance
planning along with knowledge of the tax
implications and possible alternatives are
the best ways to make acquisitions advantageous for both parties.
“In some cases, there will be no immediate taxes generated by a tax-free stock
exchange or only a capital gains rate
may apply, and in other cases, you could
be looking at double taxation under an
asset sale,” says Gary Curtis, corporate
tax partner for Haskell & White LLP.
“Since the transaction often puts buyers
and sellers at odds, it’s important to have
enough time to look at all the alternatives and structure the deal in a way
that’s best for everyone.”
Smart Business spoke with Curtis
about how to avoid excessive taxation
from acquisition transactions.
What determines the tax liabilities in an
Usually buyers and sellers benefit from
different acquisition transaction structures. In a taxable acquisition transaction, two of the influencing factors
- Whether the buyer is purchasing
assets versus stock
- The entity structure of the seller
Sellers usually want a stock sale
because the gain will be taxed only once
at the relatively low capital gains tax
rate. Buyers usually prefer an asset sale
because they can purchase known
assets and liabilities, as opposed to a
stock transaction where they take on liabilities for all previous actions of the
company, and the ‘step-up’ in basis to
fair market value can be depreciated or amortized, which improves cash flow.
Generally, the seller offers more warranties and guarantees to offset the
unknown liabilities resulting from a
stock sale, but they may get a lower sale
price, as well.
How does the seller’s legal entity impact
If the selling company is set up as a C
corporation, the principals may be hit by
two rounds of taxation during an asset
sale: income tax at the corporate level
and again at the shareholder level when
the proceeds of the sale are distributed.
You can avoid double taxation resulting
from an asset sale if the selling firm is
structured as an S corporation. An S corporation or a business set up as a pass-through entity, such as a limited liability
company (LLC), will generally only pay
one level of tax, which will be at the capital gains rate. There may be some taxes
at ordinary income rates, but these
amounts are often insignificant in relation to the overall taxes.
What are the tax alternatives?
S corporations and LLC legal structures produce the least amount of tax
liability during acquisition events. So if
your company is currently structured as
a C corporation, and you plan to keep
the company for 10 years or longer
before selling it, consider converting to
an S corporation status.
A tax-free merger is another alternative. It occurs when one company
acquires a controlling interest in the
other company in exchange for its stock.
The sellers don’t report taxable gain
until the new stock is sold. This method
is advantageous if the shareholders of
the acquired company don’t want to
cash out in the near future, but even if
the seller wants to receive some cash
from the transaction, the merger will
still work as long as the seller doesn’t
require more than 50 percent of the sale
price in cash.
Is a 338 election a viable tax alternative?
Section 338 allows the purchasing corporation to buy the stock of another
company and treat the purchase as an
asset acquisition under a set of specific
conditions. On the surface this sounds
favorable, but there are still a few things
to consider. While the transaction may
not result in double taxation, the seller
may still be liable for some additional
taxes. While an entity change may be a
solution when time allows, there are
other potential alternatives to the tax
implications resulting from acquisitions.
Each situation requires its own unique
solution that will work best for both
GARY CURTIS is a corporate tax partner with Haskell & White LLP. Reach him at (949) 450-6311 or [email protected].