Mergers and Acquisitions – What Are the Tax Considerations?
It seems like every day we’re reading about the latest Private Equity deal; a few months ago it was about the biggest deal ever involving some of our favorite video games. While Private Equity acquisitions are all over the headlines right now, mergers and acquisitions (M&A) activity has been robust for the last several years – it just didn’t quite have everyone’s attention like it does now. Because of this attention, though, regular discussions are being had surrounding the tax impact of acquisitions and what needs to be considered, regardless of whether businesses are thinking of buying or selling.
This first foray into the topic will cover the basics. And, while we never want to let the tax impact drive the decision, it can’t be ignored either.
Where to begin? Simple – Asset or Stock?
Asset Deals
The general rule is that buyers want to buy assets and sellers want to sell stock. But why? In an asset deal, it’s just as it sounds. The buyer is simply buying some assets. It may be an entire business; it may be just part of a business. The important distinction, though, is that an asset deal is the purchase of a group of assets that make up a trade or business (even if it’s not the entire business).
When assets are acquired, the purchase price is required to be allocated amongst the individual assets based on their fair market value. First start with the easy ones (e.g. cash, accounts receivable, inventory) and then move on to the more difficult ones – fixed assets and identifiable intangibles (e.g. customer lists). Anything left over is allocated to goodwill. As one might guess, this often requires a valuation.
Tax Impact
So, what’s the tax impact? As with everything in tax – it depends. One side often gets a desirable tax answer, while the other side makes up for it. The seller recognizes ordinary gain on things like accounts receivable and inventory, as well as recapture of accelerated depreciation on Section 1245 property (e.g. machinery & equipment). Any remaining gain is generally capital in nature and eligible for preferential rates.
The buyer on the other hand takes full basis in accounts receivable and inventory, and amounts allocated to fixed assets are eligible for bonus depreciation (which is now at 100%). This means the buyer gets the full tax benefit when A/R is collected, when inventory is sold, and a full deduction on eligible fixed assets in year one. They also get to depreciate other fixed assets not eligible for bonus depreciation, as well as amortize identifiable intangibles and goodwill. Plus, if the buyer takes on debt, the new interest limitation rules have expanded the ability to deduct interest expense. These are all significant tax advantages in the year of sale.
One might then ask – if selling a business, why would one ever agree to sell assets? This is where decision makers can’t get caught up in the tax impact alone. One may be able to use this to negotiate a higher purchase price. There are plenty of instances where a business simply can’t find someone who will buy stock. Thus, they may have no choice but to sell assets. The important thing is to know the tax impact such that one can understand the net overall financial impact of the transaction.
Stay tuned and make sure you’re subscribed to our Tax Insights, as the topic of our next article will be stock deals.
Questions? We’re here to help. We regularly help clients on both the buyer and seller side and would be happy to assist you; please do not hesitate to contact us. You can also learn more by visiting our Tax service page.
