Mergers & Acquisitions – What Are the Tax Considerations? Part 3
This is the third addition in our series of articles on the tax considerations related to mergers and acquisitions. January’s article covered asset deals, while the article in March discussed stock deals.
Today’s article will tackle the question of what if someone wants both? Society tends to have ever-increasing desire to get everything they want all at once, is it any surprise that acquisitions would be any different? Can the best of both worlds really be possible? The answer is… kind of. Here’s how.
The Asset and Stock Deal Solution
As previously discussed, buyers generally want to buy assets – but that doesn’t mean that there isn’t an upside to a stock deal for the buyer. Contract concerns, licensing, client consents, etc., are largely a non-issue in stock deals because the entity doesn’t change – just the ownership of it does. In many industries, there is an immeasurable benefit to entity continuity, but that doesn’t mean that the buyer doesn’t want the tax advantages of an asset deal, though. This is where what’s called an F Reorganization (F Reorg) comes into play.
An F Reorg is defined in the Internal Revenue Code as a mere change in identity, form, or place of organization of one corporation. What this means is that one can take their S Corporation and essentially convert it to a single-member LLC, which is treated as a disregarded entity owned wholly by the S Corporation’s original owners. This new, disregarded entity holds all of the assets, liabilities, contracts, operations, and value of the original corporation and can be purchased by the buyer or merged into a separate disregarded entity owned by the buyer.
The Significance of an F Reorg
Why is this important? Purchases of disregarded entities are treated as asset sales for tax purposes. This means that the buyer gets a stepped-up basis to fair market value of assets that – post acquisition – will be deductible through depreciation and amortization. In addition, since the buyer is also purchasing an entity (albeit disregarded for tax purposes), the legal advantages of buying a corporation are intact, which means that things like EINs, contracts, and licenses all continue.
This isn’t a perfect solution by any means – the seller still has potential ordinary income on the sale for things like 1245 depreciation recapture – but capital gain treatment on what could potentially be the vast majority of the gain on the sale is preserved. Further, the seller can negotiate a higher purchase price, since the buyer is getting the advantages of both a stock and asset purchase.
The Logistics of an F Reorg Transaction
Back to reality – structuring a transaction like this is not simple. There are elections, filings, and structural limitations that all come into play. Legal counsel must be involved early on. Scenarios must be run that show tax implications of multiple structures, so one knows how much one side is benefiting and how much it’s costing the other side. While there’s no perfect scenario for both parties, an F Reorg is one tool in the toolbox that can help everyone get to a win-win scenario.
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.
