Mergers and Acquisitions – What Are the Tax Considerations? Part 2
The M&A discussion back in January was focused on Asset Deals. As described in that article, buyers often want to buy assets, and sellers often want to sell stock. The reasons for this include income tax benefits and legal considerations. The deal structure is largely driven by other factors though. For example, there will always be industries where stock is the only viable option. Industries that are highly regulated at the state level, as well as those that are heavily reliant on ongoing contracts, will always see stock deals as the primary means of ownership transfer. The reason is that the target is already set up to meet regulatory requirements, and no one wants to go through the legal hassle of repapering contracts that can’t otherwise be assigned.
Stock Deals
So, what does a stock deal mean? From an external standpoint, not much is different. At the end of the day, the seller no longer owns the operations of the company, and the buyer controls everything. Once you scratch below the surface though, everything changes from a tax perspective. In an asset deal, everything (or most everything) the company owns is sold, including both tangible and intangible assets. In a stock deal, the company itself is sold, and the assets in the business aren’t directly affected in that they’re still owned by the company. On the other hand, a stock transaction is outside of the business – it’s between two individuals, groups of individuals, entities, or a combination of all three – all of which are outside the target business. The target itself isn’t selling anything – the target’s owner is selling their equity in the target.
Tax Impact
For tax purposes, the target just continues moving forward as if nothing happened. Asset basis carries over, tax attributes (mostly) carry over, and both past and future tax filings are of the same entity. What comes along with this is all of both the good and bad things that happened with the target before the acquisition. Outstanding tax liabilities? They’re now the buyer’s problem. Missed tax filings? They stay with the entity – and its new owners. For this and other reasons, due diligence is especially important in stock deals. With asset deals, one is examining what they know is there. With stock deals, one needs to quantify what they don’t know is there.
From an income tax treatment standpoint, the answer is generally seller friendly, and buyer beware. Seller generally gets capital gain treatment and reduced tax rates. Buyer gets basis in stock that they can use to offset a future gain on the sale of the same stock… someday. This is what gets us back to the old adage of sellers want to sell stock, buyers want to buy assets.
As one might guess, often times negotiations will hit a fork in the road. What happens when someone wants to sell stock, but a buyer wants to buy assets? The seller needs to know what they’re missing out on because it’s almost guaranteed that the buyer already knows. If they’re making an offer to buy assets, one’s negotiating position hinges upon their ability to understand the tax benefit that they’d be getting, and the tax cost that they would be bearing. When a buyer will get an immediate tax benefit from bonus depreciation – a seller needs to know what that is. When a buyer will get long-term tax benefits from goodwill amortization, a seller needs to be able to quantify that. When a seller will lose out on the reduced capital gains rates and instead pay as much as 37% (plus state) on their gain – they need to know the spread. This can then be used to negotiate a higher selling price.
Which is best for an owner and their company? As with everything with tax – it depends – and not just on the tax answer. There are any number of other factors that can outweigh the cost or benefit of the tax answer. The important thing, though, is to know that tax answer, so an informed decision can be made.
Stay tuned and make sure you’re subscribed to our Tax Insights, as the topic of our next article will be alternatives to asset and 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 Services page.
