Tax Implications of a Merger or Acquisition
Written by: Flynn & Company
During the intricate merger or acquisition process, it's easy to forget that you control many of the tax implications of this deal. You can improve their favorability toward your business and significantly impact your financial future. Understanding these tax considerations early in the process—or potentially before you get an offer or find the perfect company to buy—is crucial.
At Flynn & Company, our team of experienced CPAs guides you through the complexities of M&A taxation with experts in
Merger and Acquisition Advisory services, ensuring you're well-prepared, informed, and confident in your M&A decisions. This article explores the tax consequences and strategies you should consider when merging or acquiring another business.
Key Takeaways
- Effective tax planning can significantly reduce liabilities and enhance the value of a merger or acquisition.
- Understanding the tax implications for buying and selling entities can guide strategic decision-making.
- Choosing the right M&A structure is crucial for tax efficiency.
M&A Tax Implications
The implications of a merger or acquisition can vary widely depending on the transaction's structure. Whether your unique situation involves asset or stock purchases or merging of operations, each scenario has its own considerations.
When purchasing an asset, you can step up the basis, potentially leading to greater depreciation on this year's taxes. On the other hand, if you're selling, much of the tax gain arises from the depreciation of the assets sold. The longer a business holds onto an asset, the less tax basis it has, and therefore more gain must be recognized. This is particularly significant if you've built up the business from nothing, resulting in a high business valuation.
Types of M&A Structures
The structure you choose can influence tax outcomes and is your first method to manage the tax implications of a merger or acquisition. You have three basic types:
- Asset Purchase: Buyers typically prefer asset purchases to obtain a step-up in basis, which provides tax advantages.
- Stock Purchase: Sellers often favor stock purchases to benefit from capital gains treatment on the sale.
- Mergers: Mergers can be structured as tax-free reorganizations, provided they meet specific IRS criteria, allowing both parties to potentially defer tax liabilities.
Tax Strategies When Selling Your Business
Key strategies when selling a business include:
1. Timing the Sale
This strategy aligns the sale with the fiscal calendar. Selling at the end of the fiscal year might defer tax liabilities, providing liquidity benefits. While it might not reduce your tax bill overall because it's just spread across this year and the next, it does give you access to the sale proceeds longer. You can invest those proceeds and potentially grow that money, in some cases negating the taxes you'll need to pay the following year.
2. Structuring the Deal
Opting for a stock sale may offer lower tax rates on gains, especially under capital gains tax regimes.
3. Utilizing Losses
If your business has net operating losses, they can be used to offset gains realized from the sale, reducing the overall tax burden.
4. Seeking Expert Advice
Consulting with M&A tax professionals can provide customized strategies that consider both current tax laws and future implications.
5. Knowing What Your Business Is Really Worth
It goes without saying that you can only get what your business is worth if you know its true value, so it's critical to understand how to Increase the Value of Your Business both objectively and in the eyes of the buyer. You need to know the Key Factors That Impact a Business Valuation. Ultimately, if you pay more taxes because you get a better price for the company you've built, you're winning as a business seller.
Tax Consequences of Buying A Business
Key strategies and considerations for buyers include:
1. Asset Purchase Tax Consequences
Asset purchases are often favorable for the buyer because they can acquire assets without assuming additional liabilities. In an asset purchase, you can step up the basis to take larger depreciation and selectively choose which assets to acquire, thereby limiting the liabilities you take on. However, if there are preexisting contracts or other agreements associated with the sold assets, this can add complexity to the transaction. Additionally, it's important to note that this can result in higher taxes for the seller, so bringing something to the negotiating table to balance this fact is crucial.
2. Stock Purchase Tax Considerations
Stock purchases are easier than asset purchases, and the seller benefits from capital gains rates instead of regular tax rates, which can be advantageous during negotiations. In a stock sale, the seller's gain is entirely capital, unlike an asset sale where the gain is a mix of ordinary and capital. Stock purchases also improve the continuity of business operations, which can be important for retaining the trust of your "new" customers.
However, you inherit all liabilities with a stock purchase, including unknown ones, and you can't step up the basis. Additionally, your transaction may face increased scrutiny from regulators and shareholders.
3. Purchase Price Allocation
In the purchase agreement, you can choose how the purchase price is allocated to maximize your tax benefits. This strategy leads to a range of considerations to reduce your tax bill now or deliver ongoing tax advantages. Here are some highlights:
Consider the useful life of assets and allocate a higher portion of the purchase price to tangibles (equipment, buildings) and/or intangibles (patents, goodwill, etc.) based on maximizing depreciation and amortization over their useful lives. It's important to note that each business's tax situation and goals are different.
For example, goodwill has a longer amortization period and is often of great value to the buyer. Allocating more to goodwill can provide prolonged tax benefits.
Conversely, if the buyer is expecting an unusually high-profit year, it might be better to allocate more to assets with shorter depreciation periods to maximize depreciation in the purchase year rather than spreading it out over a longer period.
4. Due Diligence
While not a tax strategy per se, due diligence is critical to avoiding hidden tax liabilities and ensuring you don't miss out on tax benefits you qualify for. Make it a part of your buying plan. This can include requesting audited/reviewed financial statements and prior year tax returns.
Additional Considerations for Both Buyers and Sellers
Whether you're a US-based seller or buyer, international transactions carry additional complexity and potential tax implications that vary by country. You'll want to be very careful here. Consult international tax professionals to ensure you fully understand regulations and taxes.
Back home, state and local taxes (SALT) can also come into play. For example, if you are in Chicago and planning to merge with a business in San Diego, you need to understand how this impacts taxes for both locations.
Finally, it is important to stay current with tax changes that may be on the horizon or going into effect soon. This may influence the timing of your merger or acquisition and change your tax planning strategy.
Bottom Line
Navigating mergers and acquisitions requires detailed planning, and having expert guidance certainly doesn't hurt. We have explored many common tax implications but can only scratch the surface without looking at your unique buying, selling, or merging situation. At Flynn & Company, our team of experienced CPAs, including expert interstate and international tax professionals, is equipped to provide the expertise and support needed to guide you through these complex processes. To learn more about our M&A services, we encourage you to reach out to discuss them.
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